Investment Briefing

Sackers’ Finance and Investment Group takes a look at current issues of interest to pension scheme investors.

In this Briefing:

• Update on EMIR
• Financial Transaction Tax
• Longevity risk transfer markets
• FATCA
• NAPF: UK Pension Investment trends
• PPG Holdings BV
  

Update on EMIR

• EMIR sets out risk mitigation measures in relation to OTCs within the EEA. At the heart of EMIR is the requirement for central clearing of certain OTCs with newly established CCPs, but the regulations encompass a range of different measures.
• Our July 2013 Investment Briefing sets out some of the key aspects, including the limited exemption from central clearing for pension arrangements.

Latest Developments

• A number of risk mitigation measures came into force on 15 September 2013. These include the requirement to undertake portfolio reconciliation and compression, and to maintain detailed processes for the identification and resolution of disputes.
• Trustees who transact OTCs will need to ensure that they, or their investment managers on their behalf, comply with these requirements.
• Most managers who transact OTCs on behalf of their clients (eg segregated LDI mandates or currency hedging) will already have approached trustees to confirm what steps they are taking to ensure compliance. Trustees in pooled funds with substantial exposure to OTCs may wish to ask their pooled fund providers how EMIR will affect the pooled fund.
• ISDA has produced an EMIR protocol that counterparties can adhere to, which amends existing ISDA Agreements between those counterparties to comply with the new risk mitigation measures. The protocol waives confidentiality to the extent necessary to enable the parties to comply with their reporting obligations under EMIR. ISDA has also published a standard bi-lateral amendment to ISDA Master Agreements, adopting amendments in the same terms as the protocol, which can be used as an alternative to adhering to the protocol.
• Although the technical standards on reporting transactions to depositaries came into force on 1 July 2013, the industry still has work to do before the necessary infrastructure is in place and, at present, there is no authorised trade repository to accept mandatory trade reports. The latest indication from ESMA is that registration approval is not expected before 7 November 2013, with reporting to trade repositories therefore not expected to start before February 2014.1

Non-centrally cleared trades

• The Basel Committee on Banking Supervision and the International Organization of Securities Commissions (BCBS-IOSCO) published the final framework for margin requirements for non-centrally cleared derivatives on 2 September 2013. This is likely to form the basis for the initial and variation margin requirements to be adopted under EMIR and the Dodd-Frank Wall Street Reform and Consumer Protection Act in the US (Dodd-Frank).
• The requirement to post initial margin (on a gross rather than a net basis) will apply to new transactions from 1 December 2015 and will be phased in over a four year period, starting with very large entities. From December 2019, the requirement will still only apply to counterparties whose aggregate month-end average notional amount of non-centrally cleared derivatives exceeds EUR 8 billion. As such, this is only likely to affect the largest pension schemes.
• In addition, financial counterparties will have to exchange variation margin in relation to new transactions from 1 December 2015.
• National regulators will have flexibility to specify what assets are acceptable as collateral, subject to meeting the principle that the assets be highly liquid and capable of holding their value in times of financial stress. The illustrative list set out in the framework includes: cash; high quality government and central bank securities; high quality corporate bonds; margin requirements for non-centrally cleared derivatives; high quality covered bonds; equities included in major stock indices; and gold.

Cross-border

• The United States is among the other key jurisdictions to be adopting new rules regulating OTC markets. Dodd-Frank created a structure for reporting and, in certain cases, clearing swap transactions in the US. Several of its provisions came into effect on 1 May 2013.
• Provided the US Commodity Futures Trading Commission (CFTC) deems domestic regulations, such as EMIR, to be equivalent to Dodd-Frank, foreign branches of US banks can apply local rules under ‘substituted compliance’.
• However, the CFTC has declared that foreign branches would need to meet the clearing requirement, in effect from 9 October 2013. As no equivalent rules have yet been implemented in the EU (as central clearing is so far not in force), substituted compliance is not yet possible.
• As the 9 October deadline has not so far been is extended, it appears that a UK pension scheme dealing with the London branch of a US Bank will have to meet Dodd-Frank clearing and other rules from that date. This would only apply to new trades in clearable swaps.
• Trustees who have entered into direct or agency ISDA Agreements with foreign branches of US Banks should speak to their investment managers and/or swap counterparties to agree a way forward. Trustees who wish to avoid Dodd-Frank may, for example, seek to contract with an entity in the same group which is subject to EMIR for future transactions.

Financial Transaction Tax

• An opinion provided by the EU Council legal service concludes that the FTT which eleven EU Member States (the FTT Zone) propose to adopt does not comply with EU law.

• In its current proposed form, the FTT would apply to transactions in financial instruments (including bonds, shares and derivatives) between financial institutions (including pension schemes) where either:

• one of the parties is established within the FTT Zone; or
• the transaction involves financial instruments issued in the FTT Zone.

• As such, although the UK is not in the FTT Zone, a UK pension scheme buying US securities from a French Bank would have to pay French FTT.
• The opinion states that this:
  • breaches international law norms;
  • infringes the taxing competencies of non-participating Member States; and
  • is discriminatory and leads to distortion of competition

• We will be monitoring how the FTT develops from here. The UK Government has raised a separate legal challenge to the FTT.

Longevity risk transfer markets

• The Joint Forum (made up of the Basel Committee on Banking Supervision, the International Organization of Securities Commissions and the International Association of Insurance Supervisors) has issued a consultative report on longevity risk transfer (LRT) markets.2

• The report notes that longevity risk – the risk of paying out on pensions and annuities longer than anticipated – is significant, with certain estimates counting the total global amount of annuity and pension related longevity risk exposure as being between USD 15-25 trillion.
• The consultation (which closes on 18 October 2013) is to provide preliminary analysis of the size and structure of the LRT markets, the factors affecting their growth and development, and to raise awareness of the associated potential risks.

FATCA

• FATCA sets out certain information sharing and reporting obligations for foreign (ie non-US) financial institutions (FFIs), with the aim of preventing tax evasion by US citizens using offshore banking facilities.

• Regulations3 came into force on 1 September 2013 to implement the agreement between the US and the UK that enables UK FFIs to meet their obligations without entering into an agreement with the IRS.
• UK pension schemes are generally exempt from the need to register as an FFI, as they are categorised as “non-reporting UK Financial Institutions”. In addition, pension schemes registered with HMRC are regarded as exempt products and are therefore not treated as financial accounts.

NAPF: UK Pension Investment trends

• Using data from its annual survey, the NAPF has issued a report4highlighting the impact of pension fund closures in the private sector and the potential repercussions for their investment in UK assets.
• The NAPF reports that the recent, rapid shifts in DB asset allocations, including significant movement away from traditional growth assets such as equities and the increased pressure on closed and mature schemes to fully hedge against movement in liabilities, are changing the role of DB pension schemes as institutional investors and the ways in which they interact with the wider economy.
• As a result, the NAPF intends to explore these issues further, by means of seminars, surveys and discussion forums on three strategic themes:
  • the evolution of funding regulations and accounting standards, and the impact on today’s DB investment strategies;
  • navigating the DB ‘run-off’ and the future demand for different asset classes; and
  • the role of pension funds as institutional investors and the stewardship of the economy.

PPG Holdings BV5

• In this recent Dutch case, the CJEU ruled that an employer with a DB pension scheme is, as a taxable person, entitled to deduct the VAT paid on services relating to the management and operation of a pension fund set up for employees and former employees (both day-to-day management costs and investment management fees). The court confirmed that input tax recovery is permitted where there is a direct and immediate link between the cost of these services and the employer’s economic activity as a whole.
• In the light of its decision in the recent Wheels6 case, the CJEU found it unnecessary to answer the second question of whether the scheme fell within the VAT exemption for “special investment funds”.
• In the UK, HMRC’s position to date7 has been to allow companies to reclaim the VAT paid on some pension scheme services, including scheme set-up costs and general scheme management costs, but in general, not investment manager fees. Clarification of HMRC’s policy, and whether it should in fact extend to fund management fees, is now anticipated.

1ESMA Press Release (13 September 2013)
2Longevity risk transfer markets: market structure, growth drivers and impediments, and potential risks (August 2013)
3 The International Tax Compliance (United States of America) Regulations 2013
4 Trends in defined benefit asset allocation: the changing shape of UK pension investment (July 2013)
5 Fiscale eenheid PPG Holdings BV cs te Hoogezand v Inspecteur van de Belastingdienst/Noord/kantoor Groningen (Case C 26/12)
6 Wheels Common Investment Fund Trustees v HMRC [2013] Case C-424/11 (see our July 2013 Investment Briefing for details)
7 Notice 700/17 Funded pension schemes (January 2013)