Denmark: A tightening rein
Robert Melia Watson reviews regulatory developments in Denmark
The Danish financial supervisor Finanstilsynet is tightening the rein on the way pension funds measure the value of their assets and liabilities and how it expects to be kept informed of changes that could prove detrimental.
Possibly the most important measure has been the Danish government's review of the way pension funds and life and pension companies set their discount rates and measure their solvency levels against bond values.
The result is an agreement between the Danish government and the Danish Insurance Association that introduces changes - some temporary, some permanent - that are designed to protect against the current investment market downturn while enabling a more efficient asset liability mix.
The warning signs became urgent when the Danish Ministry of Economic and Business Affairs noticed a worrying trend in the relationship between the mortgage bond yield and the euro swap rate on long maturities, with Danish mortgage bond yields rising significantly while the long euro swap rate has declined. This has led to major capital losses on mortgage bonds - a common investment class among Danish pension funds. To curtail this, the financial regulator and the association have agreed to adopt a temporary adjustment of the maturity-dependent interest rate term structure - or yield curve.
Specifically, this means the discount rate until the end of 2009 will continue to be calculated on the basis of a euro swap yield-curve that is adjusted in accordance with the prevailing Danish-German yield spread. In addition, a maturity-independent margin of 50% of the mortgage spread will be taken into account.
The Danish authorities claim this will have two significant outcomes:
• It will realign the pricing of assets and liabilities in the portfolios of life insurance companies to protect technical provisions in the longer term for short-term extraordinary situations.
• The amendment will offset the increase in technical provisions of pension funds that have resulted from abnormal interest rate movements during the past months.
The agreement also forces pension schemes to look at their dependence on equities. In the current highly turbulent and volatile investment markets, the Danish government is keen to see life and pension companies exercise more caution. It has therefore introduced reforms to restrict their ability to increase its equity exposure if they cannot show they have sufficient funds to meet its solvency requirements which include a 30% equity ‘shock' buffer.
In addition, the Danish financial watchdog will expect life and pension companies to provide quarterly reports on their sensitivity to market developments and expects individual management board members to notify it immediately if they suspect their company is not going to meet its technical provisions or statutory funding level.
To stimulate consumer spending, the Danish authorities have decided to free up some of the capital members hold in pensions so they can take the money earlier than was previously allowed. This enables Danes to "pamper themselves, take a holiday or buy a flat-screen television", as Denmark's giant public sector scheme ATP predicted when the Danish government began the legal process of changing the rules of the Special Pension Savings Scheme (SPSS). But it is funds like ATP, the main administrator of the SPSS, that bear the brunt of the expected Dkr25bn (€3.35bn) disappearing from their coffers by the end of the year.
Paradoxically, the move may well stimulate the economy but it leaves ATP having to redraft its investment strategy in highly depressed and volatile markets. The change forced ATP to change the investment strategy it was pursuing for the SPSS by shifting 25% of its assets out of equities into cash to ensure it could meet the demand of members looking to benefit from the new law. ATP said this was at a time when the equity markets were actually showing some kind of recovery.
The result saw ATP post losses totalling Dkr2.4bn for the first quarter of 2009. But these are losses ATP says it can absorb and turn around swiftly as the amendment has a time limit. In essence, participants only have until 31 December to withdraw their cash - but it could be the start of a series of similar measures in years to come and ATP acknowledges it sets a precedent.
Socially responsible and environmental investing is also a priority. As the debate over climate change and the state of the planet in the future continues, the Danish financial authorities have adopted reforms to encourage life and pension companies to invest more responsibly and with a clearer environmental and social corporate governance framework.
The reform goes back to the beginning of 2009 when the Danish government adopted a law obliging more than 1,000 entities to specifically report on the corporate, environmental and socially responsible investment policies from 2010. This extends to state-owned firms and institutional investors as well as publically listed companies. Not only must they include information about current socially responsible investing but they should also outline their expectations for the future. The proposal falls short of compelling firms to adopt a socially and environmentally responsibly policy, but they must now declare if they do not have one.