In a reflection of the wider trend away from bilateral trading to using clearing, Danish pension giant ATP is shifting more of its derivative trades to CCPs. It’s a process that has placed an added burden on the giant fund’s treasury management and requires substantial collateral on hand either in cash or bonds to meet the demands of the clearing houses, explains Jan Ritter, senior vice president, Liability, Hedging & Treasury at ATP in an interview with Total Derivatives “I recommend the pension industry starts building up its treasury side and putting in place the right processes and structures to be ready for the future,” he warns.
ATP (which has just posted strong 2019 returns of DKK40.7bn vs a loss of DKK3.71bn in 2018) uses derivatives for both hedging its liabilities and risk taking in its return portfolio. The former predominantly involves using Danish krone and euro swaps, but the pension fund also uses FX swaps and forwards to hedge its currency risk. “The universe we use hasn’t changed for years. It’s pretty much business as usual,” says Ritter.
What has changed, however, is the processes behind that derivative use. In contrast to the old days when ATP traded the majority of its derivatives book bilaterally, it now uses a mixture of OTC and cleared processes, with the fund currently clearing through five clearing brokers on three CCP’s “We still trade a lot bilateral OTC on the hedging side, but we are also now using clearing much more.”
The fund uses a discount curve based on market rates – a blend of Danish government bond yields, Bund yields, DKK swaps and EUR swaps - out to 30y. ATP’s curve is fixed at the 30y rate out to 40y but beyond 40y, a fixed rate of 3% is assumed. That compares with EUR 50y swap rates of closer to 0.3%.
Around DKK35bn or 4.5% of ATP’s DKK760bn guaranteed pension liabilities are longer than 40y. Using the EIPOA discount curve would have reduced ATP’s estimated guaranteed pension liabilities by DKK55bn, the fund estimates. ATP had interest rate swaps with a positive fair value of DKK103bn at the end of 2019, along with swaps with a negative fair value of -DKK64bn. It also had interest rate swaptions worth a positive DKK3bn and a negative -DKK12bn.
The shift to clearing process hasn’t bought significant changes to the pricing yet, says Ritter. “If you want to trade a euro swap it’s possible to get roughly the same price OTC vs cleared swap.”
However, it has involved significantly beefing up of ATP’s treasury processes because of the need to have cash ready to fulfill margin calls on cleared swaps. “On the OTC side we have CSAs in place where we exchange bond collateral. In contrast, the clearing process is much more of a treasury task whereby we are obliged under the clearing programme to fulfill the demands from our clearing brokers. We used to have two days to settle collateral, today clearing means providing cash on the same day. You have to make sure you can handle that process coming in with the right amount of cash, in the right currency and on time.”
It means setting much more capital aside in either cash or bonds – with a particular eye on the need for more on hand if the market is moving. “You could have to pay a lot of cash, and if you don’t have that available on your account you’re in trouble” he says, adding the increasingly onerous process is forcing pension funds across Europe to behave more like banks. “It is challenging for pension funds. It’s a key topic among the majority of our peers in Europe. We are talking about it with banking partners and central banks.”
Having different currencies at the ready is also challenging. “If we do a euro swap we need to post in euros. If it’s a dollar swap we have to post in dollars. The more diversified you are, the more currencies you have to have on hand to post.” Pertinent particularly across ATP’s return seeking portfolio, where derivative use has expanded from a US and European focus, to global exposure.
It means treasury management, rather than trading, has come to hold much more of the risk inherent in ATPs derivatives book: calculating how much margin APT needs to post and setting up the process to do that with custodians and other partners is centre-stage. “It’s not particularly complicated, but if you are using the derivatives market today you have to realise the importance of being able to pay in cash: it involves lots of work on the treasury side."