Rabobank says swaps may ease Dutch FTK impact
NETHERLANDS – Rabobank says the new Dutch FTK, or financial assessment framework, will have a “marked impact” on Dutch pension schemes’ investment policy – and that a swap overlay strategy could be a solution.
The bank said in a research note that the Financieel Toetsingskader’s introduction of present valuation of pension fund liabilities would also “result in a higher volatility of cover ratios”. This would mean pension funds would have to raise the interest-rate sensitivity of their assets.
Rabobank has calculated that volatility under the FTK would be almost seven times that under the current regime.
“To achieve a comparable volatility the interest-rate sensitivity on the asset side would have to be raised markedly,” the bank said.
“Our calculations suggest that the duration of the fixed income assets would have to be raised to no less than 30 year to get a cover ratio volatility that is roughly comparable.
“This of course is not realistic.”
And even without the FTK, pension funds in the Netherlands are already faced with increased volatility as a result of new international financial reporting standards. “So, even without the FTK, the need to reduce the duration gap would exist for many pension funds.”
It argues that the average pension fund would not pass the solvency test at present. “That is why the FTK will most likely have a marked impact on the investment policy of most Dutch pension funds.”
It puts forward a swap overlay strategy which would increase the interest-rate sensitivity on the asset side, but would enable pension funds to leave the underlying portfolio unchanged.
It said: “With the current asset mix, the required cover ratio for the average Dutch pension fund would be lowered by no less than 10%-point.
“Or, given the current actual cover ratio, a swap overlay would enable the average fund to raise the equity weight by 30%-points and still pass the solvency test.”
It added that a swap overlay enables a fund to raise the expected average return on investments. And it said that an increase of two percent in the expected return due to a swap overlay package “would enable funds to lower the pension premiums by four percent”.