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Institutional Investment - May 14, 2009

Call for Reaction: The Impact of Regulatory Constraints on the ALM of Pension Funds



In 2003, the pension fund industry was severely affected by the steep fall in equity prices and the fall in interest rates. This fall and its consequences led to broad regulatory changes and spurred work on asset and liability management theory and techniques. But it seems that these new regulations and techniques have not enabled the pension fund industry to weather the current return of the perfect storm? It is this question that research currently being undertaken at EDHEC Business School is endeavouring to answer, with feedback from industry professionals.

Please click on the link below to respond to the questionnaire:



Recent regulatory data shows that the two leading pension industries in the European Union, those in the UK and the Netherlands, are now underfunded.

As in 2003, the fall in stock markets (and in the market for risky assets) has lowered the market value of assets, while the fall in interest rates has increased the value of liabilities.

In late 2008, UK funding ratios plunged to 80% (from 100% in 2007). The trend was more pronounced in the Netherlands where, as shown in a recent EDHEC publication, target indexation to inflation or wages gives Dutch pension funds an incentive to have assets that have a shorter duration than that of their nominal liabilities, making them more sensitive to falling interest rates than pension funds in most other countries.

Germany is an exception, as the smoothed interest rate used for discounting has arguably made funding ratios artificially insensitive to interest rates, so German pension funds will, on paper, at any rate, be hit only by the fall in the prices of risky assets and will probably appear more stable (2008 data not available yet) than pension funds in other European countries.

That pension funds have been devastated by the current crisis in the very same way as they were after the perfect storm of 2003 is very disheartening. After all, after 2003, both regulation and asset/liability management underwent profound change.

The tightening of regulation in itself has thus not helped prevent further plunges in the funding ratios of European pension funds. One may wonder if regulatory changes have failed to provide pension funds and their sponsors with appropriate incentives for the professional management of risks (have they even led to the closure of defined-benefit plans in the United Kingdom?), or if there are other reasons for the current underfunding.

Our call for reaction seeks the opinion of industry professionals on crucial issues concerning the impact of both regulation and modern ALM techniques on the ALM of European pension funds, such as:

  • Are modern ALM techniques, whether dynamic asset allocation or the use of derivatives, instrumental in protecting minimum funding ratios?
  • Do current funding shortfalls reflect the reluctance of the pension industry to use modern ALM techniques or the ineffectiveness of these techniques?
  • Are short-termism and pro-cyclicality an issue for pension funds and their sponsors?
  • Should regulators provide incentives to build internal models?
This feedback will allow EDHEC to analyse the use and perceived efficiency of ALM tools and concepts.

We attach great importance to your opinions and are grateful for your participation.

For more information on the impact of regulatory constraints, please refer to the summary of an EDHEC study on the topic released this month.

Questionnaire respondents will receive first-hand notification of the results, which can be used as an industry benchmark.

The questionnaire can also be filled out anonymously.