Long-Bond Liquidity Trap Sends Denmark’s Top Fund Down Curve

Denmark’s biggest pension fund, ATP, says the burden of regulatory restrictions designed to rein in risky trades has now led it to abandon its reliance on the longest-dated bonds.

The fund, based north of Copenhagen, said earlier this week it was shortening interest rate guarantees to savers amid a lack of liquid assets with maturities of 30 years and longer. Policy holders will now have the rates paid on their savings guaranteed for 15 years at a time, versus lifelong guarantees. ATP said the change will help protect pensioners’ purchasing power.

“It’s the sum of the financial crisis, tighter regulation, higher capitalization requirements for banks and maybe even the threat of a financial transaction tax that has drained liquidity,” Carsten Stendevad, chief executive officer of ATP, said in a phone interview. “I actually don’t care why this happened, I just need to deal with it.”

Stendevad, a former Citigroup Inc. banker who joined ATP last year, has repeatedly argued that financial regulation targeting the riskiest operations of commercial banks is hitting ordinary savers. In May, he said ATP struggled to find buyers for about 7 billion euros ($9.4 billion) in long German government bonds at the end of 2013. That followed pleas to German Chancellor Angela Merkel to reconsider pushing ahead with the financial transactions tax.

A Harbinger

“We’ll keep the long bonds we hold now. We still need them for the existing guarantees,” Stendevad said. “In the 15 to 20 year maturities there are plenty of bonds and other fixed income products to buy.”

ATP’s strategy shift may be a harbinger of things to come elsewhere in the pension and life insurance industry, according to Bert Lourenco, head of EMEA rates research at HSBC Bank Plc in London.

“Even though it has little immediate impact on the euro curve, in the long run it will reduce the demand for very long end fixed income assets or swaps if adopted by more pension funds,” Lourenco said by e-mail. “We suspect that ATP’s decision could become an issue encountered by more pension funds and life insurance companies.”

The change, which only affects new contributions, means that savers can benefit earlier from a rise in interest rates, instead of being locked into the near-zero returns dominating markets today, Stendevad said. Until now, rates of return were fixed to savers’ annual contributions, and then applied for the duration of a policy.

Discount Curve

“A protracted low rate environment makes guaranteed returns increasingly difficult to achieve, so more flexibility for payouts is required,” Lourenco at HSBC said.

The latest changes in ATP’s strategy affect the future treatment of a portfolio that today holds about 520 billion kroner ($93 billion) in assets. The step follows a decision in October to cut the fund’s exposure to rate swings by altering the discount curve it uses to calculate the value of its future liabilities. The curve fixes the discount rate at 3 percent for maturities of 40 years and longer. ATP estimated the move, designed to counter the growing regulatory cost of hedging, cut its interest rate risk by about 25 percent.

“When we changed the discount curve the impact on our rate risk was instant,” Stendevad said. The latest change to ATP’s guarantees “will only gradually influence our hedging portfolio.”

Repo Market

ATP’s efforts to adjust its investment strategy mark the latest example of the unintended consequences of financial regulation. Legislators from the U.S. to Europe have struggled to design a set of rules that will help prevent another crisis after bank losses since 2007 dragged down the global economy, triggering what came to be known as the Great Recession.

Yet lawmaker and regulator efforts have on occasion weakened markets that are essential to financial system health. Earlier this year, there were signs it was becoming harder for traders in the $1.6 trillion-a-day U.S. market for repurchase agreements to borrow and lend securities. In July, uncompleted repo trades touched some of the highest levels since the financial crisis started.

For investors limited in their options because of commitments to savers, such market distortions can be hard to accommodate.

“ATP’s pension liabilities are very long dated and therefore we have relatively little investment flexibility to hedge our liabilities,” Stendevad said. “Up until now we’ve been forced to buy only the longest fixed-income instruments.”

ATP holds Danish and German government bonds in its main portfolio, as well as krone and euro swaps to cover its pension liabilities. The assets “will remain very good and safe bond investments,” Stendevad said. “The change will be that we remain in the same investment universe, just with shorter maturities, though we’ll stay in the long end.”

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