The Dutch central financial institution is looking on the nation’s pension funds to contemplate boosting holdings of money and different liquid belongings to make sure that they will keep away from the turmoil that has hit the UK.
Officials on the De Nederlandsche Bank have requested native retirement funds to verify for indicators of stress, recommending that they evaluate liquidity guidelines and report on any want for hearth gross sales of belongings, individuals briefed on the matter advised the Financial Times.
The transfer comes as UK pension schemes have scrambled to promote belongings in response to a drop in authorities debt costs that sparked collateral calls in hedging methods, following Westminster’s ill-fated “mini” Budget.
So far, the danger to the Netherlands — the EU’s largest pensions market — is deemed to be manageable. But the DNB’s cautious method underlines how the tip of a budget cash period and low rates of interest demand new scrutiny of the internal workings of economic techniques world wide.
“What we see at the moment is that financial institutions basically are coming to the assessment that the period of low and structurally declining interest rates combined with low volatility is over,” stated Lex Hoogduin, a professor at Groningen college and a former board member of the Dutch central financial institution.
France’s central financial institution chief additionally warned in an FT interview this week that the current turmoil within the UK’s bond market illustrates the “vicious loop” that governments face in the event that they undermine efforts by rate-setters to curb hovering inflation.
The marketplace for office pensions within the Netherlands accounts for nearly 70 per cent of all eurozone pension fund belongings, and the Dutch system shares many similarities with the UK, together with massive defined-benefit pension liabilities, the place schemes decide to pay retirees a set quantity based mostly on their wage and size of service.
Few different EU nations have such large DB pension techniques, with France, Germany, Italy and others relying as a substitute on authorities pay-as-you-go techniques, the place retirement advantages are paid solely from contributions by employers and workers.
Many Dutch pensions additionally use derivatives contracts open for a few years to assist them match their belongings with their liabilities and shield in opposition to adjustments in rates of interest. Overall, Dutch pensions accounted for four-fifths of the derivatives of all euro space pension funds, in keeping with EU regulators.
Such contracts are delicate to every day strikes in market costs and have to be backed by margin, a sort of insurance coverage, to cowl the danger that one facet of the commerce defaults.
“Some [commercial] advisers are suggesting they should increase their liquidity buffers to cover this risk. But so far there is no panic selling going on, unlike the UK,” stated Bas van Zanden, a senior analyst at Dutch lender Rabobank.
Rising yields are typically constructive for pension funds, however the unstable strikes in international bond markets imply that Dutch funds have additionally contributed €82bn to margin calls this yr to maintain their positions open, in keeping with central financial institution information. The calls for have been the biggest requires the previous three years.
The derivatives that pensions use are usually tied to the Euribor interbank lending charge, which has been much less unstable than market costs for UK gilts. Analysts at Swiss financial institution UBS stated in a current word that the distinction had allowed Dutch schemes “to generate cash rather than engage in a fire-sale”.
Klaas Knot, the Dutch central financial institution governor, additionally pointed to a number of structural explanation why the native market was extra steady in an interview with Financieele Dagblad final week.
“Dutch pension funds have diversified their investments more, because they run no exchange rate risk within the eurozone, and the eurozone government bond market is much deeper [than the UK’s],” stated Knot. The €1.4tn of belongings managed by Dutch pension funds is sort of as large because the UK sector, however the marketplace for UK authorities debt, at £2.1tn, is far smaller than the full excellent quantity of eurozone sovereign debt at €9.7tn.
This implies that Dutch pension funds are much less more likely to must resort to promoting belongings quick at low costs, and if they’re pressured into gross sales, these are much less more likely to trigger a vicious circle of falling bond costs.
Knot flagged that the liquidity necessities within the Netherlands are more durable than within the UK, which doesn’t have equal necessities for pension funds.
The Dutch central financial institution requires pension funds to file quarterly stories to indicate if they’ve sufficient money and liquid belongings to resist a 0.5 proportion level rise in Euribor charges over 48 hours or a 1 proportion level rise over three months. Many have additional buffers on high of this, and none have breached these limits in current weeks.
Liability pushed funding (LDI) methods have been utilized by many British pension funds to hedge 85 per cent of their rate of interest threat, in keeping with actuarial consultancy LCP, making them the primary supply of margin calls.
But LDI methods are utilized by solely a tenth of Dutch pension funds — and people are largely smaller schemes. Dutch pension funds additionally solely hedge about 40 per cent of their rate of interest threat. In comparability, UK funds’ hedging ranges have been round twice as excessive in 2020, in keeping with UK trade estimates, leaving them extra uncovered to margin calls when charges rise.
However, a harsher stress check of Dutch pension funds’ use of rate of interest swaps by the European Central Bank in 2020 revealed that if bond yields jumped one proportion level in a single day it might require them to submit as a lot as €47bn of additional collateral and end in an mixture money shortfall of as much as €15bn.
Moreover, the calls could be extremely concentrated, with 61 per cent of the general money shortfall attributed to 10 pension funds.
The ECB discovered that 96 per cent of Dutch pension funds might cowl this by utilizing extremely rated authorities bonds in addition to money to satisfy margin calls. They can do that as a result of most of their rate of interest swaps are organized bilaterally with banks and different establishments moderately than via central clearing homes, as they’re within the UK, which brings stricter guidelines.
Matthies Verstegen at Pensioenfederatie, the Dutch pension fund affiliation, stated its members have been “far less likely to set off the feedback cycle” that prompted turmoil within the UK. But he stated they have been “considering what happened in the UK and recalibrating their liquidity management where needed”.
Verstegen added that there was “an urgent need to improve access to intraday liquidity”, which had been squeezed by “post-financial crisis margin rules” and a scarcity of capability in repo markets, through which bonds might be transformed into money.
Additional reporting by Josephine Cumbo