Dutch pension funds set to retire long-dated hedges – ING Think

Dutch pension funds’ demand for long-dated interest rate hedges is set to decline sharply as the country transitions from defined benefit (DB) to defined contribution pensions under the new pension system, ING Think has stated.

Pension funds in the Netherlands are currently in the process of switching to the new pension system, working towards the 2028 deadline.

ING Think forecast large flows of fixed rate paying in long dates, from 30 years out to 60 years, as prior fixed rate receivers are unwound.

It also expected “steepening pressure” along the 20 to 30 year segment as 10 to 20 year receivers remain in place.

Under the current DB model, future pension payments are fixed and the coverage ratio is the key measure to assess scheme health, resulting in active rate risk hedging.

The Dutch pension system currently relies on long-term hedges through swaps and swaptions to mitigate volatility, ING Think noted.

As the country moves to a DC pension system, future liabilities will no longer be fixed, instead moving along with the value and return of assets, reducing the need for interest rate hedges.

ING Think said it believed there would be structurally lower demand for fixed rate receiver swaps with tenors between 30 and 50 years following the reforms, as interest rate hedges will be of less interest to younger members.

It argued that the interest rate hedge for younger members may be “almost fully unwound” in the present environment of low term premia, which would “trigger significant flows”.

“For participants closer to retirement there will be a continued requirement for interest rate hedges to mitigate fluctuations in pension payments,” ING Think senior European rates strategist, Michiel Tukker, said.

“After the reforms the hedging preference for older participants could actually show an increase and may even approach 100 per cent of interest rate risk. The new system is more accommodating to such age cohort specific calibrations and thus fixed rate receiver swaps between 10-20 years may see increased activity.

"Overall, the reforms would steepen the back end of the swap curve, but the new pension system gives more flexibility to steer duration dynamically, which could lead to an extension of duration once term risk premia return.

“Currently low term premia make hedging long-term interest positions unattractive, yet these term premia should normalise in the coming years. That said, actuarial requirements, where applicable, will ultimately dominate.”

Tukker added that the reforms could generate significant volumes and price moves in swap markets, but timing these “will be difficult”.

"Most pension funds expect to transition in 2026, but the regulator has a deadline of 2028 and delays are already anticipated,” Tukker continued.

“Some funds have recently commented that they prefer to wait for other pension funds to reform rather than being the ‘early bird’.

“On top of that, the political parties currently in Dutch coalition talks have expressed their concerns about the new pension system, leaving a small chance that the present implementation of the legal framework will be challenged again.”

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