GLOBAL - Pension funds have moved quickly to assess their financial positions today following the Chapter 11 insolvency investment banking giant Lehman Brothers' voluntary and Bank of America's takeover of Merrill Lynch, but many are also being advised the unwinding of financial positions could significantly affect asset returns and volatility.
News of Lehman Bros' Chapter 11 voluntary bankruptcy broke early this morning and global investment markets quickly slumped on the news of its collapse, after the Federal Reserve and the US government this weekend refused to pump money in to keep the firm afloat and a new buyer for its asset management division was not found, as intended.

Officials at Lehman Bros are now in the process of informing all clients of the need to unwind positions, said a spokeswoman for Lehman Bros, but pension funds are likely to be advised its staff are trying to trade as usual where possible at this time.

That said, early indications are the information being provided to company spokespeople is somewhat limited as officials are still referring to "rumours" over the weekend of a potential sale of Lehman Brothers Asset Management and anticipate the asset management arm will still be sold.

The spokeswoman said it is "business as usual" albeit administrators are now in the building and the company is now "winding down", so pension funds and investors whose assets are still held with the firm are now being advised it is attempting the "orderly liquidation of counter-party trades and assets".

Moreover, she claimed those pension funds with derivatives trades "will probably still stand" albeit the risk will need to be taken on by other investment banks.

Officials at the Lehman Brothers Pensions Advisory Group were unwilling to comment on the weekend's developments, but a spokeswoman again said managing director Alan Rubenstein and his team were "advising clients" of the situation.

"We will do whatever is necessary to make sure our clients are not going to be affected tremendously," she said.

All pension funds will be hit in some way - directly or indirectly - by developments concerning Lehman Bros as some of the biggest names were either directly invested in the company over recent months or have mandate contracts with their asset management arm.

Fonds de Reserve pour les Retraite (FRR), the €34.5bn French national pension reserve fund, has confirmed it is one of the pension funds hit by developments as it selected Lehman in July 2007 to manage a €500m North American private equity mandate.

A spokeswoman for FRR said Lehman has so far invested $284m (€200m) or 40% of the funds on behalf of the body, but the assets are understood to be safe in the hands of its custodian and it is too early to decide what should happen next so Lehman Bros is under a watching brief while officials wait to see if the asset management division will be sold.

A spokesman for APG, the asset management arm of the Dutch ABP pension fund, said the group does not hold Lehman Bros stocks but its fixed income stock in Lehman has been "reduced significantly" over the last nine months.

APG was unwilling to give specific figures as to how much it now holds and the exact actions it will take, but the spokesman said it was still concerned about the "operational risk of the trades and deal settlement".

Chapter 11 documents state Lehman has more than 100,000 unsecured creditors, but the 30 largest debtors are documented.

Citigroup and Bank of New York Mellon are listed as being the largest debtors with bond debt of approximately $138bn, followed by another $17bn in debt for BNY Mellon.

Details of the 21-page petition states Lehman had total assets valued to be worth $639bn to 31 May 2008 but had total debts of $613bn of which $128.2bn was unsecured subordinated and unsubordinated debt.

Axa, the French insurer and asset manager, and its associated parties was the largest holder of common stock as it held 7.25% of shares, while ClearBridge Advisors held 6.22% and FMR had 5.87%.

Lehman appears to have been most active in recent months in the transition management sector when working with pension funds so, like many others, the Pension Protection Fund announced only last week it had recently appointed Lehman as one of its transition managers.

Martin Clarke, director of Financial Risk at the PPF, today announced Lehman had been added to its roster of managers in July but was not currently engaged in any transaction business for the PPF to officials will "continue to monitor the situation closely".
Pension fund investment consultants note while there may be little pension funds can do at this stage to recoup losses through equities and bonds trading, there may be more complicated and volatile issues to address in the swaps and derivatives trades held.

It is unclear at this stage what the "orderly liquidation" of positions might mean for real estate investors as it is understood the asset held on behalf of pension funds - most notably US pension funds - who have committed to real estate commingled funds will actually see their assets held as private equity under the asset management arm.

Elsewhere, however, the real concern for many pension funds may be in their purchase of swaps and derivatives to help mitigate their liability risk, as Jon Exley, a principal in Mercer's Financial Stability Group, noted.

"Many pension funds now use derivative contracts for risk management purposes.  These include interest rate and inflation swaps and equity derivatives," said Exley.

"While larger funds have worked directly with investment banks on these contracts, others are exposed as a result of actions taken by their investment managers. These strategies have worked very well in the main, protecting funds against recent adverse market movements.  The underlying contracts, however, involve complex legal documentation and arrangements around collateral (the assets backing valuation movements in derivative contracts)."

Exley continued: "Lehman's bankruptcy will in most cases necessitate a termination of any derivative contracts between Lehman and pension funds (whether entered into directly or through asset managers).  This will have two direct consequences.  Firstly, the market value of collateral backing contracts will be tested given current market conditions.  Secondly, there will be a time lag before new contracts can be put in place during which funds will be exposed to volatility.

"We have been saying for some time that counterparty risk and derivative documentation is an area that needs close attention, and this latest development has underlined that position."

The other big news of the weekend surprised the market as Bank of America today announced it is buying Merrill Lynch for $50bn.

The deal makes Bank of America one of the world's largest financial services firms and gives it a strong presence outside the US.

More importantly, Merrill Lynch still owns 49% of asset management firm BlackRock but officials at BlackRock said they will not have a better indication of the true impact this will have on its business until later today.

We are keen to hear about the impact this may have on pension fund capital so if you have any comments you would like to add to this or any other story, contact Julie Henderson on + 44 (0)20 7261 4602 or email