Mariska van der Westen outlines the agenda of the Dutch pension fund supervisors

In response to the financial crisis, which resulted in heavy losses and plunging funding ratios throughout the Dutch pensions sector, the financial supervisor De Nederlandsche Bank (DNB) is beefing up its supervisory capabilities and imposing more stringent supervision on pension funds.

To this end DNB appointed Olaf Sleijpen - formerly head of institutional clients at APG - to take over from Femke de Vries as head of pension fund supervision as of 1 January 2011, while De Vries will be responsible for the creation of a new division specialising in supervision in problem situations.

The new division will include an intervention unit to deal with problematic cases, De Vries explains. "In cases where more intensive supervision is indicated, a tougher approach may be necessary. That is why we are setting up a team of people with expertise in the area of interventions."

The objective is to create a more decisive and tenacious supervisor, and the new division delivers the ‘muscle' to do so.

A tougher supervisory approach also means more attention to qualitative elements such as business models and strategies, conduct and culture, that show how institutions tend to deal with risks.

"We will be looking at the way financial institutions are being run, whether there is sufficient countervailing power within the organisation and whether the people in charge are being challenged sufficiently and in a healthy manner," says De Vries.

The crisis has taught DNB that problems are often not limited to individual institutions but have a wider impact. Hence, the supervisor now looks beyond individual institutions at the pension fund industry as a whole, says De Vries. "This approach also gives us a better view of the actual risks of institutions. After all, if a pension fund drops out of the benchmark on several points, this reveals something about the fund's overall risk management as well.

"If a fund's coverage ratio appears to be more sensitive than that of other funds, for instance, this would give us cause to take a closer look at the fund's investment strategy - does it match the fund's characteristics and is it being implemented the way it should be?"

De Vries' colleague Paul Hilbers, division director of supervision policy, believes that pension funds have made improvements in the past year. Precisely for that reason, pension funds that are not up to par attract attention. "Funds that aren't doing so well cannot simply blame the circumstances, as their peers are doing fine," he says.

De Vries adds: "Pension funds that have run into trouble are not merely victims - they have also made specific choices."

Those choices often have to do with risk management. Over the past year it has become clear that pension funds' risk management is not yet up to standard, says DNB.

"Pension funds' risk management often does not match the complexity of their investments. Another issue we see a lot is sweeping mandates that virtually give asset managers carte blanche," says De Vries. Management and valuation of innovative or illiquid products are another recurring theme, she adds.

In addition, quite a few schemes still fail to sufficiently use risk indicators and many still lack the ‘countervailing power' to stand up to asset managers.

"We find that it is hard for pension funds to create a truly independent risk management capability," De Vries says. "Pension funds are accustomed to relying on their asset managers for risk management." She stresses that risk management and asset management should not be placed in one hand. "Risk management needs to be independent. But employing truly independent risk managers is not a widespread practice as yet."

She acknowledges that pension funds can't always easily find or afford a risk manager to fit the bill.

"If it is not feasible to arrange for independent risk management, though, it would be best if the schemes stay away from complicated investment products," according to Hilbers.
DNB's insistence that risk management and asset management should be strictly separate has been met with quite a bit of resistance, especially from fiduciary managers, who believe that the two are intertwined and that separating them would be neither practical nor helpful.

The supervisor is sticking to its guns. "We often come across trustees who had absolutely no idea of a product's downside risks. The upward potential is always explained in detail but asset managers are less inclined to spell out downside risks. And particularly in the case of complex and innovative products, traditional management instruments such as tracking error simply don't cut the mustard," says to De Vries.

Many schemes are too dependent on their asset managers, she notes. "Take the reports that schemes receive. Instead of giving thought to what information would be relevant to them, trustees tend to accept whatever the asset manager submits to them. But funds don't need to hear only about their returns. They need to define relevant risk indicators and they need to know what kind of exposure they are really dealing with."

Agenda for 2011
The agenda for 2011 reflects these and other concerns. DNB will once again review investment policies of a number of pension funds, "with special attention to innovative investments and their risk management," says De Vries.

Stress testing and crisis planning will also get a lot of attention in 2011: pension funds are expected to test their portfolios for bad weather scenarios and indicate how they intend to manage crises, including their communication with plan participants.

Speaking of communication, the other supervisor - the Dutch Authority Financial Markets, AFM - is focusing its attention in 2011 on improved communication regarding pensions.

As of January, plan participants are able to look up the pension rights they have accrued online, including social security benefits and pension benefits at any pension scheme they have participated in over the course of their career. This national pensions register is a huge step towards greater transparency, but much more needs to be done, according to the AFM. The supervisor wants to ensure that the information included in the register is correct and up-to-date and includes clear information on the degree to which nominal rights will be indexed to match inflation.

The so-called indexation label, which was designed to provide this information, is not up to the task and the AFM has lobbied to have it replaced by a more comprehensive quality label. Social affairs minister Henk Kamp has recently decided using the label is no longer mandatory.

The AFM has announced it will work with the pensions sector to develop a more comprehensive ‘quality label' over the next year. The new label should also reveal the costs of the arrangement, says Jan van Miltenburg of the AFM. "Costs are an important factor in determining the actual pension result. We believe trustee board should pay more attention to this issue."

New pension deal
Last summer, cover ratios plummeted as a result of low long-term interest rates and several pension funds had to announce benefit cuts. Although cover ratios have recovered somewhat and the spectre of further cuts seems to have been warded off for now, DNB is calling for a "structural solution ensuring proper financing".

Such a solution is presently being hammered out by the social partners in the form of a new pension deal. Negotiations have gone on for months now, and Hilbers warns that time is of the essence. The superviser has given pension funds dispensation of the rule that contributions must be raised to bring cover ratios up to the required minimum, but this dispensation will run out at the end of this year. "We hope that the process won't drag on for too long. If there is no significant change in the situation this year, we will have to take action," says Hilbers.

The new pension deal will likely provide for some combination of guaranteed basic rights and a conditional top-up, requiring a two-pronged supervisory framework. DNB declines to comment on such a two-track framework: "We are preparing for the outcome of the negotiations and the implications for our supervisory role, but we cannot discuss details ahead of time," says Hilbers.

Once a new pension arrangement has been agreed on, pension funds must tackle the problem of how existing rights can be migrated to the new system. The two supervisors will be watching closely: "The end result must be communicated to plan participants very clearly, so they know how the rights they used to have compare to the new system," says DNB's De Vries.