PRA and FCA consult on UK Margin Rules and propose broader fund eligibility

On 12 July 2022, the PRA and the FCA jointly published a joint consultation proposing amendments to the UK Margin Rules . The proposed changes are intended to address shortcomings that have been identified by the derivatives industry since the onshoring of the EU Margin Rules at the end of the Brexit implementation period. In summary, the changes would:

• allow non-UK funds (including EEA UCITS) to qualify as eligible collateral under the UK Margin Rules where certain criteria are met;
• introduce a six-month grace period during which newly in-scope entities that were not in scope of the September 2022 phase 6 initial margin implementation need not comply; and
• clarify the scope of the central clearing counterparty (CCP) exemption.

Non-UK funds as eligible collateral

When the UK Margin Rules were onshored on 31 December 2020, the Article 4 list of instruments that are eligible for use as collateral was amended to remove EEA UCITS and include UK UCITS, to reflect the EU's default treatment as a non-UK jurisdiction under the UK Margin Rules. Transitional provisions were incorporated to allow EEA UCITS to remain as eligible collateral until the end of December 2022.

In response, market participants argued that the removal of EEA UCITS as eligible collateral would significantly reduce the pool of assets available for use as collateral by UK firms and may hamper their ability to enter into uncleared derivatives. The PRA and the FCA propose to address this by permitting the use of non-UK funds - including EEA UCITS - but only where certain criteria are met. One such criterion would be that they invest only in government securities and cash. The transitional provisions temporarily allowing the use of EEA UCITS would be permitted to lapse.

The consultation also suggests introducing specific risk management requirements, similar to existing UK UCITS risk management principles, including a requirement for entities using non-UK funds as collateral to be able to access the daily price quote of such funds. Entities accepting such collateral would need to be able to demonstrate that they had carried out an appropriate risk assessment.

Given that the proposals apply to all non-UK funds, and are not limited to EEA funds, it will be interesting to see whether any future amendments to the UK Margin Rules will allow more US Money Market Funds to be recognised as eligible collateral than is currently the case.

Transitional provisions for newly in-scope entities

The consultation also proposes the introduction of a six-month "fallback" transitional period, during which entities that fall within scope of the UK Margin Rules for the first time need not comply with the rules, to allow for the establishment of the necessary margining arrangements. The transitional period would apply, for example, if an NFC- were to become an NFC+, if netting were to become legally enforceable in a jurisdiction where it had previously not been enforceable, or simply where a counterparty group's aggregate average notional amount of outstanding OTC derivatives (as determined under the UK Margin Rules) exceeded the €8 billion threshold for the first time. The transitional period would not apply to entities coming into scope as a result of phase 6 initial margin implementation in September this year.

Exclusion of CCPs recognised by the Bank of England

The UK Margin Rules currently exempt  CCPs that are PRA-authorised as credit institutions. In order to avoid any ambiguity and ensure that certain CCPs are not unintentionally scoped in, the consultation suggests broadening the exemption so that it applies to trades entered into by CCPs that are recognised by the Bank of England, where those trades are related to the CCP's activities.

Impact and next steps

This joint consultation by the PRA and the FCA is the first post-Brexit exercise of their regulatory powers to amend the UK Margin Rules in a way that is not merely reflecting changes made under the EU Margin Rules, and indicates that they may look to take a somewhat more pragmatic approach on certain issues than the EU has to date. This will undoubtedly be welcomed by the UK market, but whether such an approach will create future tensions with the EU in terms of the UK Margin Rules' potential equivalence of remains to be seen.

The consultation closes on 12 October 2022. Amendments are expected to be made to the UK Margin Rules once market responses have been reviewed.

Authors: Kerion Ball and Kirsty McAllister-Jones