By Lynn Strongin Dodds, Senior Writer, DerivSource
The Dutch pension fund reform, which took effect at the beginning of this year, is expected to change the way pension funds trade derivatives. Demand for long dated interest rate swaps (IRS), those with maturities beyond 30 years, will diminish in favour of shorter maturities of 10 to 20 years.
The overhaul of the Dutch pension system – the largest in the euro zone with almost €1.8 trn of assets under management – will be staggered over a two-year period.
It comprises a shift to defined contribution (DC) system from defined benefit (DB) which is in line with other developed countries with ageing populations and a workforce that no longer stays with one employer.
In terms of the overall transition, Michiel Tukker, senior European rates strategist at ING, estimates that roughly €550bn in assets will move to the new pension system this year, with another approximate €900bn in 2027. However, “we see a non-negligible probability that a material amount of this will be delayed to 2028,” he said.
“Most eyes will be on ABP (civil service and education), the largest fund with over €500bn in investments, accounting for around a third of the sector’s total size,” Tukker said.
The move to a life cycle investing strategy will enable pension funds to invest more in riskier assets and reduce their exposure to long-dated assets, such as longer-dated sovereign bonds and euro IRS which have typically been deployed for hedging.
Analysts estimate that funds may reduce their long-dated bond and swap holdings by €100 bon to €150 bn through 2028. This unwinding involves paying fixed rates on swaps they previously received leading to higher long-term rates and steeper yield curves.
Tukker also notes securities with shorter tenors will become more popular because the new regime gives flexibility to hedge by age cohort. “In effect, funds will choose to reduce the hedges for their younger participants – those with long maturities on their liabilities- while for older participants, funds may actually increase the hedging ratios as these have relatively shorter liabilities,” he said.
The reforms are significant for the eurozone because Dutch pension funds have historically been the most significant buyers of longer-dated euro IRS. While there are a handful of others, market participants have concerns over liquidity over the long term.
It is early days though and the move by 24 Dutch pension funds, including PFZW, the health care and social welfare sector fund, and PMT, a fund for workers in the metals industry and technical sector, has so far failed to trigger significant disruption in the long dated IRS market, according to research from consultancy Sprenkels.
A recent paper from ING Think notes, in the near term, there may be more flattening pressures as speculative positions get challenged, but that as pension flows start materialising, the overall net impact should still be steeper curves.
