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OECD calls for limits on the use of derivatives

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The Organisation for Economic Cooperation and Development has called for strict limits, if not prohibition, of 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, which was released recently.
“The use of derivatives that involves the possibility of unlimited commitments should be strictly limited if not prohibited,” it says.
“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 wants investment in assets of the plan sponsor to be prohibited or limited. The 14-page guidelines – backed by all 30 OECD member governments – also calls for the ‘prudent person’ approach to investing and for investment restrictions to be loosened.
Among the recommendations is a call for funds to define and follow overall investment policy. They should also require the governing body to act in the “best interest” of beneficiaries when investing plan assets. There are also calls for internal
controls to be set up, and for risks to be identified and measured. Current market values should be used to value assets, and asset value and liabilities should be disclosed on a regular basis – to give trustees early warning of a fund’s underperformance.
“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 organisation 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 said more than 1m pension funds operate in OECD countries, holding over $16trn (€13trn) in assets.

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