Pension Fund Clearing Obligation Exemption (Amendment) Regulations 2025

Lord Davies of Brixton Excerpts

Thursday 5th June 2025 Grand Committee

In closing, these regulations will maintain this important exemption for the long term. They will provide certainty for pension funds on this issue and will remove the need for the Government to renew this exemption every two years via secondary legislation if they conclude that this is necessary. They will support pension funds’ ability to generate returns, which fund the retirement benefits of future pensioners, and align with the Government’s objectives to unlock productive investment in order to support economic growth. I hope that noble Lords will join me in supporting these regulations and their objectives. I beg to move.

[Lord Davies of Brixton (Lab)]

I thank my noble friend the Minister for his clear and helpful introduction of these regulations.

I just have two issues to raise; it would overegg them to describe them as issues of concern, but we need to recognise them. First, these clearing obligations are there to protect investors. The level of risk is materially increased by removing those obligations; we need to understand that. On balance, it may still be a reasonable thing to do, but we need to recognise that there is risk involved.

The second, bigger issue is that the Pension Schemes Bill, which was published an hour ago—I am holding it in my hand—makes significant on pension schemes in terms of the investments that they hold and the way in which they undertake their investment policy. It needs to be recognised that this very minor measure is part of that more general review, which will take place because of the Bill. I was very glad to hear my noble friend the Minister report that the policy will be kept under review. The fact that we have this pensions Bill means that it will inevitably be part of that process. The whole thing needs to fit together both to provide the investments that secure members’ benefits and to provide members with the reassurance that their money is being kept well.

[Baroness Neville-Rolfe (Con)]

My Lords, I thank the Minister for bringing this important debate before the Grand Committee today. While technical in nature, the debate strikes at the very heart of our pensions system. It concerns the management of risk, the generation of returns for pension schemes and the financial security of our country. Derivatives play a crucial role in the operation of pension funds. They allow for efficient exposure to asset classes without necessitating the purchase of the underlying assets. They enable tactical asset allocation decisions to be executed more swiftly and cost-effectively than physical rebalancing and, through leverage, they offer the ability to increase market exposure without tying up significant amounts of capital. I know all of this from my experience as a trustee of the Tesco pension fund some years ago. Above all, derivatives are essential because pension funds face long-term liabilities that are highly sensitive to changes in interest rates, to inflation and to currency fluctuations.

These instruments are vital in managing such risks, especially in an uncertain and volatile world. Interest rate swaps hedge against fluctuations in interest rates that affect the valuation of liabilities. Inflation swaps protect against unexpected shifts in inflation, which is especially relevant where pensions are index-linked. Currency forwards and options manage foreign exchange risk where assets or liabilities are denominated in non-sterling currencies. It is the management of risk more than anything else that justifies their inclusion in the portfolio strategies of pension funds and, as the noble Lord, Lord Davies of Brixton, said, the level of risk is materially increased by this regulation. He also rightly referred to the Pension Schemes Bill, which has only just been published. I am afraid that due to other commitments, I have not yet had time to study it.

Since the European Market Infrastructure Regulation was introduced in 2012, pension funds have been granted an exemption from the central clearing obligation, recognising their unique challenge in meeting margin requirements as central counterparties. Pension funds operate on a long-term, illiquid investment model, and this fundamentally mismatches the short-term, high-frequency liquidity demands of CCPs, particularly under stressed market conditions.

Will the Minister outline the contingency plans in place should the absence of mandatory clearing suddenly appear to increase the risk of counterparty defaults?

I have to say that the exemption from these insurance-type arrangements of a CCP carries its own risks. The Government bear a heavy responsibility to maintain confidence in a financial system upon which livelihoods depend. The government review mentioned by the Minister concluded that removing the exemption could impair the ability of pension funds to invest in productive assets. That must be weighed carefully against the imperative of effective risk management. Can the Minister clarify how bilateral arrangements will be monitored for resilience, given that derivatives are no longer subject to central clearing? He talked about keeping this under review, which I think was helpful.

Our financial markets are deeply embedded in the global system. Can the Minister explain how this move aligns with international financial regulatory frameworks and, indeed, with the EU and US, which have slightly different rules from the UK? Furthermore, has the Minister assessed the potential reputational impact on the UK’s standing in international markets, particularly in the context of post-G20 commitments to mandatory central clearing, which the Minister referred to? Finally, will the Minister publish the underlying risk analysis or cost benefit assessment that supports the decisions to go for an indefinite extension period? Without such transparency, it is difficult to understand how the Government have reached their conclusion and indeed why they have chosen this policy path.

The current impact assessment states that the measure

“mitigates the risk of disruption to the market”

that might occur if pension funds were required to restructure their investment strategies “at short notice”. This would be ahead of the exemptions expiring, which happens to be 18 June—the week after next. However, this is a narrow, short-term cost analysis. I am interested in the wider picture of longer-term cost versus the benefits of alternative systems, so I very much look forward to the Minister’s response on whether he is willing to publish his cost-benefit assessment or, perhaps, to say bit more about the detail.

I urge the Minister to engage deeply with the concerns raised and to provide reassurance that the Government’s decision rests on a sound and transparent evidential foundation. We are dealing with an important subject and a risk that, as I am sure we all agree, needs to be properly managed in the interests of UK plc.