Dutch pension reform sounds incredibly tedious. To be honest, it is a bit tedious. But it’s also pretty important, given Dutch pension plans are some of Europe’s biggest money pools, with €1.45tn of assets under management.
The main point is that the Dutch occupational pension system will shift from defined benefit to “defined contribution”. As mainFT’s Jo Cumbo writes, this could cause some serious ripples.
“This is a once-in-a-generation event,” said Onno Steenbeek, managing director for strategic portfolio advice at APG Asset Management, the country’s largest pension fund manager with €541bn of assets under management. “I would expect some changes in the way and extent pension funds will use interest rate swaps and currency hedging products.”
Luckily, the fine folk at Rabobank have sent over one of its idiosyncratically designed research notes that helps put some meat on the bone. Basically, after the reforms, pension plans will have to choose between two different types of DC set-ups:
1) a “solidarity contract” where the plan still decides on investments and how they divvy up returns over different age cohorts; and
2) a “flexible contract” that resembles a more traditional DC set-up, where the member can choose their own investment mix.
Rabo predicts that at least 70 per cent of that €1.45tn of pension money will go into solidarity contracts, which are favoured by the labour unions.
So what impact will it have? Well, Rabo says that there will be two distinct periods: the transition period leading up to the January 2028 implementation date, and afterwards. Basically, expect strong demand for hedges against interest rate movements and market volatility up until then as they scramble to de-risk as much as possible. But once they’re over the hump they will probably hold less safe assets and hedges.
Rabo’s emphasis below:
In our view the most prominent impact of the new regulation will be on how pension funds hedge their interest rate risk. Up to the reforms we expect strong demand for hedging especially when we get closer to the dominant transition dates of 2026 and 2027. The top 3 pension funds in assets under management, which hold approximately 50% of total assets, are likely too big to temporarily increase their hedges (significantly) which should limit the market impact. Nonetheless we expect continued demand for (long) hedging up to these transition dates. On a sector level the DV01 is currently approximately 1,250mm01. In our view ceteris paribus this can potentially get pushed up by 100mm01 and possibly higher. Pension funds will want to hedge shorter on the curve where possible to limit the impact of the changes of the reformed regulation.
With respect to the changes due to the new regulation, pension funds have already been making adjustments where possible. If possible within their mandate, they are already moving shorter on the curve for all new swaps. The current regulation still applies to pension funds which means they have limited room to re-adjust the matching portfolio in advance without creating a significant mismatch risk (with liabilities). We expect pension funds will start to implement most of their changes around and mostly after the reforms and over time.
Ideally pension funds want to make as few changes as possible and reduce the duration of the portfolio over time. This will likely not be enough and will require some additional selling of long duration and buying additional short duration which could result in curve steepening after the transition dates. Mainly due to the reduction in duration, we expect that this will go down by approximately 100mm01 up to 300mm01 (compared to current levels) after the reforms.
Like glaciers, this will move slowly. But like glaciers, it could still leave a major mark on the landscape.