REPORT FROM THE COMMISSION TO THE EUROPEAN PARLIAMENT AND THE COUNCIL under Article 85(2) of Regulation (EU) No 648/2012 of the European Parliament and of the Council of 4 July 2012 on OTC derivatives, central counterparties and trade repositories, as amended by Regulation (EU) No 834/2019, assessing whether viable technical solutions have been developed for the transfer by pension scheme arrangements of cash and non-cash collateral as variation margins and the need for any measures to facilitate those viable technical solutions
Date: 2020-09-23
Institutions: Directorate-General for Financial Stability, Financial Services and Capital Markets Union, European Commission
Subjects: financial derivative, financial legislation, financial risk, financial supervision, financial transaction, pension fund, pension scheme, technical standard

EN 

  EN 

   EUROPEAN COMMISSION  Brussels, 23.9.2020  COM(2020) 574 final  REPORT FROM THE COMMISSION TO THE EUROPEAN PARLIAMENT AND THE COUNCIL under Article 85(2) of Regulation (EU) No 648/2012 of the European Parliament and of the Council of 4 July 2012 on OTC derivatives, central counterparties and trade repositories, as amended by Regulation (EU) No 834/2019, assessing whether viable technical solutions have been developed for the transfer by pension scheme arrangements of cash and non-cash collateral as variation margins and the need for any measures to facilitate those viable technical solutions  
 
 
REPORT FROM THE COMMISSION TO THE EUROPEAN PARLIAMENT AND 
THE COUNCIL 

under Article 85(2) of Regulation (EU) No 648/2012 of the European Parliament and of 
the Council of 4 July 2012 on OTC derivatives, central counterparties and trade 
repositories, as amended by Regulation (EU) No 834/2019, assessing whether viable 
technical solutions have been developed for the transfer by pension scheme 
arrangements of cash and non-cash collateral as variation margins and the need for any 
measures to facilitate those viable technical solutions 

1. 

INTRODUCTION 

The European Market Infrastructures Regulation (EMIR)1, which introduced in the EU 
in  2012  the  G20  reforms  on  over-the-counter  (OTC)  derivative  contracts,  granted  a 
temporary exemption from the central clearing obligation to entities operating pension 
scheme arrangements (PSAs), in relation to certain types of OTC derivatives2.  

Under  the  Regulation,  PSAs  include  Institutions  for  Occupational  Retirement 
Provisions  (IORPs)  as  defined  under  Art.  6(a)  of  Directive  2003/41/EC,  the 
occupational  retirement  provision  businesses  of  institutions  under  Art.  3  of  that 
Directive, the occupational retirement provision of insurance undertakings covered by 
Directive  2002/83/EC  (provided  that  the  assets  and  liabilities  associated  with  such  a 
business are segregated from the other activities of the insurance undertaking), as well 
as  any  other  authorised  and  supervised  entity  or  arrangement  operating  on  a  national 
basis whose primary purpose is to provide retirement benefits.  

The temporary exemption was granted in order to take into account the specific features 
of the business model of such entities and the impact mandatory clearing could have on 
pensions:  as  recalled  in  Recital  26  EMIR,  entities  operating  pension  scheme 
arrangements  “typically  minimise  their  allocation  to  cash  in  order  to  maximise  the 
efficiency and the return for their policy holders. Hence, requiring such entities to clear 
OTC derivative contracts  centrally would lead to divesting a significant  proportion of 
their  assets  for  cash  in  order  for  them  to  meet  the  ongoing  margin  requirements  of 
CCPs”. Clearing OTC derivatives centrally requires adequate amounts of cash available 
in  order  to  meet  the  margin  requirements  of  central  counterparties  (CCPs).  As  the 
EMIR framework recognises, holding large amounts of cash in order to meet potential 
variation margin calls could impact negatively the retirement income of pensioners.  

An  independent  study  provided  to  the  Commission  by  the  Europe  Economics  and 
Bourse  Consult  in  2014  estimated  the  potential  variation  margin  EU  pension  funds 
could be required to pay in the event of a 1% shift in rates. While the study still covered 

1  
2  

Regulation (EU) No. 648/2012. 
The  exemption  concerns  OTC  derivative  contracts  which  are  objectively  measurable  as  reducing 
investment  risks  that  directly  relate  to  the  financial  solvency  of  pension  scheme  arrangements  and  to 
entities established to provide compensation to members of such arrangements in case of default, and PSAs 
which encounter difficulties in meeting the variation margin requirements (Art. 89 EMIR).  

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the UK, the results excluding the UK showed that such an amount would range between 
106 and 133 billion euros, further increasing in more stressed scenarios.  

More  recently,  further  studies  were  carried  out  by  the  Eurosystem3  and  the  Danish 
central  bank4.  Such  studies  suggest  that  the  potential  variation  margin  of  Dutch  and 
Danish pension funds – which account for around 52% of EU pension funds’ financial 
assets (excluding the UK)5 – under the same stress scenario (1% shift in rates) would be 
below EUR 53 billion and DKK 106 billion (or around EUR 14 billion) respectively, 
hence  somewhat  lower  than  the  corresponding  figures6  of  the  aforementioned 
independent study. On the basis of available cash balances, the aggregate cash shortfall 
could amount up to 17 billion euros for all euro area pension funds. 7 

Similar moves in rates, costs and risks would not be specific to PSAs only, but would 
impact  other  financial  firms  which  clear  centrally  as  well  (e.g.  investment  funds, 
insurance companies), and risks of default for lack of eligible collateral can arise also in 
the  case  of  bilateral  derivatives  trading,  not  only  in  the  central  clearing  world. 
However, as ESMA recognises in its first report on this topic, PSAs seem to be more 
constricted  in  their  capacity  to  mitigate  these  risks  through  flexibility  in  investment 
strategies,  availability  of  investments  matching  their  liabilities,  access  to  sources  of 
liquidity, as discussed in the following sections.  

The  temporary  exemption  was  intended  to  provide  the  time  needed  in  order  to  find  a 
suitable technical  solution, which would allow PSAs to  clear  centrally  at CCPs while 
avoiding  materially  adverse  effects  on  pensioners’  income.  Within  the  EMIR 
framework, the OTC derivative business of PSAs is already subject – under the relevant 
thresholds  -  to  the  operational  risk  mitigation  and  margin  requirements  for  uncleared 
OTC trades set out in Article 11, which started applying in 2017 according to a phase-
in8:  these  requirements  aim  at  addressing  the  risks  related  to  non-centrally  cleared 
derivatives, while also providing incentives to clearing centrally. PSAs are also subject 
to the EMIR reporting obligations. 

Although  discussions  with  PSAs  and  other  stakeholders  confirm  that  PSAs  want  to 
clear trades at CCPs, and indeed already do so in certain cases, mandatory clearing has 
continued  to  pose  challenges.  The  central  clearing  exemption  has  therefore  been 
extended over the years, since no viable technical solution had emerged. EMIR Refit, 

3  

7  

8  

European Central Bank, Financial Stability Review, May 2020. Estimates for Dutch pension funds are in 
the range of 36 to 47 billion euros; given that Dutch pension funds hold around 89% of interest rate swaps 
of euro area pension funds, the margin call on all euro area pension funds is estimated to range between 
40-53 billion euros. 

4   Danmarks  Nationalbank,  “Pension  companies  will  have  large  liquidity  needs  if  interest  rates  rise”, 

November 2019. 

5   According to Euro Area Accounts at the end of 2019. 
6  

The  corresponding  figures  amounted  to  approximately  60  and  27  billion  euros  for  Dutch  and  Danish 
pension funds respectively. 
Estimates for the cash shortfall of Dutch pension funds are in the range of 6 to 15 billion euros. Given that 
Dutch pension funds hold around 89% of interest rate swaps of euro area pension funds, the cash shortfall 
on all euro area pension funds could be up to 17 billion euros. 
Commission Delegated Regulation (EU) No. 2016/2251. 

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entered into force in June 2019, extends the exemption until June 2021, with a further 
potential  extension  through  Commission  delegated  acts  twice,  each  time  by  one  year 
maximum.  The  ultimate  aim  of  the  Regulation,  however,  remains  central  clearing  for 
PSAs as soon as possible, considering that current regulatory and market developments 
should enable market participants to develop appropriate solutions (EMIR, Recital 30). 
CCPs, clearing members and PSAs are required to make their best efforts to contribute 
to the development of such solutions.  

Article 85 of EMIR Refit  requires  the Commission to  prepare  yearly reports  until  the 
final  extension  of  the  exemption,  assessing  “whether  viable  technical  solutions  have 
been developed for the transfer by pension scheme arrangements of cash and non-cash 
collateral as variation margins and the need for any measures to facilitate those viable 
technical solutions”.  

The Regulation also establishes that ESMA, in cooperation with EBA, EIOPA and the 
ESRB,  shall  submit  annual  reports  to  the  Commission  assessing  the  issue.  The  first 
report  by  ESMA  was  received  by  the  Commission  in  April  2020.  Together  with  the 
report,  ESMA  launched  a  public  consultation  in  order  to  gather  further  input  from 
stakeholders  and  submit  a  second,  more  comprehensive  report  to  the  Commission  by 
December 2020. ESMA's comprehensive report is therefore not available in time to be 
incorporated into this report from the European Commission.  

EMIR  Refit  also  mandated  the  Commission  to  set  up  an  expert  group  including 
representatives of the relevant stakeholders, so as to monitor their efforts and assess the 
progress  made  towards  finding  viable  technical  solutions.  The  expert  group,  which 
continues  the  work  of  its  predecessor  (Commission  High  Level  Group  on  Pension 
Funds)  includes  representatives  of  CCPs,  clearing  members,  PSAs,  central  banks  and 
other  relevant  stakeholders;  it  met  twice,  in  October  2019  and  in  April  2020  (via 
conference  call)  and  will  continue  meeting  every  six  months.  The  Commission 
continues to build on the group's work for its reports to the co-legislators.  

2. 

PURPOSE OF THE REPORT 

With this Report the Commission fulfils its obligation under Article 85 of EMIR.  

This Report duly takes into account the first report by ESMA, as well as the discussions 
which  took  place  within  the  expert  group.  As  explained,  the  results  of  the  public 
consultation  launched  by  ESMA  will  feed  into  the  second  Commission  report,  to  be 
issued next year. 

This Report provides an analysis of the main issues identified by stakeholders around 
PSAs’ central clearing, as well as of the solutions explored thus far. As mentioned, the 
PSA  exemption  from  central  clearing  is  in  force  until  June  2021:  in  view  of  that 
deadline, this report aims at updating the European Parliament and the Council as to the 
progress made in this field, also in view of identifying the aspects to be explored further 
in order to favour a feasible and sustainable central clearing solution. 

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3.  MAIN ISSUES IDENTIFIED 

3.1  Background on PSAs’ business model and use of derivatives 

European  PSAs,  especially  in  some  Member  States  such  as  the  Netherlands  and 
Denmark,  are  active  participants  in  the  OTC  derivatives  market.  They  use  such 
derivatives to hedge their liabilities from a number of risks, including interest rate and 
inflation  volatility,  and  ultimately  protect  themselves  from  financial  solvency  risks. 
Pension  funds’  liabilities  towards  current  and  future  pensioners  have  long  maturities, 
which need to be matched with long-term assets; such assets are typically government 
and  corporate  bonds;  however,  fully  hedging  liabilities  with  bonds  does  not  seem 
feasible  for  EU  PSAs,  given  the  limited  availability  of  bonds  with  the  appropriate 
characteristics;  in  addition,  derivatives  can  offer  a  better  match  for  PSAs’  liabilities 
because  swaps  are  often  used  to  discount  such  liabilities  for  valuation  purposes.  As 
reported by ESMA, the situation of EU PSAs in this regard is different from that of US 
pension funds, which rely more on long-dated assets such as corporate and government 
bonds  for  hedging  purposes:  US  pension  funds  tend  to  have  a  shorter  duration  of 
liabilities  relative  to  EU  PSAs,  their  liabilities  are  typically  discounted  using  AA-
corporate bond yields, and the US corporate bond market is deeper. As such, as ESMA 
recognises, PSAs seem to have a structural need for engaging in OTC derivatives. 

The derivatives portfolio of PSAs is typically large, long-dated and unidirectional, with 
the  aggregate  position  of  the  industry  representing,  according  to  ESMA,  a  potential 
systemic risk.  

As  to  the  types  of  derivatives,  PSAs  are  extensive  users  of  long-term  interest  rate 
swaps:  according  to  2015  EMIR  data  from  DTCC,  about  20%  of  interest  rate  swaps 
with at least one counterparty as an insurer or a pension fund in the EU had a maturity 
of 30 years, compared to a global average of less than 10%9. Interest rate swaps are the 
class  of  derivatives  subject  to  the  clearing  obligation  under  EMIR.  PSAs  trade  their 
derivatives  bilaterally,  or  clear  centrally  at  CCPs  generally  as  clients  of  clearing 
members. 

It is worth noting that pension schemes and markets are rather diverse across the EU: in 
some Member States second pillar pension systems are more developed than in others, 
and  defined-benefit  pension  funds  are  more  widespread;  in  others,  the  defined-
contribution model is prevalent. The largest PSAs markets in the EU are to be found in 
the Netherlands, with an average ratio of assets to GDP of 173.3%, and Denmark, with 
a  ratio  of  198.6%,  according  to  end-2018  data.  Ireland  also  has  similar  schemes  in 
place.  In such countries, private pension schemes play an important  role in  providing 
retirement income to pensioners.  

3.2   The issue with PSAs’ central clearing 

9 European Systemic Risk Board, Occasional Paper Series 11, 2016. 

4 

 
 
 
                                                           
The main issue identified with regard to PSAs’ central clearing concerns the fact that 
clearing at CCPs requires posting variation margin in cash; the discussions held in the 
Commission stakeholder group have shown that this is problematic for PSAs in case of 
stressed market conditions. 

In the central clearing model, CCPs ask variation margin to their participants, so as to 
compensate  for  the  changes  in  the  market  value  of  the  derivative  positions  they 
manage.  In  this  way,  CCPs  are  always  covered  from  market  movements  and  market 
participants do not build-up large losses over time in relation to their centrally cleared 
portfolio. Losses and gains are calculated by the CCP and exchanged daily through the 
marking-to-market  process.  Cash  can  best  serve  the  purpose  of  variation  margining, 
because  it  minimises  any  risk  of  value  losses  and  its  transfer  is  final.  Passing  though 
cash as variation margin is also operationally less complex and is compatible with the 
approach to CCP liquidity risk management set out under EMIR10.  

This means that clearing participants have to be able to cope with such requests through 
appropriate amounts of cash: if this is not the case, and a clearing member cannot post 
the required variation margin in due time, it is declared in default by the CCP, which 
then triggers its default procedures in order to re-match the book. Moreover, variation 
margin  needs  to  be  posted  to  CCPs  in  a  short  timeframe,  raising  further  operational 
difficulties11. 

Cash  has  a  high  opportunity  cost,  as  it  is  not  as  profitable  as  other  assets  and  is  not 
adequate  to  balance  the  maturities  of  PSAs’  liabilities,  thus  exposing  them  to  asset-
liability  mismatches.  Holding  large  amounts  of  cash  instead  of  other  higher-yielding 
assets would contribute to decreasing the returns for pensioners and impact PSAs’ asset 
allocation, and indeed pension funds typically do not hold a lot of cash, as it is shown 
also in the annual global pension statistics published by the OECD. 

The issue of cash variation margin can prove challenging especially in times of stressed 
market  conditions,  in  conjunction  with  increasing  interest  rate  levels,  when  variation 
margin requests by CCPs could increase significantly for PSAs.  

Indeed,  large  variation  margin  calls  can  occur  also  in  the  context  of  non-centrally 
cleared trades, in which PSAs currently participate. However, in that context PSAs can 
post  variation  margin  also  in  other  forms  than  cash,  for  instance  using  high-quality 
government bonds (an asset pension funds are typically rich of) - even if the extent to 
which PSAs are requested to post variation margin in cash also in their bilateral trades 
may have increased recently.  

It  is  to  be  noted  that  the  rationale  of  the  EMIR  regulatory  framework  is  such  as  to 
promote central clearing also by making bilateral trades less convenient, in line with the 

10   Also,  cash  variation  margin  allows  CCPs  to  remain  certain  of  their  ability  to  value  their  transactions 
correctly and is the market convention for cleared swaps adopted by all market participants of the cleared 
swaps market. 

11   For intraday margin calls some CCPs allow participants to use securities instead of cash; however, end-of-

day margin calls have to be met with cash. 

5 

 
 
                                                           
associated  risks:  this  and  other  regulatory  developments,  together  with  market  forces, 
are  expected  to  lead  to  increasing  volumes  of  centrally-cleared  derivatives,  with 
potentially  better  pricing  in  the  cleared  segment  relative  to  the  non-centrally  cleared 
one. Indeed, as mentioned, some pension funds have already started clearing centrally 
on a voluntary and select basis. 

It  is  to  be  noted  that  generally  PSAs  are  more  likely  to  clear  indirectly  as  clients  of 
clearing  members  than  to  become  direct  clearing  members  of  a  CCP,  as  further 
discussed in the following sections.  

The  above  provides  the  background  for  the  characteristics  that  a  potential  solution  to 
the central  clearing issue should have:  it should be such as to  strike the  right  balance 
between the objective of financial stability and the need to be viable for PSAs in terms 
of cost, so as not to excessively impact the benefits of retirees and it should be robust 
enough also under stressed market conditions. 

3.3   Potential solutions explored so far 

The  debate  over  PSAs  central  clearing  has  led  to  explore  different  avenues  over  the 
years.  An  outline  of  some  potential  solutions  was  included  in  the  report  the 
Commission  delivered  under  EMIR  in  2015  on  this  issue,  which  concluded  that  no 
viable technical solution had been developed. 

The options explored so far have focussed on how PSAs could post variation margins 
to  CCPs  in  a  safe  and  cost-effective  way.  In  a  first  stage,  as  described  in  the  2015 
Commission report, it was considered whether CCPs could accept variation margin in 
other  forms  than  cash,  such  as  high-quality  government  bonds:  however,  it  has  been 
generally recognised that such an avenue would be difficult to pursue, because it would 
require CCPs to manage a portfolio of bonds to be converted into cash with the related 
risks, which could lead to a distortion of their role as pass-through running a flat book.  

A second range of options is  thus being explored, under which PSAs could  exchange 
their bonds with cash in order to meet CCPs’ margin calls (collateral transformation). 
Potential solutions explored and developed over the last years by industry stakeholders 
have focussed indeed on ways to allow efficient collateral transformation by PSAs.  

Collateral transformation by clearing members 

Clearing  members  such  as  banks  can  typically  provide  to  their  clients,  including 
pension funds, collateral transformation services12, by means of repos. Indeed, most of 
the PSAs which engage in central clearing do so as clients of clearing members today, 
and may continue doing so even under mandatory clearing. A repo transaction is one in 
which a party sells an asset to another party and commits to repurchase the asset at an 
agreed  price  at  a  future  date.  The  asset  is  typically  a  bond  and  serves  as  collateral  to 
insure  the  cash  lender  against  counterparty  credit  risk.  Repos  can  thus  be  used  as  a 

12   Such  a  service  could  also  be  provided  to  pension  funds  by  other  banks,  different  from  their  clearing 

member. 

6 

 
 
                                                           
means for transforming bonds into cash and post variation margins, with the additional 
advantage that the provider of the bonds retains ownership of the bonds themselves and 
continues getting the returns in the longer term.  

Large  banking  groups  are  typically  active  in  the  repo  market.  However,  some  factors 
have  been  raised  as  disincentivising  clearing  members  from  engaging  in  such 
transactions.  As  raised  by  many  market  participants,  the  construction  of  the  leverage 
ratio under the Basel III framework made it less convenient to engage in repos, because 
such  transactions  have  low  margins  and  expand  banks’  balance  sheets,  thus 
contributing to increasing the denominator of the ratio. As such, banks need to have a 
larger  amount  of  Tier  1  capital  to  respect  the  requirement.  Similar  considerations  are 
developed  by  the  Committee  on  the  Global  Financial  System’s  2017  analysis  of  repo 
markets13, which pointed to the possible trade-off between regulatory reforms focussing 
on  the  size  of  banks’  balance  sheets  (aimed  at  limiting  excessive  leverage)  and  the 
consequences,  including  for  end  users,  in  terms  of  repo  availability14.  In  this  regard, 
repo market volumes in the EU have nonetheless been increasing in recent years15 and 
according to the ECB’s analysis unintended consequences of regulatory reforms on the 
provision of repo services by euro area banks have not been material16. 

In addition, the way the leverage ratio was originally conceived made it less convenient 
for banks to  provide client  clearing services, because margins  posted by  clients  could 
not  be  used  to  offset  the  amount  of  the  exposure  (which  would  feed  into  the 
denominator  of  the  ratio).  In  2019  the  Basel  Committee17  proposed  to  introduce 
changes  in  the  calculation  of  the  leverage  ratio,  so  that  client  clearing  would  not  be 
unduly  penalised.  These  changes  were  reflected  in  the  revised  Capital  Requirements 
Regulation (CRR2), which entered into force in June last year.  

An  amendment  to  the  leverage  ratio  was  also  introduced  concerning  the  treatment  of 
reverse repos. These changes may contribute to encouraging banks to engage in client 
clearing and possibly in repo intermediation, thus also supporting repo market liquidity. 
The impact of such changes will have to be assessed.  

In addition, concerns have been raised as to the capacity of the repo markets to meet the 
cash demand of all PSAs together, especially in times of stress, as discussed in greater 
detail below.  

Collateral transformation through cleared repo markets 

13   CGFS, “Repo market functioning”, 2017. 
14  

“A contraction in intermediation capacity may also reduce the degree to which repo markets can respond to 
demand  during  future  periods  of  stress.  A  reduction  in  repo  market  functioning  might  create  frictions  in 
cash and derivatives markets, and reduce the ability of financial institutions to monetise assets. The scale 
of  the  resulting  costs  to  financial  stability  and  the  real  economy  in  times  of  stress  might  be  significant 
altogether,  although  such  situations  have  not  materialised  on  a  substantial  scale  in  the  most  recent  past. 
Repo market adaptations might mitigate the costs to some end users, but could also introduce new risks”. 
ICMA, December 2019 European Repo Market Survey. 

15  
16   ECB, Financial Stability Review, 2017. 
17   Basel Committee on Banking Supervision, “Leverage ratio treatment of client cleared derivatives”, 2019. 

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In  recent  years,  some  CCPs  have  developed  new  models  to  support  PSAs  central 
clearing based on facilitating access by PSAs to CCPs and to the cleared repo markets; 
this  may  also  involve  access  to  the  cleared  OTC  market.  These  models  have  been 
developed  in  the  European  Union  by  at  least  one  CCP  and  to  the  Commission 
knowledge  similar  models  are  likely  to  be  adopted  also  by  other  CCPs18.  In  this 
framework, PSAs have a direct contractual relationship with the CCP and are “assisted” 
(or  otherwise  “sponsored”)  by  a  clearing  member  (typically,  a  bank)  which  acts  as  a 
clearing agent and facilitates PSAs’ central clearing, for instance by contributing to the 
CCP’s default fund and engaging in default management and other services (collateral 
management etc.). 

These  models  do  not  eliminate  per  se  the  need  to  post  variation  margin  in  cash  for 
cleared OTC derivatives, however they do provide PSAs with additional access to repo 
markets. Such “facilitated membership” models would also aim at alleviating some of 
the limitations of client clearing, such as the concentration of client clearing in the EU 
at just a few clearing members or the issue of portability of clients’ positions in the case 
of default of a clearing member. From the point of view of banks, such models should 
prove  less  demanding  in  terms  of  capital  requirements  than  traditional  client  clearing 
activities.  

To the Commission best knowledge, such a model has been developing overtime with 
somewhat  increasing  appetite  from  the  market,  however  only  a  few  PSAs  –  typically 
large ones  - have started using such  a service so far. One obvious reason may be  the 
fact that having a direct relationship with a CCP may require additional operational and 
legal  preparedness  and  investment  by  market  participants,  both  PSAs  and  clearing 
members.  Moreover,  the  pension  funds  participating  in  the  Commission  stakeholder 
group  reported  that  such  models  are  generally  available  only  to  large  PSAs,  only  a 
small  number  of  banks  currently  support  them,  and  still  imply  reliance  by  PSAs  on 
clearing member’s willingness to provide the related services. 

According  to  a  joint  paper  by  the  International  Swaps  and  Derivatives  Association 
(ISDA) and Pensions Europe of 201819, direct membership or “facilitated” membership 
models  are  looked  at  with  interest  by  the  market,  also  because  they  may  be  more 
interesting  for  banks  than  the  traditional  client  clearing  relationships.  Full  direct 
membership appears to be challenging for a number of reasons (including the need to 
meet  CCPs’  participation  requirements  and  default  fund  contributions,  as  well  as  to 
have  operational  capability);  facilitated  access  models  may  be  a  way  to  get  closer  to 
that.  According  to  the  pension  funds  participating  in  the  Commission  stakeholder 
group, some further improvements would still be required. 

Discussion on the repo market 

18   Outside  the  EU,  based  on  the  information  available  to  the  Commission,  LCH  Ltd  (UK),  Canadian 
Derivatives  Clearing  Corporation  (Canada)  and  the  DTCC  FICC  (US)  have  established  buy-side  repo 
clearing offerings. 

19   Pensions Europe and ISDA joint paper “Potential demand for clearing by EU Pension Funds”, 2018. 

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The repo market is generally seen by PSAs as a useful tool for their liquidity needs, and 
in  the  discussions  of  the  expert  group  set  up  by  the  European  Commission  it  has 
generally  been  described  as  a  potential  piece  of  the  overall  solution  to  the  variation 
margin issue.  

However,  industry  concerns  remain  as  to  the  capacity  of  repo  markets  to  meet  the 
overall demand for cash stemming from all PSAs having to clear under stressed market 
conditions, when repo markets are likely to be under pressure to absorb large liquidity 
demand – not only from PSAs. Moreover, banks may not always be willing to provide 
repos to PSAs, or to the same extent, in times of stress. As ESMA points out, a number 
of  these  and  other  aspects  also  have  to  do  with  the  overall  commercial  relationship 
between  banks  and  their  PSA  clients.  If  PSAs  are  not  in  a  position  to  use  the  repo 
market under stress conditions, they may be unable to meet the margin calls of CCPs 
and  even  be  at  the  source  of  broader  financial  stability  issues.  In  this  regard,  the 
possibility  to  establish  a  diversified  set  of  liquidity  arrangements  between  banks  and 
PSAs could prove helpful. 

Cleared repo markets should have the advantage of being more liquid than the bilateral 
markets,  as  banks  are  in  principle  more  willing  to  trade  cleared  repos  rather  than 
bilateral repos – not least because they can net their positions with the CCP. According 
to  the  CGFS  (2017),  in  the  Euro  Area  “the  share  of  repo  market  trading  via  CCPs 
increased  over  the  past  years,  accounting  for  50-60%  of  the  euro  area  repo  market 
volumes,  owing  to  their  attractiveness  for  the  balance  sheet  management”.  Efforts 
developed by some CCPs to allow for direct participation of end users to their cleared 
repo platforms have to  be put  also  in this perspective. PSAs reported that  the cleared 
repo market can offer additional repo capacity relative to bilateral repos, but also have 
the limitations mentioned above.  

An  overview  of  the  functioning  of  the  European  repo  markets  is  provided  by  the 
International  Capital  Markets  Association  (ICMA),  which  in  its  2019  Repo  Market 
Survey estimates the overall size of the market  at 8,310 billion euros20. The 2018 and 
2019 European Repo Market Surveys by ICMA confirm that the European repo market 
is  seen  as  generally  functioning  well,  thus  potentially  being  a  channel  for  collateral 
transformation; however, repo markets are less liquid at quarter-end and year-end, due 
to  banks  tending  to  close  down  their  repo  positions  when  approaching  reporting 
deadlines. The range of such regular shrinks has been decreasing in recent years and is 
expected to decrease further in the future, also thanks to implementation in the EU of 
BCBS recent recommendations aimed at reducing quarter-end and year-end volatility. 

ICMA also provides analysis21 of the most recent developments occurred in the market 
during the Covid-19 crisis. According to this survey, the European repo market for the 
most part held up well during the Covid-19 pandemic starting from end-February/early-
March 2020. Repo market activity increased over the first two weeks of March, due to 

20   Based  on  the  value  of  the  repo  and  reverse  repo  contracts  outstanding  on  the  books  of  the  58  financial 

institutions participating in the Survey. 
ICMA, “The European repo market and the Covid-19 crisis”, April 2020.  

21  

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increased  collateral  transformation  requests  to  meet  margin  calls  and  to  flows  out  of 
riskier  assets  towards  short-term  assets.  However,  clients  reported  that  banks  hardly 
coped  with  the  increasing  demand  for  repos  and  some  started  serving  only  top-tier 
clients.  According  to  the  survey,  “While  the  demand  to  access  the  repo  market 
increased during the height of the crisis, banks’ capacity to intermediate that access did 
not.  Buy-side  participants  report  an  increased  reliance  on  the  repo  market  as  fund 
outflows drove the need to  generate cash against holdings,  as well as  to  meet  margin 
calls against derivatives positions as volatility increased. However, it would seem that 
banks struggled to keep pace with client demand. Many report limiting business to top 
tier clients, with no capacity for new business. Banks further report that in light of the 
heightened  volatility,  it  was  more  a  case  of  RWA  (risk  weighted  assets)  limits 
becoming  the  binding  constraint  on  business,  rather  than  the  Leverage  Ratio, 
particularly for one-directional business flows (such as net borrowers of cash).”  

Reportedly, central bank interventions eased such tensions, by freeing up banks’ credit 
lines and reversing the sell-off of risk assets. 

Market  developments  during  the  Covid-19  crisis  have  been  discussed  also  in  the 
context  of  the  Commission  stakeholder  group.  CCPs  reported  continued  smooth 
performance of cleared repo markets during the crisis, with high volumes of activity. In 
their  recollection,  access  was  not  constrained  for  buy-side  firms  participating  in  the 
cleared  repo  market.  Overall  resilience  of  market  infrastructure  was  also  highlighted, 
including when it comes to the margin models, thus contributing to the predictability of 
margin requests to participants. Pension scheme arrangements reported suffering from 
the  considerable  market  volatility,  with  large  margin  calls  from  bilateral  counterparts 
and from clearing members to clients. They reported being just able to cope with such a 
situation,  but  if  markets  had  performed  worse,  they  would  have  faced  very  serious 
difficulties.  They  also  confirmed  that  banks  were  reluctant  to  engage  in  repo 
intermediation and that they struggled to get access to clearing member banks’ balance 
sheet to access repo markets. As a consequence, PSAs feel that the repo market cannot 
be  relied  upon  in  all  market  conditions;  PSAs  often  heavily  depend  on  banks  for 
accessing it, and banks have limited repo lines for their clients in times of stress. 

In light of the difficulties with repo markets in times of stress, market participants have 
often raised the issue of the need for a central bank liquidity backstop in times of stress. 
According to market participants, this backstop role of central banks could be designed 
as central banks providing liquidity to a regulated entity which would then provide it to 
the  PSAs:  such  an  entity  could  be  banks  or  CCPs.  After  receiving  the  liquidity  from 
banks or CCPs, the PSAs would be able to meet the cash variation margin calls.  

It  is  to  be  noted  that,  given  that  central  banks  are  exclusively  competent  for  the 
establishment  of  central  bank  facilities  and  for  the  interpretation  of  their  intended 
usage, any option based on a central bank liquidity backstop would need to be endorsed 
and supported by the central banks.  

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The  ECB  provided  its  perspective  on  the  issue.  As  regards  banks,  of  course  they  are 
monetary policy counterparties and are authorised to provide collateral transformation 
services subject to the relevant banking regulation. Therefore, they are in a position to 
intermediate  in  the  repo  market,  including  on  the  basis  of  their  use  of  central  bank 
facilities.  

According to the ECB, however, the central bank backstop role does not appear to be 
straightforward,  or  may  even  not  be  feasible  for  CCPs,  even  when  the  latter  have  a 
banking  license:  taking  up  collateral  transformation  services  by  CCPs  seems  to  be 
outside  of  their  core  business,  hence  it  may  raise  concerns  in  relation  to  risk 
consequences.  Further,  according  to  the  ECB,  should  CCPs  take  up  collateral 
transformation  on  the  basis  of  their  additional  banking  license  (if  allowed),  current 
exemptions  granted  to  them  from  certain  prudential  banking  requirements  on  the 
ground  that  CCPs  do  not  engage  in  typical  banking  activities  and  have  a  different 
business  model  do  not  seem  to  be  reasonable  anymore.  Therefore,  further  analysis 
would  be  needed  to  ascertain  the  legal  nature,  CCP  risk  management  impact  and 
regulatory  compliance  of  any  such  arrangements.  First  reactions  by  some  CCPs  have 
also shown some scepticism. 

As regards the need for a potential “dedicated” central  bank backstop for PSAs (with 
PSAs  becoming  counterparties  to  central  banks  and  receiving  liquidity  from  them 
directly), the ECB contributed to the debate of the Commission stakeholder group from 
the  perspective  of  the  Eurosystem,  i.e.  focussing  on  the  euro-denominated  funding 
needs of entities domiciled in the euro area. The Eurosystem’s quantitative assessment 
estimated the liquidity needs of euro area PSAs to meet variation margin under a stress 
scenario based on a 1% shift in rates (see also above). Within the euro area, according 
to  data  available  to  the  Eurosystem,  the  Dutch  PSAs  are  the  most  involved  in 
derivatives, with 89% of all pension fund interest rate swaps entered into by them. The 
Eurosystem’s analysis found that the actual liquidity needs of euro area PSAs in such a 
circumstance would be manageable (i.e. below 2%) as compared to the overall size of 
the  European  repo  market  (proxied  by  the  outstanding  amount  of  reverse  repos), 
suggesting that repo market per se could offer solutions to euro area PSAs’ needs. On 
the  basis  of  the  findings  it  was  concluded  that  the  Eurosystem’s  monetary  policy 
framework,  including  its  counterparty  framework,  is  adequate  for  monetary  policy 
implementation  purposes  and  does  not  warrant  changes  to  establish  a  dedicated 
Eurosystem liquidity backstop for PSAs22.  

4.  CONCLUSION 

The  issue  of  PSA  central  clearing  has  been  longstanding,  and  during  the  last  EMIR 
negotiations  it  became  apparent  that  co-legislators  sought  to  encourage  as  much  as 
possible  a  solution  which  could  make  such  actors  access  the  central  clearing  system 

22   Such  a  Eurosystem  liquidity  backstop  facility  would  be  distinct  from  Emergency  Liquidity  Assistance 

(ELA), which falls within the remit of national central bank mandates. 

11 

 
 
 
                                                           
designed  by  the  G20  reforms  in  2009,  while  taking  into  account  the  need  to  have 
adequate solutions in place to accommodate concerns in a stressed market situation.  

Long  discussions  have  taken  place  in  the  Commission  stakeholder  group,  where  it 
emerged  that  PSAs  have  already  started  clearing  some  derivatives  voluntarily,  and  it 
can  be  concluded  that  the  key  issue  which  remains  to  be  solved  is  the  issue  of  cash 
variation margin in times of stressed market conditions. 

The  Commission  has  been  constantly  monitoring  market  developments  and  has 
facilitated exchanges and discussions among the relevant stakeholders to find possible 
ways  forward.  Over  the  years  efforts  have  been  made  by  industry  stakeholders.  In 
particular, once the option of posting variation margin in bonds directly with CCPs was 
eventually dismissed due to compatibility issues with the nature and business model of 
CCPs,  other  avenues  have  been  explored  in  order  to  better  allow  PSAs  to  transform 
collateral.  

As outlined in this report, facilitated access models have been developed during recent 
years in order to explore a potentially viable avenue for PSAs’ central clearing. To the 
Commission’s  best  knowledge,  such  an  option  is  already  being  used  by  a  few  PSAs. 
The  Commission  intends  to  explore  further  with  relevant  stakeholders  this  option, 
including its cost for PSAs. The fact that more than one CCP is adopting such a model 
seems to be a positive development, also in terms of promoting more choice. 

Finding  a  suitable  solution  will  most  likely  require  effort  on  a  number  of  different 
fronts. On the one hand, some aspects of banking regulation should be further assessed, 
including whether the recent changes in the leverage ratio calculations have helped. On 
the  other  hand,  it  should  be  considered  which  ways  of  securing  liquidity  facilities  to 
PSAs in times of stress can be explored. 

The results of the public consultation launched by ESMA should provide further insight 
into  recent  market  developments  and  possibly  further  quantitative  data  which  will  be 
examined  carefully.  The  Commission  is  also  committed  to  exploring  any  appropriate 
and  feasible  initiative  in  order  to  move  further  towards  a  viable  and  robust  central 
clearing solution. 

These  analyses  over  the  next  months  will  inform  the  Commission’s  decision  with 
regard to the central clearing exemption. 

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