CP5/25 – Margin requirements for non-centrally cleared derivatives: Amendments to BTS 2016/2251

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Responses are requested by 27 June 2025.

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Please address any comments or enquiries by email to: CP5_25@bankofengland.co.uk for PRA-regulated firms, or cp25-5@fca.org.uk for FCA firms. Other respondents should submit responses to both authorities.

Alternatively, please address any comments or enquiries to:

For PRA-regulated firms:
Muhammad Anuar and Mariana Albuquerque
Market and Counterparty Credit Risk Policy
Prudential Regulation Authority
20 Moorgate
London
EC2R 6DA

For FCA Firms:
Hannah Muskett and Philip Bronk
Market Conduct and Post Trade Policy
Financial Conduct Authority
12 Endeavour Square
London
E20 1JN

1: Overview

1.1 In policy statement (PS) 18/23 – Margin requirements for non-centrally cleared derivatives: Amendments to BTS 2013/2251 we made amendments to extend the existing temporary exemption for single-stock equity options and index options from the UK bilateral margining requirements until 4 January 2026. The Prudential Regulation Authority (PRA) and the Financial Conduct Authority (FCA) extended the temporary exemption for these contracts, while undertaking deeper analysis to develop a permanent approach. This consultation paper (CP) sets out the PRA’s and the FCA’s proposal to implement an indefinite exemption for single-stock equity options and index options from the UK bilateral margining requirements.

1.2 This CP also proposes two amendments to reduce the burden of the bilateral margining regime in the UK. The first amendment relates to legacy contracts (ie outstanding contracts entered into before firms enter into scope or fall out of scope of the requirements), where the proposal amends the margining treatment of legacy contracts for firms that subsequently fall out of scope of the requirements. The second proposal would permit UK firms when transacting with a counterparty subjected to the margin requirements in another jurisdiction, to use that jurisdiction’s threshold assessment calculation periods and entry into scope dates to determine whether those transactions are subject to Initial Margin (IM) requirements.

1.3 The proposals in this CP would result in changes to the UK version of Commission Delegated Regulation (EU) 2016/2251 of 4 October 2016 and the regulatory technical standards for risk-mitigation techniques for over-the-counter (OTC) derivative contracts not cleared by a central counterparty (hereafter Binding Technical Standards (BTS) 2016/2251) (Appendix 1 and 2). This BTS supplements Article 11(15) of Regulation (EU) 648/2012 on OTC derivatives, central counterparties, and trade repositories (UK European Market Infrastructure Regulation (EMIR)).

1.4 The proposals in this CP:

• implement an indefinite exemption for single-stock equity options and index options from the UK bilateral margining requirements;
• remove the obligation to exchange IM on outstanding legacy contracts, where a firm subsequently falls below the in-scope thresholds; and
• when transacting with a counterparty subjected to the margin requirements in another jurisdiction, permit UK firms to use that jurisdiction’s threshold assessment calculation periods and entry into scope dates to determine whether those transactions are subject to IM requirements.

1.5 The PRA and the FCA consider that the proposed indefinite exemption of single-stock equity options and index options from the UK bilateral margining requirements strikes a proportionate balance in meeting the objectives of prudential safety and soundness and a level playing field across jurisdictions. The PRA and the FCA continue to support full implementation of the margining standards. However, based on the data collected, the PRA considers that fragmented international implementation of margin requirements for single-stock equity options and index options is unlikely to produce the desired financial stability effects nor incentivise central clearing for these products. Having considered the data, the PRA considers that there would be a material risk that most of the trading in these products would move to locations with no margin requirements. This would negate any prudential benefits from the UK implementing margin requirements on these products. At the same time, firms maintain capital requirements against counterparties’ risk attached to these products. This mitigates the significant level of risk that would otherwise be mitigated through the bilateral margin requirements.

1.6 The FCA considers that the proposal meets its strategic objective of ensuring that the relevant markets function well, its operational objective of protecting and enhancing the integrity of the UK financial system. The FCA also considers that the proposal meets its secondary objective to support the international competitiveness and growth of the UK economy in the medium to long term, by maintaining a level playing field for UK firms and allowing them to remain competitive with firms in other jurisdictions. As such, while the PRA and the FCA continue to support the adoption of the BCBS-IOSCO margin framework, the PRA and the FCA propose not to implement margining standards for single-stock equity options and index options at this stage.

1.7 The PRA and the FCA consider that removing legacy contracts from the scope of the IM requirements for firms who subsequently fall below in-scope thresholds more accurately reflects the lower systemic risk of such market participants. The proposed amendment would make the bilateral margining framework more proportionate to the risk and reduce disproportionate operational burdens. The current framework may also impose operational complexity on cross-border trades. The PRA and the FCA therefore propose to permit UK firms when transacting with a counterparty subjected to the margin requirements in another jurisdiction, to use that jurisdiction’s threshold assessment calculation periods and entry into scope dates to determine whether those transactions are subject to IM requirements. This would remove an unnecessary operational complexity that offers limited prudential benefit and would support UK competitiveness in those markets.

1.8 The CP is relevant to PRA-authorised UK banks, building societies, and PRA-designated UK investment firms in scope of the margin requirements under UK EMIR. In addition, this CP is relevant to all FCA solo-regulated entities and non-financial firms in scope of the margin requirements under UK EMIR.

1.9 The PRA and the FCA conclude that the introduction of an indefinite exemption from the UK bilateral margin requirements for single stock equity and index options has costs of minimal significance. There are also potential benefits for UK economic growth from avoiding a potential migration of business from the UK if the current exemption were to expire without replacement. The PRA and the FCA have not quantified this impact.

1.10 The PRA has a statutory duty to consult the FCA when making technical standards instruments (section 138P(4) of the Financial Services and Markets Act 2000 (FSMA)) . The PRA also has a statutory duty to publish draft technical standards instruments through which the PRA considers to be the best way to bring them to the attention of the public (s138S(2)(g) of FSMA). When not making rules, the PRA has a public law duty to consult widely where it would be fair to do so. 

1.11 In carrying out its policy making functions, the PRA and the FCA are required to comply with several legal obligations. Chapter 3 lists the statutory obligations applicable to the PRA’s policy development process. The analysis in this CP explains how the proposals have had regard to the most significant matters, including an explanation of the ways in which having regard to these matters has affected the proposals.

1.12 The PRA has a statutory duty to consult when amending a technical standard such as BTS 2016/2251 under s138S of FSMA. When not making rules, the PRA has a public law duty to consult widely where it would be fair to do so. 

1.13 The FCA has a statutory duty to consult when amending a technical standard such as BTS 2016/2251 under s138S FSMA. Please refer to the ‘FCA compatibility statement’ section in the Chapter ‘FCA Cost benefit analysis’ for an explanation of how the FCA is complying with relevant statutory requirements applicable to the proposal in this consultation. When not making rules, as a public authority, the FCA may have a public law duty to publicly consult where it would be fair to do so or may choose to consult for other reasons.

1.14 The PRA and the FCA have not engaged with the statutory panels in advance of the CP but have been directly engaging with the industry bodies and firms most affected by the proposals, both on the sell and buy side. In addition, the PRA undertook an extensive data collection from major trading firms to inform this policy.

Background

1.15 In 2011, to mitigate the risks associated with non-centrally cleared OTC derivatives, the Group of Twenty (G20) agreed to add uncleared margin requirements to its reform programme, and tasked the Basel Committee on Banking Supervision (BCBS) and the International Organisation of Securities Commissions (IOSCO) to jointly develop consistent global standards. In 2013, BCBS and IOSCO published a standard on Margin requirements for non-centrally cleared derivatives. The introduction of the bilateral margining requirements is a key aspect of the post-financial crisis reforms aimed at mitigating systemic risk and incentivising central clearing. These requirements are implemented in the UK via the onshored EMIR and BTS 2016/2251.^{footnote [1]}

1.16 The standard requires counterparties to exchange IM and variation margin (VM) on non-centrally cleared OTC derivatives. IM protects the transacting parties from the potential future exposure due to market movements that could occur between failure of one counterparty and the close out of the transaction. VM protects the transacting parties from changes in the mark-to-market value of the contract after the transaction has been executed.

1.17 The EU version of BTS 2016/2251, which implements the substantive aspects of the BCBS and IOSCO framework in the EU, was published in the EU Official Journal on Thursday 15 December 2016. The EU BTS 2016/2251 included a temporary exemption for single stock equity options and index options from the bilateral margin requirements. The Bank of England (Bank) and the PRA PS27/20 – The Bank of England’s amendments under the European Union (Withdrawal) Act 2018: Changes before the end of the transition period noted an intention to consider whether pending amendments, including a proposed extension to the temporary exemption for single-stock equity options and index options from the UK bilateral margining requirements, should be adopted into the UK framework.

1.18 PS18/23 – Margin requirements for non-centrally cleared derivatives: Amendments to BTS 2016/2251 made amendments to extend the temporary exemption for single-stock equity options and index options from the UK bilateral margining requirements until 4 January 2026. The PRA and the FCA extended the temporary exemption for these contracts, while undertaking deeper analysis to develop a permanent approach. This is in line with similar actions taken in the US, European Economic Area, Switzerland, and other major jurisdictions to exempt single-stock equity options and index options from the bilateral margining requirements.

1.19 In the course of our work, the industry raised two separate issues regarding the current framework for IM requirements. The BCBS-IOSCO margining standards bring firms into scope of the IM requirements when both counterparties' average aggregate notional amount (AANA) exceeds an €8 billion threshold. The AANA for each firm is calculated over a specified period for all outstanding non-centrally cleared OTC derivative contracts entered into by the firm, and not limited to the contracts between the two counterparties.

1.20 Firms over the €8 billion threshold may subsequently fall out of scope and vice versa. Currently, the BTS states firms that fall below this scope do not have to exchange IM on any new contracts they enter into with their counterparties. However, they must continue to exchange IM on their legacy contracts for the life of the trade. Industry has argued that in some cases this makes it uneconomical for the sell-side to continue servicing these smaller clients, due to the loss of netting benefits, and complexity in retaining the operational infrastructure for margin requirements for a small volume of trades.

1.21 Industry has also raised issues of cross-border operational friction as a result of the current requirements. Firms may be in scope of IM according to one jurisdiction’s methodology but not the other’s or come into or out of scope in a different calendar month across jurisdictions. This complicates cross-border transactions.

Implementation

1.22 The PRA and the FCA propose to amend BTS 2016/2251 using powers under Article 11(15) of EMIR, and s138P of FSMA. The PRA and the FCA propose that the changes resulting from the proposals in this CP would take effect when the final technical standards are published. Consistent with the respective mandates under EMIR, the PRA’s proposed amendments will apply to PRA-regulated firms, while the FCA’s proposed amendments will apply to all other firms covered by the requirements. For the purpose of this consultation, the proposals are identical.

1.23 This is a joint consultation by the PRA and the FCA. The PRA and the FCA have also consulted with the Bank and HM Treasury (HMT).

Responses and next steps

1.24 This consultation closes on Friday 27 June 2025. The PRA and the FCA invite feedback on the proposals set out in this consultation. PRA-regulated firms should address any comments or enquiries to CP5_25@bankofengland.co.uk. FCA firms should address any comments or enquiries to cp25-5@fca.org.uk.

1.25 When providing your response, please tell us whether or not you consent to the PRA and the FCA publishing your name, and/or the name of your organisation, as a respondent to this CP.

1.26 Please also indicate in your response if you believe any of the proposals in this consultation paper are likely to impact persons who share protected characteristics under the Equality Act 2010, and if so, please explain which groups and what the impact on such groups might be.

1.27 Unless otherwise stated, any remaining references to EU or assimilated legislation refer to the version of that legislation which forms part of assimilated EU law.^{footnote [2]}

2: The regulator’s proposals

Proposal 1 – Bilateral margin requirements for single-stock equity options and index options contracts

2.1 The PRA and the FCA propose to indefinitely exempt single-stock equity and index options from the UK bilateral margining requirements.

2.2 Firms are exposed to counterparty credit risk when entering certain derivatives contracts, including single-stock equity and index options contracts. As such, the BCBS-IOSCO margining standards envisage mandatory margining requirements applying to these contracts. However, global implementation has been fragmented, with these contracts remaining out of scope in most jurisdictions. The BCBS-IOSCO framework recognised that the effectiveness of margin requirements could be undermined if the requirements were not consistent internationally. Reflecting this concern, the EU and UK implemented a temporary exemption for single-stock equity and index options. Given the continued fragmented implementation globally, these temporary exemptions have persisted since implementation in 2017, having been extended in 2019, 2021, and 2023. When proposing the 2023 extension, the PRA and the FCA noted their intention to develop a more enduring approach ahead of the exemption’s expiry in 2026.

2.3 The PRA and the FCA have considered the prudential risks of retaining an exemption and the potential prudential benefits of allowing the exemption to expire, both for specific firms and market-wide. To inform this assessment, the PRA requested data from PRA supervised firms. This data gathered information on market participants, current market practises relating to margin exchange and collateralisation, and the size and quantum of risks posed by these types of products. Seven firms, covering a range of business models, elected to participate. Additionally, the FCA conducted further engagement with buy side firms particularly active in these markets to understand the relevant market and the likely impact of our proposals.

2.4 Analysis from the survey data suggests that the increase in margin on these contracts, were the exemption to expire, could be material. In addition, specific market analysis indicates that such trades would likely migrate to jurisdictions that have not implemented mandatory margining for these products, particularly as there has yet to be a material change to the international position since 2017. As such, even if the UK were to unilaterally implement such a requirement, it would likely have limited practical impact on the amount of margin in the system and therefore limited impact on reducing systemic risk.

2.5 In the absence of margin, these contracts are capitalised according to the micro-prudential framework. Mandatory margining brings additional macroprudential benefits capitalising the risks associated with these contracts and market dynamics is consistent with the PRA’s primary objective. It would also support the competitiveness of the UK market, by reducing the risk of trades moving to other jurisdictions if the UK unilaterally implemented the requirements.

2.6 The PRA and the FCA consider that an indefinite exemption provides a clear framework for firms to conduct business. The PRA and the FCA consider this approach strikes a proportionate balance between maintaining the safety and soundness of firms and ensuring consistency of approaches and a level playing field across jurisdictions. Existing firms’ capital requirements are mitigating the micro-prudential firm risks, and without wider international implementation, domestic implementation of mandatory margining is unlikely to significantly address the remaining unmitigated macro-prudential risk. The PRA and the FCA will continue to support the BCBS-IOSCO standards and support a full and consistent implementation of the BCBS-IOSCO framework across jurisdictions.

Proposal 2 – Amendments for legacy contracts for counterparties that fall under the AANA threshold

2.7 The PRA and the FCA propose to remove the requirement to exchange IM for legacy contracts once a counterparty subsequently falls out of scope of the margin requirements.

2.8 The BCBS-IOSCO margining standards bring firms into scope of the IM requirement (for all in-scope products) when both counterparties’ AANA exceeds a threshold of €8 billion. Firms assess this on annual basis, with the requirements applying for the upcoming 12-month calendar period. Firms may subsequently fall out of scope by falling under the €8 billion threshold. The threshold was set to include firms with material exposures in OTC derivatives into the IM requirements. A practical issue has arisen since full implementation in 2022, relating to the treatment of legacy contracts where firms subsequently fall below the IM thresholds.

2.9 If a firm falls below the €8 billion threshold, the BTS currently require legacy contracts to remain margined. This imposes a significant operational burden for firms having to maintain IM calculation and exchange, and custodial relationships. This may persist for decades, depending on the contract length. In contrast, a new trade by the firm would remain outside the IM requirements. It also creates a comparative disadvantage, as some jurisdictions exempt legacy contracts from the requirements in such cases.

2.10 Having considered the materiality of the issue and associated burden of maintaining the requirements, the PRA and the FCA therefore propose to exempt legacy contracts from the IM requirements.

Proposal 3 – Amendments to allow firms to align dates with other jurisdictions

2.11 The PRA and the FCA propose to permit UK firms, when transacting with a counterparty subjected to the margin requirements in another jurisdiction, to use that jurisdiction’s threshold assessment calculation periods and dates of dates of entry into scope of IM requirements to determine whether those transactions are subject to IM requirements.

2.12 Industry raised that the implementation of the BCBS-IOSCO margining standards described in paragraph 2.8 created a second practical issue. The AANA calculation dates and date of entry into scope of IM requirements may differ where firms trade cross-border.

2.13 A cross-border issue occurs when calculation and implementation dates do not align across jurisdictions. Under UK rules, firms are required to assess the IM in-scope threshold as calculated in March to May.^{footnote [3]} Once a counterparty falls below the threshold, the requirements cease applying for the next calendar year (ie forthcoming January – December).

2.14 Under the rules in other jurisdictions, firms are required to assess the threshold as calculated in June to August. Once a counterparty falls below the threshold, the requirements cease applying from September of the same year.

2.15 Where a UK firm trades with a counterparty in one of these jurisdictions, the discrepancy between the annual calculation and implementation dates under each regime may lead to transactions that are within scope of mandatory margin requirements according to one jurisdiction but out according to the other for a brief period. Transactions can also come into or fall out of scope of the requirements on different dates according to each regime.

2.16 Industry reported that this introduces operational burdens and a disincentive to trade with international counterparties operating close to these calculation thresholds. The treatment of trades with these firms changes throughout the year and across jurisdictions. This effect is compounded by the issue raised above around the differing treatment of legacy contracts across jurisdictions. There are limited prudential benefits to cross-border relationships being subject to multiple non-overlapping calculation periods, provided the AANA calculation is undertaken on a three-month period and requirements remain in force for 12 months.

2.17 The PRA and the FCA propose to permit UK firms when transacting with a counterparty subjected to the margin requirements in another jurisdiction, to use that jurisdiction’s threshold assessment calculation periods and entry into scope dates to determine whether those transactions are subject to IM requirements. This would allow consistency between the different regulatory regimes for when they would assess and subsequently apply or disapply the IM requirements.

3: The PRA’s statutory obligations

PRA objectives analysis

3.1 The PRA has a primary objective to promote the safety and soundness of firms that it regulates. The PRA also has a secondary objective to facilitate effective competition in the markets for services provided by PRA-authorised persons in carrying out regulated activities. The PRA has considered whether the proposals set out in this CP would facilitate the international competitiveness of the UK economy and its growth in the medium to long term.

3.2 The PRA has considered the impact of the proposed indefinite exemption on single-stock equity options and index options on the safety and soundness of firms. A margin exemption remains sufficiently prudent. Counterparties’ credit risk is subjected to either capital requirements (survivor-absorb) or the margin requirements (defaulter-pay). Capital and margin are to some degree, substitutes (increased margin reduces capital). Margin is designed to spread absorption of the losses from counterparty failures to the creditors of the failed firm and capital is designed to enable firms to absorb such losses if they do occur without affecting firm stability. Absent any margin requirements, micro-prudential risks are still captured through risk-based capital, but macro-prudential risks may be higher with losses not diversified around the system. Given the international landscape, it is doubtful that unilaterally implementing the requirements would significantly reduce systemic risk, a key objective of the margin reforms.

3.3 The PRA considers that full implementation of the margining requirements would improve financial stability. That is, it would be expected to reduce contagion and spillover effects by ensuring that collateral is available to cover losses of any defaulting derivatives counterparty. Margining can also have broader macro-prudential benefits, by reducing the financial system’s vulnerability to potentially destabilising procyclicality and limiting the build-up of uncollateralised exposures within the financial system.

3.4 At the same time, BCBS identified that the effectiveness of margin requirements could be undermined if the requirements were not consistent internationally. For example, firms could choose to operate in the jurisdictions where products are exempted from the margin requirements. In this instance margin across the system would not increase even if certain jurisdictions do implement margining requirements for single-stock equity options and index options. Having considered the data and the international status, the PRA is of the view that for these contracts, the risk of the margin requirements being undermined through unilateral implementation is material. The PRA continues to support full implementation of the BCBS standards, but fragmented implementation will likely not achieve its goal.

3.5 The PRA considers proposal 2 would advance the PRA’s primary objective to promote the safety and soundness of UK firms. Firms would retain market access, which in turn prevents market dislocation. The framework already exempt transactions newly entered into when firms fall out of scope. The PRA considers it remains prudent to extend the exemption to legacy trades entered into with the same firms when they were previously in scope. The PRA considers it would be a disproportionate burden to continue the margin requirements after a firm ceases to be systemic as defined by the thresholds established in the BCBS-IOSCO framework.

3.6 The PRA has also considered the impact of the proposals in facilitating competition, the international competitiveness of the UK economy and its growth in the medium to long term. The PRA considers proposal 1 is compatible with facilitating medium to long-term growth and international competitiveness of the UK. Allowing the exemption to expire could lead to an increase in costs for trading and a shift in activity to other, lower regulated, jurisdictions. This could reduce the standing of the UK as a global financial centre. A smaller financial sector may be less able to lend to and support the real economy. Retaining the equity options business would promote markets that enable the pricing, hedging and sharing of risks. A stronger financial sector enables real-economy firms to do this efficiently and more cheaply. The PRA considers proposal 1 would therefore facilitate the secondary objective of growth.

3.7 On proposal 2 and 3, the PRA considers it remains a prudent approach while advancing the secondary competitiveness objective. The proposals reduce operational burden for third-country firms that trades in the UK derivatives markets, which would thus support UK competitiveness.

‘Have regards’ analysis

3.8 In developing the proposal, the PRA has had regard to the FSMA regulatory principles and the aspects of the Government’s economic policy as set out in the HMT recommendations letter from November 2024. The following factors, to which the PRA is required to have regard, were significant in the PRA’s analysis of the proposal:

1. Efficient and economic use of PRA resources. The PRA considers proposal 1 to be the most efficient use of PRA resources. The Bank will continue to support a uniform implementation of the BCBS-IOSCO standard across jurisdictions, this will take time. As such, a rolling temporary treatment would require going through the policy making process on a regular basis, while the fundamental dynamics remain unchanged. This would not use the PRA resources in the most efficient way. The PRA considers proposals 2 and 3 recognise the variability of the firms that the PRA supervises (or requirements that would apply to PRA-supervised firms based on the different businesses carried out by its OTC derivatives counterparty) and ensures the requirements would be applied appropriately and proportionately.

2. The desirability where appropriate of [the PRA] exercising its functions in a way that recognises differences in the nature of, and objectives of, businesses carried on by different persons (including different kinds of persons such as mutual societies and other kinds of business organisations) subject to requirements imposed by or under [FSMA]: The PRA considers that proposal 1 recognises the variability of the firms that the PRA supervises. Equity options trading is a cross-border activity. Unilaterally implementing a margining standard for equity options might incentivise firms to book equity options trades in less-regulated jurisdictions. This might put UK firms at a disproportionate advantage. The proposal seeks to recognise those differences and ensures the requirements would be applied appropriately. The PRA considers proposals 2 and 3 ensure the requirements are applied in a proportionate manner relative to the risk.

3. The principle that a burden or restriction which is imposed on a person should be proportionate to the benefits which are expected to result from the imposition of that burden: The PRA considers proposal 1 would apply the requirements in a proportionate manner, ensuring risk mitigation and benefits are balanced. A fragmented implementation of margining standards across jurisdictions will not achieve its intended goal of mitigating financial stability risk. As such implementing margin would create a disproportionate burden to UK businesses whilst potentially having limited macro or micro prudential benefits. The PRA considers proposals 2 and 3 would support the sustainable growth of the UK economy by reducing operational and margining costs when trading with firms subjected to the margining requirements in other jurisdictions and not introducing idiosyncratic burden to UK firms/markets.

4. The desirability of sustainable growth in the economy of the United Kingdom in the medium to long term: The PRA considers proposal 1 would support the sustainable growth in the economy of the United Kingdom by remaining consistent with other jurisdictions and not introducing idiosyncratic burden to UK firms/markets.

3.9 The PRA has had regard to other factors as required. Where analysis has not been provided against a ‘have regard’ for these proposals, it is because the PRA considers that ‘have regard’ to not be a significant factor for these proposals.

PRA Cost benefit analysis (CBA)

3.10 The PRA has considered the cost-benefit analysis of the proposed indefinite exemption of margin for single-stock equity options and index options. This CBA is assessed against the status absent any policy action ie exemption expires, and margin requirements apply. In this case, risks are margined, and capital requirements are reduced. An indefinite exemption of margin would instead result in firms requiring less margin, but they would be subject to higher capital requirement. The PRA acknowledges, should the proposal go ahead, that industry won’t feel benefits or cost noted here relative to the status quo.

3.11 This assessment has been made based on the PRA data collection exercise referenced in paragraph 2.3. The survey found that allowing the exemption to lapse for single stock and index equity options margin would impose material compliance costs on market participants (see paragraph 3.13). These costs would be avoided if the indefinite exemption were to be implemented. The data indicates that business could move jurisdiction to avoid the margin requirements and the associated costs, eliminating the potential benefit to financial stability.

3.12 PRA notes that exempting margin would generally represent a less prudent approach, and an increase in risks to financial stability. However, the PRA has assessed that requiring margin for single-stock equity options and index options is unlikely to have any practical beneficial effects for financial stability and considers that, absent any margin requirements, the prudential risks of OTC derivatives are still captured through risk-based capitalisation. While there are differences between margin and capital, in terms of amount, fungibility, and incentives, the capital requirement framework has a clearly defined, and accepted, mechanism to cover the risks associated with OTC derivatives.

3.13 Using data from the survey, the PRA analysed compliance costs avoided (ie benefits) of the proposed indefinite exemption using different assumptions about how much business would migrate out of the UK: more outward migration implies more compliance costs avoided (ie higher benefits to the indefinite exemption). In the scenario where all foreign businesses migrated out of the UK but all business between UK counterparties stayed, UK firms would face an additional financial compliance cost of £0.74 billion (taking into account the additional cost of margin of £1.08 billion less reduced capital costs of £0.34 billion) and additional operational costs of £0.0031 billion. This implies a net benefit of £0.74 billion in implementing an exemption to margin indefinitely. Given the risks are mitigated as outlined in paragraph 3.12, the PRA considers there to be minimal costs incurred from the introduction of an indefinite exemption.

3.14 The PRA considers proposal 1 brings wider benefits to the UK economy (eg through greater employment earnings and tax revenues) from avoiding the migration of business, which the PRA has not quantified. Given the level of the costs were the exemption to expire, UK counterparties’ business might migrate also. Should that happen, the compliance costs avoided by the proposed exemption would be lower and the wider benefits would be higher.

3.15 In light of the minimal costs induced from the introduction of an indefinite exemption (refer to paragraph 3.13), the PRA considered that FSMA does not require CBA and that consulting the CBA Panel would be disproportionate.

3.16 In the absence of proposals 2 and 3, the PRA considers that:

• Firms would have to continue exchanging margin on legacy contracts with firms that are no longer in scope of IM requirements, continuing to incur operational and margin costs for the life of the trade. Firms would otherwise be able to enter into an identical but new contract with the same counterparty and not have to exchange margin. As such, the prudential effect of the proposal is minimal.
• Different calculation dates would require firms to undertake the same relevant assessment of the requirements and the subsequent implementation of the requirements multiple times on different dates with the same counterparties where they are subjected to the margining requirements in other jurisdictions. The PRA considers that these introduce an unnecessary operational burden with minimal prudential benefit.

3.17 The PRA does not consider there to be any additional costs as a result of implementing its proposals. The PRA therefore considers the costs expected to be incurred to both it and firms not to be material relative to the benefits.

Impact on mutuals

3.18 PRA considers that the impact of the proposed changes on mutuals is expected to be no different from the impact on other firms. The reasons for this include the fact that firms that transact uncleared options are either PRA supervised firms or FCA supervised firms and are included in these proposals.

Equality and diversity

3.19 In developing its proposals, the PRA has had due regard to the equality objectives under s.149 of the Equality Act 2010. The PRA considers that the proposals do not give rise to equality and diversity implications because they do not have any impact on the Equality Act 2010.

4: The FCA’s statutory obligations

Compliance with legal requirements

4.1 This Chapter records the FCA’s compliance with a number of legal requirements applicable to the proposals in this consultation, including an explanation of the FCA’s reasons for concluding that the proposals are compatible with certain requirements under the FSMA.

4.2 When consulting on technical standards, the FCA is required by section 138S(2)(f) and 138I(2)(d) of FSMA to include an explanation of why it believes making the proposed rules are:

• compatible with its general duty, under s1B(1) of FSMA, so far as reasonably possible, to act in a way which is compatible with its strategic objective and advances one or more of the FCA’s operational objectives;
• so far as reasonably possible, advances the secondary international competitiveness and growth objective, under s1B(4A) of FSMA; and
• complies with its general duty under s1B(5)(a) of FSMA to have regard to the regulatory principles in section 3B FSMA.

4.3 The FCA is also required by s138S(2)(h) and s138K(2) of FSMA to state its opinion on whether the proposed technical standards will have a significantly different impact on mutual societies as opposed to other authorised persons.

4.4 This Chapter also sets out the FCA’s view of how the proposals are compatible with the duty on the FCA, in so far as is compatible with acting in a way which advances the market integrity objective, to discharge its general functions (which include technical standards) in a way which promotes effective competition in the interests of consumers (s1B(4) of FSMA).

4.5 In addition, this Annex explains how the FCA has considered:

• The 15 November 2024 recommendations made by HM Treasury under s1JA of FSMA about aspects of the economic policy of His Majesty’s Government to which the FCA should have regard in connection with its general duties; and
• the secondary statutory objective to facilitate the international competitiveness of the UK economy and its growth in the medium to long term as outlined below.

4.6 This section includes the FCA’s assessment of the equality and diversity implications of these proposals.

4.7 Under the Legislative and Regulatory Reform Act 2006 (LRRA) the FCA is subject to requirements to have regard to a number of high-level ‘Principles’ in the exercise of some of the FCA’s regulatory functions and to have regard to a ‘Regulators’ Code’ when determining general policies. The FCA is not subject to these requirements when exercising legislative functions like making technical standards, but the FCA has had regard to the principles for the proposals which consist of a supervisory policy as set out below.

The FCA’s objectives and regulatory principles: Compatibility statement

4.8 The proposals in this consultation are intended to advance the FCA’s operational objective of market integrity.

4.9 The FCA considers that proposal 1 is justified and continues to meet our operational objective of market integrity. The equity options market is already subject to significant levels of risk mitigation through voluntary margining and other capital requirements. Given fragmented international implementation, the introduction of mandatory margin requirements would likely drive much of this business offshore where it would remain unmargined, thereby still not enhancing market integrity.

4.10 The FCA also has a secondary objective to support the international competitiveness and growth of the UK economy in the medium to long term. Proposal 1 supports this secondary objective by maintaining a level playing field for UK firms and removing unnecessary barriers to business operating in the UK.

4.11 The FCA also considers that proposals 2 and 3 meet our objective to ensure that relevant markets function well, since they reduce unnecessary operational burdens and improve firms’ ability to transact with counterparts in other jurisdictions.

4.12 The FCA considers that proposals 2 and 3 allow for a reduction in operational and margin costs for firms without any significant risk, thereby more efficiently pursuing our primary objective to enhance market integrity.

4.13 The FCA also considers that these proposals support our secondary objective to support the international competitiveness and growth of the UK economy in the medium to long term, by maintaining a level playing field for UK firms and removing unnecessary barriers to business operating in the UK.

4.14 The FCA also consider that these proposals do not contradict our need to contribute towards achieving compliance by the Secretary of State with section 1 of the Climate Change Act 2008 (UK net zero emissions target) and section 5 of the Environment Act 2021 (environmental targets).

‘Have regards’ analysis

4.15 In preparing the proposals set out in this consultation, the FCA has had regard to the regulatory principles set out in s3B of FSMA.

1. The need to use resources in the most efficient and effective way. Proposal 1 will remove the uncertainty and future work associated with temporary exemptions. Proposals 2 and 3 will reduce the cost of compliance for some firms. We therefore consider the proposals compatible with this.

2. The need to use resources in the most efficient and effective way. The proposals are consistent with this principle because they each in aggregate provide a net reduction in cost and operational burdens to firms.

3. The desirability of sustainable growth in the economy of the United Kingdom in the medium or long term. The FCA considers the proposals consistent with this principle as they maintain a level playing-field with other jurisdictions and reduce unnecessary burdens for firms.

4. The principle that consumers should take responsibility for their decisions. The FCA considers that the proposals do not undermine this principle.

5. The responsibilities of senior management. The FCA considers that the proposals do not undermine this principle, since they do not significantly impact these responsibilities.

6. The desirability of recognising differences in the nature of, and objectives of, businesses carried on by different persons including mutual societies and other kinds of business organisation. The FCA considers that we have taken steps to examine the effect of the proposals on different market participants and that these proposals do not undermine this principle.

7. The desirability of publishing information relating to persons subject to requirements imposed under FSMA, or requiring them to publish information. This principle is not relevant to these proposals.

8. The principle that the FCA should exercise its functions as transparently as possible. The proposals are consistent with this principle.

9. The importance of taking action intended to minimise the extent to which it is possible for a business carried on (i) by an authorised person or a recognised investment exchange; or (ii) in contravention of the general prohibition, to be used for a purpose connected with financial crime (as required by s1B(5)(b) of FSMA). The FCA considers that this is not relevant in relation to these proposals.

10. Expected effect on mutual societies. The FCA does not expect the proposals in this paper to have a significantly different impact on mutual societies.

11. HM Treasury recommendations on economic policy and the future secondary growth and international competitiveness objective. The FCA considers that these proposals are consistent with the recommendations in HM Treasury’s remit letter dated 15 November 2024 and issued to the FCA under s1JA of FSMA. In particular, the FCA also considers that the proposals are compatible with the HM Government’s defining mission to drive growth and the FCA’s secondary objective on the international competitiveness of the UK economy and its growth in the medium to long term. By providing a level playing field with other jurisdictions in a way which is consistent with the FCA’s operational objective of ensuring market integrity, the proposals maintain the UK’s competitiveness as a global financial centre relative to other major jurisdictions. The proposals also remove unnecessary operational and cost burdens for firms, compatible with the Government’s request in its Remit Letter that we consider growth and competitiveness across our policy making.

12. Compatibility with the duty to promote effective competition in the interests of consumers. In preparing the proposals as set out in this consultation, the FCA has had regard to the FCA’s duty to promote effective competition in the interests of consumers. The FCA considers that the proposals will support competition in the interests of consumers by striking a proportionate balance between ensuring the safety and soundness of firms and maintaining alignment with other jurisdictions so there is a level-playing field to enable competition in the interests of consumers.

Equality and diversity

4.16 The FCA is required under the Equality Act 2010 in exercising our functions to ‘have due regard’ to the need to eliminate discrimination, harassment, victimisation and any other conduct prohibited by or under the Act, advance equality of opportunity between persons who share a relevant protected characteristic and those who do not, and to foster good relations between people who share a protected characteristic and those who do not.

4.17 As part of this, the FCA ensures the equality and diversity implications of any new policy proposals are considered. The FCA has considered the equality and diversity issues that may arise from the proposals in this CP. Overall, the FCA does not consider that the proposals materially impact any of the group with protected characteristics under the Equality Act 2010.

Legislative and Regulatory Reform Act 2006 (LRRA)

4.18 The FCA has had regard to the principles in the LRRA in relation to the proposed policy. The FCA considers that this proposal is:

• transparent: the FCA is consulting on its approach to these proposals;
• accountable: the FCA is consulting and will publish a finalised policy after considering all feedback received;
• proportionate: the proposed policy will provide a net reduction in costs to firms;
• consistent: the FCA’s proposal will apply in a consistent manner to all in scope firms, including those regulated by the PRA; and
• targeted only at cases in which action is needed: the proposals are only targeted at firms within the scope of the UK EMIR margin requirements.

4.19 The FCA has had regard to the Regulators’ Code and considers that the proposal will help provide long-term clarity as to how the UK intends to apply margin requirements to derivatives transactions.

FCA cost benefit analysis (CBA)

Introduction

4.20 The FSMA (2000) requires the FCA to publish a CBA) of our proposed rules. Specifically, section 138I requires the FCA to publish a CBA of proposed rules, defined as ‘an analysis of the costs, together with an analysis of the benefits that will arise if the proposed rules are made’.

4.21 In this CBA, we consider the impact to indefinitely exempt single-stock equity and index options from the UK bilateral margining requirements (proposal 1).

4.22 This consultation also proposes two further changes to remove mainly operational burdens which, as set out below, are not subject to a CBA.

4.23 Proposal 2 would remove the obligation to exchange Initial Margin (IM) on outstanding legacy contracts, where a firm subsequently falls below the in-scope thresholds. Currently, when a firm falls below the threshold, their existing trades are required to remain margined, even though for new trades that firm would not be required to post margin. Firms consequently have an incentive to enter into new contracts and cancel existing ones. The costs that arise from cancelling and creating contracts do not lead to any benefits for parties or the wider market. The proposals therefore do not impose any costs on firms but there is a small saving for firms.

4.24 Proposal 3 would permit UK firms, when transacting with a counterparty subjected to the margin requirements in another jurisdiction, to use that jurisdiction’s threshold assessment calculation periods and dates for which requirements apply to determine whether those transactions are subject to IM requirements. This would reduce the administrative burden that firms face but not otherwise affect the benefits the regime seeks to bring about. Consequently, there are no costs from this change and therefore we are not required to undertake a CBA.

Problem and rationale for intervention

4.25 Absent Proposal 1, UK EMIR would unilaterally apply margin requirements to equity options when the temporary exemption expires. This would likely lead to three types of costs:

The cost of margining

4.26 There are material direct costs from the requirement to exchange margin. Mandatory margin must be posted in the form of high-quality assets (eg cash, government securities, etc). The returns on these assets are generally below firms’ cost of capital and therefore represent a cost. Absent margin requirements, firms could put that capital to more productive use.

4.27 Margin exchange also creates operational and compliance costs. Firms must enter into specific arrangements with third parties to facilitate the exchange of margin. Unless the amount to be posted is below €500,000, firms must also calculate and exchange variation margin on a daily basis.

4.28 Absent proposal 1, there would therefore be considerably higher costs for UK firms relative to peers in other jurisdictions.

Lost profit and flight of market activity from the UK

4.29 Absent proposal 1, counterparties in other jurisdictions may be less willing to trade with the UK counterparties given the costs associated with doing so. As a result, foreign firms might be able to compete for business on more favourable pricing terms, or by offering lower cost options than UK counterparties. Consequently, some business would likely migrate to other jurisdictions, resulting in lower profits for UK firms.

Market fragmentation

4.30 The likely migration of some equity options trading from the UK absent proposal 1 would result in a fragmentation of equity option markets, with a potentially detrimental impact on price formation and liquidity. This could result in excessive price dispersion between trades between different parties increasing the cost of equity options for parties looking to gain exposure, or hedge risk, on equities. This could reduce liquidity, increasing trading cost for market participants

Our proposed intervention

4.31 Proposal 1 would implement an indefinite exemption for single-stock equity options and index options from the UK bilateral margining requirements. We consider this preferable to the alternative of allowing the existing exemption to expire without replacement, which would carry the costs noted above and put us out of alignment with other major jurisdictions.

Baseline

4.32 For any CBA, to assess the cost and benefits of the intervention we need to compare the outcomes under the policy proposals against a counterfactual. This baseline is what would happen absent our proposal. In this situation, absent intervention, the margin exemption would lapse, and firms would be required to post initial and variation margin on in-scope equity option contracts. This baseline is different from the status quo in which uncleared equity options are currently temporarily exempt from margin requirements. We acknowledge, should the proposal go ahead, that industry will not experience the benefits or cost noted here relative to this status quo.

4.33 Under the requirement to margin trades, we would expect a significant number of trades undertaken by FCA regulated firms to migrate to other jurisdictions. This is in line with the analytical approach taken in the PRA CBA. The extent to which trades migrate to other jurisdictions may be different for FCA regulated firms, compared to PRA regulated firms. This is because while we would expect the shift in trade from FCA regulated investment firms to be similar to that for PRA regulated firms, for other entities like pension and alternative investment funds who are using options to gain exposure to equities, or managing risk, trades may not be able to move jurisdictions to avoid margining.

4.34 However, there are alternative options for FCA regulated firms and entities, other than investment firms, to take when considering the response to the margin requirements for their equity option trades. Investors may no longer engage in equity option trades. If firms no longer engage in these trades, they lose the exposure or ability to hedge risk in their portfolios.

4.35 Firms could also change the counterparties that they trade with. By doing so, these firms may be able to reduce the required initial margin below the €50 million threshold under which initial margin is not required to be paid. They would still need to pay initial margin if the variation margin payments were above €500,000.

4.36 This baseline assumes the current international context remains unchanged.

Summary of Impacts

4.37 The following tables set out the costs and benefits of the FCA proposals.

4.38 The EANCB is the annualised present value of the net direct costs to business over 10 years. The costs are negative to reflect the lower costs to business from being exempted from margin requirements for equity options.

Benefits

Lower costs of administering margins

4.39 The mandatory exchange of margin carries administrative costs, which Proposal 1 reduces relative to the baseline.

4.40 The PRA’s survey data found that the increase in administration costs absent Proposal 1 for the surveyed firms would be £106,000 – £980,000. We use these numbers to estimate the savings to FCA regulated firms.

4.41 PRA dual regulated firms enter into many more equity option contracts than FCA solo-regulated ones. In EMIR reporting data, we observe that on average, PRA firms have approximately 33 times as many trades to administer as FCA firms.

4.42 We assume that these costs are proportional to the number of trades. Consequently, we assume that the costs are between £3,000 – £30,000. For the 208 firms we observe are under UK EMIR, this means Proposal one is likely to save FCA EMIR firms £620,000 – £6.2 million per annum relative to the baseline.

Lower margining costs

4.43 Absent proposal 1, FCA firms that continued in-scope equity options activity in the UK would face an increase in the costs associated with posting mandatory margin. Proposal 1 would remove this cost increase. However, we assume that in this baseline scenario, investment firms contracting with firms outside the UK would in many cases migrate this business to other jurisdiction. For UK-UK transactions involving FCA firms, much of this activity might remain below the thresholds requiring mandatory margin exchange. In addition, firms might adjust their businesses to avoid mandatory margin. Consequently, proposal 1 may not result in a very significant direct decrease in the cost of mandatory margining for FCA firms outside of the larger counterparty relationships.

Other indirect benefits

4.44 There are a number of other potential indirect benefits to firms from proposal 1, which we do not think it is reasonably practicable to estimate. These are explained in the following four sections.

Maintenance of activity in the UK

4.45 Proposal 1 removes the likely loss in profits for UK firms from the baseline scenario in which firms divert equity options activity overseas to avoid mandatory margin requirements and from reduced competitiveness of UK firms in this market relative to their counterparts.

Costs associated in structuring trades

4.46 Under the baseline scenario, firms would be incentivised to remain under the €50 million threshold for mandatory margin requirements. This could incentivise firms to increase the complexity of their portfolios and to transact with counterparties that might not otherwise offer the best price. Proposal 1 removes the possible increase in costs and risks associated with this.

Continued use of equity options within portfolios

4.47 Under the baseline scenario, investors may no longer engage in equity option trades, to avoid mandatory margin, meaning their portfolios no longer benefit from the desired exposure or hedging. Proposal 1 removes the possible increase in costs and risks associated with this.

Fragmentation of equity options markets

4.48 Under the baseline scenario, foreign counterparties may be less likely to trade with UK counterparties, fragmenting liquidity. This will lead to increased prices and a potential premium to transacting with UK participants. Proposal 1 removes the costs associated with this.

Costs

Familiarisation costs

4.49 We do not expect any significant costs to firms to arise from our intervention.

4.50 In most CBAs that we publish, we consider that firms will incur costs in understanding the new requirements they face. In this instance, we do not expect firms to incur these familiarisation costs because our rules seek to maintain the status quo. In our baseline, firms would need to ensure they understood the changes to the margin requirements. We do not think these costs are materially different for our proposals. We note that the instrument to make the margin exemption is very short and will not require significant resources in understanding this proposal.

Market integrity costs

4.51 The BCBS-IOSCO requirements were implemented to prevent the build-up of large counterparty exposures between market participants which were not appropriately risk-managed. However, we do not expect there to be a material increase in market integrity risk from unmargined equity options as a result of our proposals. This is because our baseline assumes no great increase in margining absent proposal 1 since trades would likely migrate or firms adjust their behaviour to avoid the costs of margining. We note that investment firms will still need to hold capital against the counterparty risks they face when contracts are not margined.

Wider economic impacts, including on secondary objective

4.52 The purpose of these changes is to maintain equity option margining activity within the UK. Maintaining activity in the UK helps to prevent a detrimental impact on UK economic activity and seeks to maintain the UK’s position as the centre of international finance.

Monitoring and evaluation

4.53 We do not propose any significant ongoing monitoring or evaluation of our proposals given that we do not envisage any material changes.