Rik Albrecht: Integrity in the reduction of interest rate hedges for Wtp
This column was originally written in Dutch. This is an English translation.
This is a column by CFA Society Netherlands.
The large-scale reduction of interest rate hedges by pension funds during the transition to the Wtp presents both risks and opportunities. How do you act with integrity when interests clash, information is asymmetrical and the market is tight?
By Rik Albrecht, CFA, director and chairman of the investment committee at various pension funds, member of the Ethics Committee and Advocacy Committee of CFA Society Netherlands
During the transition to the new pension system, many pension funds will reduce their interest rate hedges by selling government bonds and swaps. Sprenkels has calculated that the selling pressure is many times greater than the market can handle at any given time. In addition, PensioenPro warns of the risk of front running by speculators who take advantage of predictable transactions by pension funds. In this tense context, investment professionals face an ethical challenge.
Traders
Imagine you are a trader and you have a large and a small pension fund client. Both want to sell their swaps and government bonds at the same time, but the market cannot handle all the transactions simultaneously. Do you give priority to the large or the small client? Standard III(B) on Fair Dealing stipulates that you may not favour one of the two clients. You can ensure this by drawing up and following procedures that clearly set out how you handle transactions fairly and objectively. Share these procedures with your clients in advance and report on the transactions afterwards. Targeted supervision by the Compliance Officer can provide additional confidence.
Advisors
Suppose you are an advisor who exclusively represents the interests of a small customer, but you are familiar with the internal and detailed sales planning of a large customer, which could potentially influence the market. Can you base your advice on the small customer's transactions in part on what you know about the large customer? Standard II(A) Material Nonpublic Information prohibits insider trading. Information is considered material if it is both non-public and material. In this example, internal information is both non-public and material, because it comes from a reliable source and could move the market. So no, you may not include your knowledge about the large client in your advice to the small client, because that would constitute insider trading. Avoid coming into contact with inside information in the first place, so that you can fulfil your role as an advisor with integrity and honesty. Procedures such as a Chinese Wall can help with this. Share the procedures with clients and have the Compliance Officer monitor them specifically.
Speculators
What if you are a hedge fund manager and you want to take a position based on the sales planning of pension funds in order to profit from this? Is that allowed? Here too, standard II(A) Material Nonpublic Information is relevant. Some pension funds make public when they intend to transfer funds, and schedules with pension funds' transfer plans circulate in the sector and the press. This can therefore be considered public information. However, the transfer schedules are not very material, as pension funds often postpone transfers. Moreover, it is a transfer schedule, not necessarily a detailed schedule of transactions. You are therefore allowed to act on the basis of this information. It is the responsibility of pension funds and their asset managers to protect themselves against this by acting sensibly, for example by spreading their investments over time. A pension fund cannot shift the responsibility for losses in value onto “unethical” speculators. It is precisely these speculators who keep the market efficient, which ultimately benefits us all.
The phasing out of the interest rate hedge during the Wtp transition is a stress test – not only for markets, but also for the integrity of investment professionals. Those who rely on clear processes, transparent communication and the ethical standards of the CFA Institute and act accordingly will be in a stronger position in this complex phase.