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IPE special report May 2018

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Cost of clearing forcing pension funds to reconsider hedging approach

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The cost of centrally clearing trades associated with hedging programmes is forcing pension providers, including the UK’s Pension Protection Fund (PPF), to examine new approaches.

Opkar Sara, principal fund manager for asset allocation and investment strategy at the PPF, told IPE magazine the “unintended consequence” of increased regulation of the derivatives market was an increase in the cost of the lifeboat fund’s hedging programme.

“The Gilt repos are less impacted, and the assets affected are mostly ones that fall under the International Swaps and Derivatives Association’s purview – the swaps and total return swaps. These are impacted by clearing rules,” he said.

“We are looking for new ways to reduce that cost and decrease our reliance on them over the long term.”

Jannik Hjelmsted Nielsen, senior portfolio manager at Denmark’s PKA, also noted the increased costs that would come as a result of central clearing requirements, such as client broker fees.

“However, we have observed that, with other standardised instruments, such as rate futures, when clearing is introduced, spread costs fall,” he said.

“We hope for this positive impact because many other aspects point to higher costs in future.”

Sara also echoed previous comments by Martin Clarke, outgoing executive director of financial risk at the PPF, that it would examine other hedging options not reliant on clearing.

“One idea we have considered but have yet to implement is the use of illiquid assets such as infrastructure and loans, with stable cashflows being used as a hedge in place of interest rate swaps,” Clarke told IPE last year.

He said the fund was looking to reduce its dependency on unfunded hedging strategies and instead opt for a hybrid approach.

“This will involve including more physical assets and making a greater allocation to illiquid asset classes and buy-to-hold strategies to improve performance and maintain our hedge effectiveness,” he added.

The fund in January said it was also considering entering the direct lending market.

For more, see On The Record in the June edition of IPE magazine

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