DENMARK, home to the world’s top-ranked pension system, will toughen oversight of the US$500 billion industry after regulators observed a surge in risk-taking linked in part to more widespread use of hedge funds.
The Financial Supervisory Authority in Copenhagen will require pension funds to submit quarterly reports on their alternative investments to track their use of hedge funds, exposure to private equity and infrastructure projects. The decision follows funds’ failures to account adequately for risks in their investment strategies, according to an FSA report.
The regulatory clampdown comes as Denmark deals with risks it says are inherent to a system due to be introduced across the European Union in 2016. The new rules will allow pension funds to invest according to a so-called prudent person model, rather than setting outright limits. In Denmark, the approach has proven problematic for the only EU country to have adopted the model, said Jan Parner, the FSA’s deputy director general for pensions.
“The funds are setting up for their release from the quantitative requirements, but the problem is, it’s not clear what a prudent investment is,” Parner said in an interview. “The challenge for European supervisors is to explain to the industry what prudent investments are before the opposite ends up on the balance sheets.”
Denmark, which has almost two years of experience with the approach after its early adoption in 2012, says a lack of clear guidelines invites misinterpretation as firms try to inflate returns.
The new framework comes as European policy makers look for ways to spur a recovery by making some assets cheaper to hold. The European Commission on Oct 10 decided to set a lower charge on asset-backed securities than the European Insurance and Occupational Pensions Authority recommended.
The rule, which reflects the cost for funds of holding assets, means insurers face a 2.1 percent charge on AAA securities, compared with EIOPA’s 4.3 per cent recommendation. For BBB assets, the charge will be 3 percent, versus 17 per cent proposed by the EIOPA.
Denmark is telling its industry, rated the world’s best three years in a row by the Melbourne Mercer Global Pension Index, to take a conservative view on what a “prudent person” would invest in.
“Supervisors are not saying no, but we have to warn them not to get too enthusiastic,” Parner said. “There’s a concern that funds underestimate the underlying risk and get too high a concentration in certain areas, exposing funds to credit risk, which is cyclical and which funds haven’t previously had.”
Danish funds and insurers have overestimated the value of alternative investments they made while failing to adequately account for the risks, the FSA said in a February report.— Bloomberg