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Swedish Regulator Deals Blow to Bond Haven Play: Nordic Credit

Sweden’s financial regulator dealt a blow to the country’s status as a haven from Europe’s debt crisis as it moved to shield life insurers and pension funds from soaring liabilities fueled by record-low bond yields.

Swedish bonds plunged yesterday, posting the biggest move in global debt markets, after the Financial Supervisory Authority proposed a temporary floor on the discount rate used by life insurers and pension funds to calculate liabilities. The measure will protect them from yield declines and removes an incentive for them to buy debt.

“During the last couple years when yields have gone really low, Swedish yields have tended to go even lower than European peers and that dynamic will most likely be quite different now because there’s no domestic factor that will drive down Swedish yields,” said Mats Hyden, chief analyst for strategy research at Nordea Bank AB in Sweden. “We still may have some related flows in the euro zone.”

The largest Nordic economy offered refuge from Europe’s debt crisis thanks to its fiscal health and its decision to remain outside the euro. The AAA rated nation, one of only 12 left, will have a debt level of 36 percent of gross domestic product this year, compared with a European Union average of 86 percent, according to the European Commission.

Sustainable Yields

Sweden’s 10-year yield surged 31 basis points, or 0.31 percentage point, to 1.45 percent yesterday, the biggest move since at least 1990. The 10-year went from yielding less than Germany yesterday to eight basis points more. The two-year yield surged 16 basis points to 0.87 percent.

The bonds recouped some losses today, with the yield on the June 2022 note sliding seven basis points to 1.38 percent and the two-year declining five basis points to 0.82 percent.

“This is good news for all lifers as the FSA doesn’t view these yield levels as sustainable,” said Andreas Halldahl, head of Swedish rates in Stockholm at Storebrand Kapitalforvaltning, a unit of Norwegian insurer Storebrand ASA. “Most importantly, lifers weren’t the ones who bought long bonds all the way down here. It has mostly been flight-to-quality bids from international investors, central banks and sovereign funds.”

The watchdog’s move may hamper central bank efforts to stimulate the economy. The Riksbank has cut interest rates twice since December after the economy contracted amid waning demand for exports from Europe. While growth revived in the first quarter, key economic data since have shown a deepening contraction in the service industry and a rise in unemployment.

Policy makers in May proposed forming a 10 billion-krona portfolio of bonds as part of a strategy to help it purchase debt securities and guide long-term rates in times of crisis.

New Territory

“Time will tell” what the effect will be, Riksbank Governor Stefan Ingves said yesterday in Copenhagen. “When you operate insurance companies in a low interest environment then you sort of move into new territory compared to where we were. That essentially comes from the fact that with low nominal interest rates then you have to try to deal with that as best as you can and that’s what the FSA is doing.”

The regulator proposed a floor over the next year to the rate at which life insurers and pension funds discount their liabilities in solvency calculations. The liabilities are discounted by a market rate and their value rises when rates fall. The companies will be allowed to calculate the rate according to the current method based on May 31 closing prices.

Insurance Takers

“This is the best way to protect the interests of insurance takers in a situation with messy markets, a lot of turbulence and when it’s difficult to predict what will happen,” said Martin Andersson, director general at the agency, in a phone interview yesterday. “It’s sound to have a model based on market valuations. The problem is that we right now have exceptional market conditions in Europe and we don’t want big, short-term fluctuations to spill over.”

Halldahl said regulators in Denmark use a moving average to calculate the discount rate. In Norway, yields and swaps are trading a “fair bit higher” so it may not be urgent to change methods right now, he said. “But if they would approach Swedish levels, I guess they might be looking to Sweden to see how we have handled the situation,” he said.

Ole Sohn, Denmark’s business and growth minister, said yesterday that his country is also considering measures to help pension funds to cope with soaring liabilities. The government may raise the discount rate, helping reduce their obligations, he said in a statement.

‘Complete Surprise’

According to Charlotte Asgermyr, an analyst at SEB AB in Stockholm, yesterday’s move came as a “complete surprise” as the regulator earlier indicated that insurers would have to lower their guarantees to customers. Still, it may not be enough to halt a bond rally, given the potential for further stimulus in Europe and the U.S., she said.

“The recent trend in long bond yields has been a massive drop,” she said. “Yesterday’s and today’s movements follow from market expectations that the Federal Reserve will deliver quantitative easing and that the European Central Bank will cut rates in July. It remains to be seen if they deliver before you could say that we have passed the bottom in long bond yields.”

The ECB on June 6 kept its benchmark rate at a record low of 1 percent, even as President Mario Draghi said that officials stand ready to act as the growth outlook worsens. Federal Reserve Chairman Ben S. Bernanke told lawmakers yesterday that the central bank has options for further easing while declining to specify them.

“We predict that the turbulence that exists today won’t continue for a long time, but it could very well be that we will have to live with low rates for a long time and companies need to learn to adjust to that,” said the FSA’s Andersson.

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