Liquidity Trap Hitting AAA Bonds Has ATP CEO Sounding Alarm

Carsten Stendevad, chief executive officer of Denmark’s biggest pension fund, says some of the world’s biggest bond markets are becoming dangerously illiquid.

Overseeing $130 billion in assets, the 41-year-old former Citigroup Inc. banker is urging policy makers to take seriously evidence that even the safest assets are getting harder to offload amid tighter regulatory requirements. He says ATP struggled to find buyers for about 7 billion euros ($9.7 billion) in German government bonds at the end of last year.

“It was amazing,” Stendevad said in an interview in his office north of Copenhagen. “One of the world’s biggest banks, which before 2008 would have been able to trade any quantity of German government bonds at any time of day, was not even willing to offer a quote for a reasonable size.”

Stendevad says his biggest concern now is that regulatory intervention will distort the markets he relies on to manage pension savings. Last year, he asked Chancellor Angela Merkel to think twice before moving ahead with the financial transactions tax, warning ATP would need to sell German bonds if the levy was imposed. Europe’s decision to commit to tighter rules is now having some unintended consequences, he said.

Stendevad says he’s worried regulators will end up ensnaring ordinary savers in their efforts to punish big banks. He says ATP’s difficulty in offloading German government bonds was linked to the bank in question, which he didn’t identify by name, being uncertain on how the transaction would be treated under proprietary trading rules.

Derivative Bets

Curbs designed to stop speculation using derivatives are instead hitting long-term investors in some of the world’s best-rated markets, according to Stendevad.

“We’re not talking about selling some exotic instrument here,” he said. “We’re talking German government bonds.”

The 2008 financial crisis drove regulators on both sides of the Atlantic to shield taxpayers from having to bail out troubled banks. The measures included curbs on trades that weren’t on behalf of clients.

U.S. lawmakers in December passed the so-called Volcker rule, part of the Dodd-Frank Wall Street Reform and Consumer Protection Act, to prevent banks protected under deposit insurance programs from using their own funds for speculative trading. European lawmakers may vote on similar rules later this year.

Curbs will give “authorities ways to interfere if banks’ market making or other operations lead to too large risks to the banks’ stability and future,” Erkki Liikanen, Finland’s central bank governor and author of the Liikanen report, told reporters in Athens on April 2.

Liikanen Report

The framework, which Liikanen devised to prevent deposit banks from taking large positions and risks, is ill-suited to Europe’s needs, Jesper Rangvid, chairman of Denmark’s government-appointed committee examining the causes of the financial crisis, said in a telephone interview.

“Some banks in the U.S. got into trouble investing in sub-prime debt, but no other trading scandals have forced big lenders to their knees,” Rangvid said. “If you want to govern banks’ trading risks, ring-fencing is a much better option as it will force banks to raise the necessary capital.”

Denmark’s central bank has criticized curbs on proprietary trading, arguing the measures miss their target.

“Proprietary trading wasn’t the cause of the crisis in Europe,” Danish central bank Deputy Governor Per Callesen said in an interview in March. “Problems were caused by traditional lending. Now they want to create a system where banks are less diversified, which we’re not convinced is actually healthy.”

Poorest Citizens

Henrik Ramlau-Hansen, chief financial officer at Danske Bank A/S, said “there’s no doubt it would make the market and banking more complicated,” in a phone interview today. “So people have to consider doing this very well before going ahead.”

After advising some of the world’s largest institutional investors while working at Citigroup, Stendevad now oversees assets for some of Denmark’s poorest citizens.

“We never want to be in a position where we have to give people less money back than we promised them,” he said. “This means we have to give realistic promises, and ensure that we hedge all our liabilities.”

ATP’s exposure to rate swings dropped after it rewrote its discount curve in October, fixing the rate it uses to calculate how much it owes over time at 3 percent for maturities of 40 years and longer. ATP estimates the move, designed to counter the growing regulatory cost of hedging, cut its interest rate risk by about 25 percent.

Cab Driver

For Stendevad, the goal was to prepare ATP for a market in which liquidity is scarce and the cost of trading derivatives to guard against risk is rising.

The fund’s profit rose 28 percent in the first quarter from a year earlier, buoyed by its stock portfolio, it said yesterday.

“The other day a cab driver quizzed me the whole ride on ATP’s performance,” Stendevad said. “He finally looked me in the eye through his rear view mirror and told me he was counting on me not to mess up his pension. It was different from a banking performance review, but it felt no less intense.”

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