NETHERLANDS - Risk managers are not sufficiently aware that hedging strategies could increase the overall risk of pension funds in current market conditions, the former director of the Netherlands Authority of the Financial Markets (AFM) has warned.

Gerald Santing, who was closely involved in the indexation communication of Dutch pension funds but left AFM earlier this year after a restructure, has claimed pension fund regulators should be more prudent when suggesting schemes should lower there vulnerability to interest changes by using interest swaps.

According to Santing, the risks swaps pose in the current market environment is not fully understood.

"It is notable that regulators currently have a preference for reducing the sensitivity of pension funds against interest changes, which is not illogical since buffers of funds have dropped steeply and more interest lowerings can be expected," he said.

"However, nowhere have I read about a link with the credit crisis, yet the instruments used to reduce these kind of risks - matching the duration of the liabilities and assets as much as possible - increase the counterparty risk of the funds," added Santing.
 
New techniques to measure and hedge risks as part of quantitative risk management - through interest swaps and swaptions, currency overlays, CDS and CDOs - work well in what Santing dubs ‘normal times', though he warnspension funds should take heed of the counterparty risk as these instruments are constructed by banks and insurance companies.

"What is alarming is, thanks to the hedge, the risk taken by the pension fund would be acceptable even though it can be higher than without the coverage," concluded Santing.

If you have any comments you would like to add to this or any other story, contact Carolyn Bandel on +44 (0)20 7261 4622 or email carolyn.bandel@ipe.com