Most pension funds do not measure counterparty risk, six months after the collapse of Lehman Brothers Holdings Inc., a survey by Pensions & Investments and Capital Market Risk Advisors shows.
The P&I/CMRA survey found that pension funds appear to be lacking in two other crucial risk areas: measurement of liquidity and leverage. About half of respondents said they do not measure leverage or liquidity in funds in which they invest. Given the collapse of the global financial system and the steep decline of capital markets over the past nearly 19 months, however, this lack of oversight and monitoring is going to change. The problem is, it's not like flipping a switch: Pension executives are going to have to either open up their wallets or simplify their asset allocations and eliminate exotic investments.
The survey was split into two parts: one for pension executives and one for plan board members or trustees. Roughly 40 people responded to each question on the survey.
The survey of pension executives and trustees found that 70% of respondents do not gauge counterparty risk for the overall pension fund. Counterparty risk, also known as default risk, is the possibility that one party to a trade will fail to meet its contractual obligations.
The results were “startling but not surprising,” said Leslie Rahl, president of New York-based Capital Market Risk Advisors. “It's a rather important finding when you consider that managing and measuring counterparty risk began to be raised in 1999” after the 1998 failure of Long Term Capital Management.
In addition, the disintegration last September of Lehman Brothers left money managers, pension funds, custodians and banks holding the proverbial bag, with hundreds if not thousands of trades unsettled. That should have pushed the issue of counterparty risk squarely to the top of investment committee agendas.
Ms. Rahl said even though more pension funds measure liquidity risk than counterparty risk, “that's something that should be moved up the priority scale” as well.
Overall, too few pension fund executives and trustees are fully plugged into their plan's risk management process and simply receive risk reports mostly on a quarterly basis, according to the survey.
“The main conclusion that I drew is that pension funds want and need more,” she said. “There seems to be a general understanding that what they're getting is not sufficient.”
In fact, while the majority of pension board respondents (58%) receive quarterly risk reports, 39% plan to increase the frequency of risk reporting.
“Clearly at the board level, they're crying out for information on a more frequent basis,” Ms. Rahl said. She added that the results largely confirm what pension fund executives have told her.