Denmark’s financial watchdog has laid out its expectations of how the country’s pension firms should handle increased risks associated with illiquid credit, warning them to take account of pressure on credit premiums and a loosening of credit terms.

The Danish Financial Supervisory Authority (FSA, Finanstilsynet) described the focus areas of its scrutiny of the asset class in a report on the study it has been conducting over the last few years into investments in illiquid credit made by life insurance companies, lateral pension funds, ATP and LD Pensions.

This thematic study has included a written survey of all pension companies, and on-site inspections at four selected organisations between February and August 2019.

As a result of these, over the last few months ATP, P+ and Velliv were given various official orders to correct some of their procedures relating to the management of risks around illiquid credit.

The FSA said: “The study showed that most pension companies had investments in illiquid credit and that they typically expected to maintain or increase exposure.

“At the same time, the pension companies mentioned factors such as that there was pressure on credit premiums and more lenient credit terms,” it said.

The agency said it was important that firms knew they had to make sure their boards of directors set a guiding risk profile for illiquid credit investments that was sufficient to prompt adequate identification and supervision of risks in credit investments – including investments made through funds.

Another area of scrutiny was, the FSA said, that pension firms’ models and data used to measure risk, risk management and asset allocation should reflect the risks of the investments in question.

“The Danish Financial Supervisory Authority expects the pension companies – in connection with allocation considerations and analyses, for example by determining expected future returns and correlations between asset classes, etc – to note any possible structural shifts in the loan markets,” it said.

Examples of these shifts were the tendency for some loans to be transferred from the banking sector to other investors, and for loan terms to weaken, the watchdog said.

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