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EMIR/UK EMIR Initial Margin Requirement – is your scheme ready for Phase 6?

FAQs for UK Pension Schemes

EMIR/UK EMIR Initial Margin Requirement – is your scheme ready for Phase 6?


Certain buy side market participants, including pension schemes and asset managers, will be required under EMIR/UK EMIR to exchange initial margin on most of their uncleared OTC derivatives transactions from 1 September 2022. Your pension scheme will be affected by this upcoming regulatory requirement if it uses uncleared OTC derivatives with an aggregate notional amount above EUR8bn. Where your OTC derivatives usage is below this amount, you will not be affected, but your investment manager may require confirmation of the level of your scheme's overall OTC derivatives use.

UK EMIR is the UK version of the European Market Infrastructure Regulation (EMIR), which was on-shored into UK law following the end of the Brexit implementation period on 31 December 2020.

EMIR/UK EMIR brought in various risk-reducing regimes, including mandatory clearing for certain OTC derivatives transactions, mandatory exchange of initial and variation margin for non-cleared OTC derivatives transactions, and post-trade reporting requirements.

Exchange of variation margin has been mandatory since 2017 for most counterparties to OTC derivatives. Mandatory exchange of initial margin for uncleared OTC derivatives has however been phased in over several years, based on a counterparty's trading volume, calculated by notional amount.

This note focuses on the upcoming final phase-in date applicable to the mandatory initial margin requirement, which is set to take effect on 1 September 2022 and will apply to a range of buy-side market participants such as asset managers and pension schemes. This final phase-in is referred to as "Phase 6".


Firstly, pension schemes should work with their investment consultants and investment managers to assess whether the AANA of their OTC derivatives transactions will bring them within scope of Phase 6.

If the scheme is in scope, the following preparations will be necessary:

  • Notify investment managers and derivatives counterparties that the scheme will fall within scope of Phase 6

  • Determine which custodians will be used by counterparties

  • Determine the preferred methodology for valuation of initial margin (e.g. grid, ISDA SIMM, etc)

  • Consider impact of choice of collateral on liquidity and funding

  • Consider operational requirements that may be needed to enable compliance

  • Begin negotiation of relevant documentation, taking into account factors such as jurisdiction of custodians.
What is the Phase 6 threshold notional amount and how is it calculated?

The final phase-in of mandatory initial margin exchange will bring counterparties within scope if they have, or belong to a group which has, an average month-end aggregate notional amount (AANA) of uncleared OTC derivatives above EUR 8 billion for the months March, April and May of 2022.

All uncleared OTC derivatives are included in this calculation, including hedging transactions used to mitigate risk and transactions which are otherwise exempt from the requirement to exchange initial margin (such as physically-settled FX forwards and swaps, as mentioned below).

When determining whether the initial margin requirement applies, the counterparty will need to calculate the AANA in respect of its and, in most cases, its group’s uncleared OTC derivatives. These calculations need to be considered on a case-by-case basis taking into account the specifics of the relevant counterparty. By way of example:

  • Pension schemes which operate on a sectionalised basis (and segregate pools of assets for different categories of members) may conduct the calculation at the level of the individual section rather than the whole scheme.

  • In most cases, the sponsor employer of the pension scheme will not be required to account for the scheme's AANA in determining whether the EUR 8 billion threshold is reached. However, as the tests for which entities are to be included in the group are complex, scheme sponsors may wish to seek specific advice.

What is initial margin?

Initial margin is the collateral collected by a counterparty to a derivatives transaction to cover potential exposure in the period between the last exchange of variation margin and either the liquidation of positions following default of the other party or the hedging of that position. Variation margin, on the other hand, is the collateral collected to cover the change in market value of the contract on a daily basis.

Who is required to exchange initial margin?

Certain Financial Counterparties (FCs) and Non-Financial Counterparties above the EMIR/UK EMIR 'clearing threshold' (NFC+s) are required to exchange initial margin under their OTC derivatives transactions, subject to certain thresholds and some exemptions.

EU and UK pension schemes are FCs and may be subject to the mandatory initial margin requirement.

What is the initial margin requirement?

Both EMIR and UK EMIR require all in-scope entities to have risk-management procedures in place that include a requirement to collect initial margin in respect of OTC derivatives transactions that are not centrally cleared. In particular (N.B. this is not an exhaustive list):

  • Initial margin must be collected on a gross basis, without offsetting initial margin amounts due between the parties. This differs from the treatment of variation margin, which is paid on a net basis to the party who would stand to lose in the event of a default by the other party.

  • Initial margin must be segregated from the holding party's assets to protect the initial margin from the holding party's insolvency. Collateral segregation can raise legal issues beyond the scope of this note.

  • Counterparties to derivatives transactions are required to conduct an independent legal review of their initial margin arrangements to verify that they meet the segregation requirements for non-cash collateral and must provide evidence of this to their supervisor.

  • Under UK EMIR, cash collateral must be held in an account with a UK bank (or a bank in a third country which benefits from an equivalence decision) which is not one of the counterparties. Collateral posted as initial margin may not be re-hypothecated. This means it cannot be re-used as collateral under a repo or other securities financing transaction. (This requirement does not apply to cash collateral held by a third party).

  • Initial margin must be freely transferable to the posting counterparty in a timely manner in case of the default of the collecting counterparty.

  • Initial margin is calculated for each netting set. There are detailed rules concerning the timing and methodology for valuation of the derivative contracts in a netting set for this purpose. A standardised approach to valuation is set out in Annex IV to the EMIR technical standards, which has been on-shored into UK law, which is based on a percentage of the notional amount of the contracts in the netting set (the so-called "grid" methodology). Bespoke margin models are also permissible, such as the ISDA Standard Initial Margin Model (ISDA SIMM), provided they meet certain criteria for capturing risk. Preference between grid and ISDA SIMM is fact-specific and depends on cost, operational and technical considerations.

  • More generally, the margin rules impose requirements on counterparties to establish and document risk management procedures relating to initial margin. These include for example, procedures governing eligibility of collateral, the procedures for meeting segregation requirements, the terms of the collateral exchange agreement between the parties (such as an ISDA credit support document) procedures for valuation of initial margin and various other requirements. If you would like to discuss these requirements, please let us know.
What happens if the volume of non-cleared derivatives entered by the counterparty falls below EUR 8 billion at a date after phase-in?

Following the final phase-in, the requirement to collect initial margin remains subject to a notional amount threshold on a year-on-year basis. No initial margin is required to be collected for new contracts from January of each year where one of the counterparties has, or belongs to a group which has, an AANA of uncleared OTC derivatives for the months March, April and May of the preceding year below EUR 8bn.

Are there any others thresholds and exemptions?

The following exemptions and thresholds also apply to mandatory initial margin exchange:

  • Where the counterparties are not in the same group (or do not belong to a group), initial margin need not be collected if the amount otherwise due to be collected from all parties in the posting party's group would be equal to or less than EUR 50 million. Where the counterparties are part of the same consolidated group, this threshold reduces to EUR 10 million. Note that collecting counterparties may collect a reduced amount in these circumstances rather than waiving the full EUR 50/10 million, so this should be discussed between counterparties. Where the counterparties are in different groups, use of the EUR 50 million exemption requires counterparties to include, in their risk management procedures, provisions for monitoring whether this threshold is exceeded.

  • Initial margin may not need to be exchanged for certain transactions between FCs within the same group. There are detailed conditions which set out whether the transaction qualifies as an "intragroup transaction" enabling counterparties to rely on this exemption.

  • Initial margin need not be exchanged for physically-settled foreign exchange forwards, physically-settled foreign exchange swaps and the exchange of principal under a currency swap.

  • There is a temporary exemption under both EMIR and UK EMIR from the requirement to exchange initial margin in the case of singe-stock equity options or index options. This time-limited exemption expires on 4 January 2024.

What kind of collateral is eligible to be provided as initial margin?

Eligible collateral includes cash, money markets deposits, gold, sovereign debt, corporate bonds, convertible bonds, equities, etc. subject to certain concentration limits aimed at diversifying risk. The types of collateral that have predominantly been used by banks and other large sell-side firms in earlier stages of initial margin phase-in have included fixed income and other non-cash collateral, such as government debt. However, pension schemes may wish to post collateral from other eligible categories, such as money market instruments and units in UCITS. Pension schemes are advised to discuss their preferred collateral types with their investment managers, prime brokers and custodians, to ensure that operational issues are addressed prior to the Phase 6 phase-in date.

Further, following the end of the Brexit implementation period, UK EMIR requires that eligible collateral in the form of government bonds must be UK government bonds and collateral in the form of units in a UCITS must be in a UK UCITS. The FCA and PRA have stated that units in EEA UCITS will remain eligible as collateral under UK EMIR until the end of 2022, and they will consult in early 2022 as to whether to make this permanent. Pension schemes wishing to use units in EEA UCITS as collateral need to remain aware of this issue and the lack of a permanent decision at the time of writing.

How do the ISDA documents deal with the mandatory initial requirement?

The requirement that initial margin must be segregated from the collecting party's proprietary assets means that an English Law ISDA Credit Support Annex (CSA) cannot be used for the transfer of initial margin, as an English law CSA creates a title transfer of the collateral which would allow the collecting party to use the collateral freely.

As a result, ISDA has published a suite of documents to assist counterparties with compliance with the EMIR and UK EMIR initial margin rules:

  • The 2018 Initial Margin Credit Support Deed (2018 IM CSD) creates a security interest over the transferred collateral rather than a title transfer mechanism. The 2018 IM CSD contains a negative pledge, preventing the collateral provider from using the collateral as security for other liabilities as well as restrictions on use of the collateral for other purposes. It sets out many of the documentary requirements of the UK EMIR rules for initial margin, such as procedures for margin calls and settlement,

    valuation mechanics and segregation arrangements. It also requires the parties to enter an Account Control Agreement with a custodian, setting out the terms on which the custodian may release or return collateral.

  • The ISDA 2019 Clearstream Collateral Transfer Agreement and Security Agreement, and 2019 Euroclear Collateral Transfer Agreement and Security Agreement use the collateral transfer provisions of the 2018 IM CSD and create separate Luxembourg law and Belgian law security requirements where the custodian is Clearstream or Euroclear respectively.

  • The ISDA 2019 Bank Custodian Control Transfer Agreement and Security Agreement governs arrangements for other custodians under a variety of governing laws of the security depending on where the collateral is held.

These documents will need to be negotiated in advance of the Phase 6 phase-in date in September 2022.


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