Denmark's Financial Supervisory Authority will require pension funds to submit quarterly reports on their alternative investments to track their use of hedge funds, exposure to private equity and infrastructure projects. The decision follows pension funds' failures to account adequately for risks in their investment strategies, according to the FSA.
The regulatory clampdown of the $500 billion industry comes as Denmark, home to the world's top-ranked pension system, deals with risks it says are inherent to a system due to be introduced across the European Union in 2016. The new rules will allow pension funds to invest according to a so-called prudent person model, rather than setting outright limits. In Denmark, the approach has proved problematic for the only EU country to have adopted the model, said Jan Parner, the FSA's deputy director general for pensions.
“The funds are setting up for their release from the quantitative requirements, but the problem is, it's not clear what a prudent investment is,” Mr. Parner said in an interview. “The challenge for European supervisors is to explain to the industry what prudent investments are before the opposite ends up on the balance sheets.”
Denmark, which has almost two years of experience with the approach after its early adoption in 2012, says a lack of clear guidelines invites misinterpretation as firms try to inflate returns.
Denmark is telling its industry, rated the world's best three years in a row by the Melbourne Mercer Global Pension index, to take a conservative view on what a “prudent person” would invest in.
“Supervisors are not saying no, but we have to warn them not to get too enthusiastic,” Mr. Parner said. “There's a concern that funds underestimate the underlying risk and get too high a concentration in certain areas, exposing funds to credit risk, which is cyclical and which funds haven't previously had.”
Pension funds held 152 billion kroner ($26 billion) at the end of 2012, or about 7% of their balance sheets, in equity stakes and other assets sold on markets the FSA characterized as illiquid, opaque and thin. The agency said they need to account better for those risks and ordered reports from the third quarter.