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Differing attitudes across Europe

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The desire to minimise risk is a common thread running through pension fund investment. Consequently, this is a driving force behind the continued expansion in the number of derivatives instruments available to investors. But just how is such investment monitored, and how can it be regulated?
Across Europe the picture is far from clear or consistent, except perhaps that most countries’ funds are more conservative than those in the UK and Guernsey, where funds are restricted merely by their trust deeds, and the attitude of their trustees.
Ann Seiersen at the Danish Insurance and Pension Association, confirms this, and questions the viability of pan-European regulation. “Derivatives are definitely becoming more popular as an investment designed to reduce risk. Our regulatory body is continuously in talks with other countries and the EU Commission trying to co-ordinate regulation, but I think the gut feeling among managers is that pan-European regulation tends to be too rigid, and does not take account of the differences from country to country. There are no definitive legal restriction but all funds are required to act prudently.”
The “prudent man” also raises his head in Ireland where Bríd Horan at the Irish Association of Pension Funds confirms there are no legal constraints on the use of derivatives by funds. However, Tom Murphy of William M Mercer in Dublin says, “Obviously the first port of call is the trustees, but then the prudent man rule applies, and use of derivatives must not be seen as leveraging up the fund.” Similarly, in the Netherlands no restrictions apply, but a spokeswoman for the VB pension fund association, using similar language, says, “While no restrictions are laid down by law, the investment must be in a ‘solid instrument’ and be clearly seen to be reducing risk.”
Belgium also has a liberal attitude to derivatives. “In common with the UK there are no restrictions on the use of this kind of investment,” said Hans Callebaut of Brussels consultant Integrate, “other than the obvious control exercised by the trustees.”
In Austria no more than 3% of a fund’s capital may be invested in derivative instruments. In Germany, draconian restrictions on investment means that derivatives are rarely used. In France Arnauld d’Yvoire of the Observatoire de Retraites in Paris says, “There are no specific rules relating to derivatives, but most of our schemes are ‘pay-as-you-go’ and we do not really invest in the range of assets that the UK funds do.”
Across northern Europe, while there is no strict legal requirement placed on funds in respect of this asset class, there are guidelines. In Iceland, for example, such an investment must be seen as “reducing risk”, but only a few lines in the regulatory legislation refer to derivatives. However, such an investment may not be used as a means of leveraging up the fund. The same is true in Sweden, where most funds are dedicated to securing employers’ liabilities. There the funds are regulated by regional authorities, and rules vary from county to county. The Swedish Association of Institutions for Retirement Provision confirms there are no detailed restrictions on investment such as those relating to life foundations (insurance companies).
In Finland, the regulatory body spells out that derivatives can only be used “for protecting other asset classes within the fund”. Similar wording is used by the Norwegian regulatory body. Hasse Nilsson at Alcifor Advisory Associates says, “Investing in derivatives is not particularly popular in Norway yet, but is formally restricted to hedging.”
Further south in Spain, Angel Martinez Aldama of Inverco confirms that Spanish funds are not restricted by law in their investment in derivatives, “Where it is seen to be done for hedging this is OK, but although there are no written rules each fund proscribes certain investment. Derivatives are, however, an increasingly popular asset class in Spain.” Across the border in Portugal, Rui Guerra of William Mercer’s Lisbon office confirms that legal references to derivatives are equally vague: “The legislation simply says derivatives may be used to reduce risk and increase the efficiency of management.”
Mike McShee at Buck Heissmann in Geneva points out that whilst the rules on derivatives investment in Switzerland are not explicit, ground rules were set out in the OPP2 directive five years ago: “This asset class can be used for protective purposes only, although the interpretation of that is quite wide. For example it can be used for implementing changes in portfolio strategy, or hedging a foreign currency holding. Clearly it must not be seen as being used for leverage.”

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