During periods of interest rate rises, forced bond sales by Dutch pension funds to meet margin calls push down the prices of these bonds, according to a study by the academic research institute Netspar.

In their most recent study, Netspar researcher Kristy Jansen and three colleagues looked at the effects of large interest rate rises on pension funds’ bond portfolios, between 2012 to 2022.

“We observe additional price falls of the most liquid government bonds, those with maturities between one and seven years, when interest rates rise sharply. These falls result from bonds sales by Dutch pension funds to meet margin calls for their interest rate hedges,” said Jansen, who has been working as an assistant professor at the University of Southern California since 2022 but continues to do research on Dutch pension funds from the US.

The trigger for the Netspar research was the liability-driven investing (LDI) crisis in the summer of 2022 in the UK. At the time, British pension funds were forced to sell government bonds to raise cash in order to meet margin calls following a sharp rise in interest rates. In the end, the Bank of England had to intervene to avoid billions in losses for pension funds.

Dutch regulators DNB and AFM subsequently investigated whether the country’s pension funds could also run into liquidity problems in the event of such an interest rate rise. DNB concluded in January that this is unlikely in most cases.

Kristy Jansen August 2022

Kristy Jansen at the University of Southern California


According to Jansen, her research should be seen as supplementary to the regulators’ study.

“DNB and AFM did a stress test: they wanted to know whether pension funds would run into liquidity problems within a few days in an extreme scenario,” she said. “We looked at the effects of interest rate rises over a longer, one-month period.”

Jansen and her co-authors – Sven Klingler, Angelo Ranaldo and Patty Duijm – hypothesised that sales of Dutch and German government bonds by pension funds to meet their margin obligations would lead to an additional fall in the value of those debt securities.

During 10-day periods with an interest rate rise of at least 40 basis points, which occurred during the study period only in 2015, 2020 and 2022, this indeed proved to be the case.

“During those periods, om average we found an additional drop of 7 basis points of Dutch government bonds with a maturity between one and seven years that are widely held by pension funds with high margin obligations, compared to the same government bonds that are held less by those funds,” said Jansen.

For German government bonds, the effect was also present, but less pronounced, probably because German government paper is more liquid than Dutch government paper.

“Pension funds should be aware of their exposure to margin calls and should have established in advance a policy on exactly what they will sell in the event of a rise in interest rates in order to meet margin calls.”

Netspar researcher Kristy Jansen

Two developments have recently made pension funds more vulnerable to interest rate rises. The first is the obligation to use central clearing for interest rate swap transactions. Since last summer, bonds can no longer be used as collateral, which means pension funds will be forced to sell such government paper for cash more often.

Secondly, many Dutch pension funds have also increased their interest rate hedges in recent months in the run-up to the defined contribution (DC) pension transition in the Netherlands, which means they will have to deposit even more collateral than before in case of future interest rate rises.

The Netspar researchers’ study highlights the importance of good liquidity management by pension funds, said Jansen.

“Pension funds should be aware of their exposure to margin calls and should have established in advance a policy on exactly what they will sell in the event of a rise in interest rates in order to meet margin calls.”

DC switch

Many Dutch pension funds are expected to sell government bonds with maturities of more than 30 years when transitioning to the new DC pension system as they will then no longer need these bonds because the duration of their interest rate hedges will be reduced.

Jansen does not expect this to have a significant effect on the prices of those bonds, however.

“In 2012, with the introduction of the Ultimate Forward Rate, pension funds and insurers started selling 30-year bonds suddenly, which resulted in a flattening of the yield curve. But that happened as a result of a sudden regulatory change as the UFR was then fixed at a maximum of 4.2%.”

Now the situation is different, said Jansen. “Pension funds now have a few years to reduce their exposure to certain bonds. As a result, I do not expect any particular market effects.”

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