Denmark To Monitor Pensions' Use Of Hedge Funds

Oct 21 2014 | 12:22pm ET

Denmark is cracking down on risk-taking by pension funds.

The country's Financial Supervisory Authority will require funds to file quarterly reports on their alternative investments—hedge funds, private equity, infrastructure.

According to the market watchdog, the decision stems from the failure of the country's $500 billion pension fund industry to adequately account for risks in their investment strategies.

The regulator said the risks are inherent in an investment model adopted in Denmark two years ago—and due to spread throughout the EU in 2016—which allows pensions to invest according to a “prudent person” model, rather than to set limits. Solvency II, as the framework is known, is a fundamental revamp of the capital adequacy regime for the European insurance industry that has been in the works for over a decade. It aims to allow companies greater flexibility to invest while tying capital requirements to their risk of being unable to meet liabilities.

“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,” Jan Parner, the FSA’s deputy director general for pensions, told Bloomberg. “The challenge for European supervisors is to explain to the industry what prudent investments are before the opposite ends up on the balance sheets.”

In a February report, the FSA said Danish pensions—which boast a very good reputation worldwide—have overestimated the value of alternative investments while failing to account properly for the risks.

“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," said Parner.

At the end of 2012, Denmark's pension funds held about 152 billion kroner (US$26 billion), about 7% of their balance sheets, in equity stakes and other assets sold in markets the FSA considers illiquid, opaque and thin.

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