A changing regulatory landscape means pension funds have a more active role to play in calculating risk. Small to medium sized pension funds in particular are employing external tools for this purpose. This will also herald changes for the asset manager based on pension funds access to risk tools, according to Diogo Malato Moura, global head of Product Sales Specialists Investment Reporting & Performance at BNP Paribas Securities Services.
While insurers and the asset management arms of insurers are being asked to measure their risk on timelier basis, as mandated by Solvency II, pension funds will be impacted by Occupational Retirement Provision (IORP) scheme regulation. This regulation will spur these funds to take a more active approach to risk-based governance. With significant investment in the past three years (two million on average per medium to large company, per year) and an expected increase in this investment over the next two years (on average, a medium to large insurer has now 20 people working around Solvency II), the insurance industry is now more prepared than the pension funds in terms of internal risk models, risk documentation and validation as they have had to look at it for longer, says Moura.
BNP Paribas Securities Services risk measurement dashboard is available online and provides pension funds with a two page report helping them to diversify their investments based on a calculation of their risk. The dashboard suite is available for BNP Paribas Securities Services 90 clients including 24 pension funds. 80% of these pension funds are small to medium in size. As a result of regulations, insurers and pension funds will need distinct processes of performance and risk monitoring, says Moura.
Moura cites the increasing complexity of financial instruments and the sovereign bond crisis as some of the reasons that led towards the increasing perception of risk. Moura adds: Risk-based regulations like UCITS IV (affecting asset managers) and Solvency II (affecting insurers), and probably the coming IORP (affecting pension funds), make it mandatory to have a better notion of risk when investing assets”. “Pension funds have relied a lot on external asset managers to give them an idea of the risk taken, but they now have to work out ex ante market risk what is my global risk exposure today?
The dashboard helps to identify the investments that have the most marginal volatility. This can mean different things to different people, depending on how they are diversified, says Moura. UK pension funds, investing in Japanese stock, diversify away more risk than a Japanese pension fund would have investing in that same stock. Some risks offset others but it is not just about risk taking but making more money with the same type of risk. More performance can translate into more risk or not, depending on the overall holdings of a pension fund. Systematic risk cannot be diversified, but specific risk can. If youre looking at oil stocks, systematic risk means that all oil companies can be impacted in an oil crisis. A pension fund cannot diversify away this risk. The specific risk of a specific oil company having an offshore accident can be diversified by investing in several oil companies affected.”
According to Moura, once pension funds integrate these risk models the culture will change. They will delegate through risk budgeting and instruct the asset manager accordingly. This risk measurement will be integrated into pension fund asset allocation.”
It will mean some changes for the asset management industry, concludes Moura. Pension funds will need globally consolidated views of their assets and how their are managed risk wise this will either mean that asset management will be insourced by them or that the more distinct processes of performance measurement and risk monitoring will be outsourced.
(JDC)