GLOBAL – The Organisation for Economic Cooperation and Development has called for strict limits, if not outright prohibition, on pension funds’ use of derivatives with the potential for unlimited commitments.

“Legal provisions should address the use of derivatives and other similar commitments, taking into account both their utility and the risks of their inappropriate use,” the OECD says in its new ‘Guidelines on Pension Fund Asset Management’ released today.

“The use of derivatives that involves the possibility of unlimited commitments should be strictly limited if not prohibited.”

“The use of derivatives as a management instrument may prove useful and effective if done in a prudent fashion in order to reduce investment risks or facilitate efficient portfolio management,” the Paris-based body says in an annex.

But it adds: “Specific rules may need to be established in order to ensure that their use is consistent with appropriate management systems.”

The paper also says that investment in assets of the plan sponsor should also be prohibited or strictly limited.

The 14-page guidelines – backed by all 30 OECD member governments - also called for the so-called prudent person approach to investing and for investment restrictions to be loosened.

Among the recommendations were that funds should define an overall investment policy and actively follow. They should also require the governing body to act in the “best interest” of beneficiaries when investing pension plan assets. Internal controls should be established. Risks should be identified and measured. Current market values should be used to value assets.

Also, asset value and liabilities should be disclosed on a regular basis – to give trustees early warning of a fund’s underperformance and enable them to take quick corrective action.

“The guidelines mark an initiative by OECD countries to set international standards for the oversight and day-to-day management of pension fund investments,” the OECD said in a statement.

“They simultaneously call on regulators to give pension funds more flexibility in their investment choices and on trustees to be more diligent in monitoring their fund’s investments.”

It added that more than 1m pension funds operate in OECD countries, holding more than $16trn in assets.