Regulating and Monitoring Investment Risk: Application of the OECD Guidelines Juan Yermo Financial...
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Regulating and Regulating and Monitoring Investment Monitoring Investment Risk: Risk: Application of the OECD Application of the OECD Guidelines Guidelines Juan Yermo Juan Yermo Financial Affairs Division Financial Affairs Division OECD OECD
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Transcript of Regulating and Monitoring Investment Risk: Application of the OECD Guidelines Juan Yermo Financial...
Regulating and Monitoring Regulating and Monitoring Investment Risk: Investment Risk:
Application of the OECD GuidelinesApplication of the OECD Guidelines
Juan YermoJuan YermoFinancial Affairs DivisionFinancial Affairs Division
OECDOECD
What do we mean by investment risk?What do we mean by investment risk?
What is the time horizon?
Is there a liability (commitment, guarantee or target benefit)?
Who is the risk bearer?
Choice of risk measure will depend on these factors
Main risk measuresMain risk measures
Overall risk measures• Volatility (standard deviation)• Beta (market correlation)
Downside risk measures• Expected shortfall / expected tail loss• Stress test• Value-at-Risk
Downside risk more relevant for DC pensions because of benefit target
Investment risk in DC pensionsInvestment risk in DC pensions
Long-term horizon, terminal wealth matters most
Consumption matching requirement after retirement
Some relevance of investment outcomes up until retirement
Expected shortfall from targeted replacement rate
Drawbacks of VaR as a risk measure Drawbacks of VaR as a risk measure in DC pensionsin DC pensions
Short-term horizon (one day/month)
It does not tell us anything about losses below VaR limit
It does not tell us anything about the portfolio’s exposure to annuity rate risk
To be useful for beneficiaries, VaR needs to be integrated into
replacement rate model
Regulating investment riskRegulating investment risk
Directly:• Setting ceilings on risk measures
Indirectly:• Setting ceilings on portfolio allocations
Self-regulation:• Prudent person rule
Regulatory approach depends critically on extent of market and regulator
knowledge, competition, and redress
Drawbacks of quantitative rulesDrawbacks of quantitative rules
Optimal asset allocation is a moving target
Difficult to change (often set in law)
Does not ensure diversification within limits
Quantitative risk control measures can achieve same goals without
these drawbacks
Recent reforms to quantitative rulesRecent reforms to quantitative rules SharesShares
• Belgium: 65% - no limit (2002)Belgium: 65% - no limit (2002)• Czech Rep.: 25% - no limit (2004)Czech Rep.: 25% - no limit (2004)• Denmark: 50% - 70% (2001)Denmark: 50% - 70% (2001)• Mexico: 0% - 15% (2005)Mexico: 0% - 15% (2005)• Portugal: 50% - 55% (2002)Portugal: 50% - 55% (2002)• Spain: 10% - 30% for unlisted (2003)Spain: 10% - 30% for unlisted (2003)
Foreign investmentForeign investment• Japan: 30% - no limit (1999)Japan: 30% - no limit (1999)• Canada: 30% - no limit (2005)Canada: 30% - no limit (2005)• Denmark: 5% - 10% for non-OECD (2005)Denmark: 5% - 10% for non-OECD (2005)• Mexico: 0% - 20% (2005)Mexico: 0% - 20% (2005)• Germany: no limit for Germany: no limit for PensionsfondsPensionsfonds (2002) (2002)• Korea: 20% - 30% (2003)Korea: 20% - 30% (2003)
Limits on sharesLimits on shares0% 10% 20% 30% 40% 50% 60% 70% 80%
Australia
Austria
Belgium
Canada
Czech Rep.
Denmark
Finland
Germany
Greece
Hungary
Iceland
Ireland
Italy
Japan
Mexico
Netherlands
New Zealand
Norway
Poland
Portugal
Slovak Rep.
Spain
Sweden
Switzerland
Turkey
UK
United States
No limit
No limit
No limit
No limit
No limit
No limit
No limitNo limit
No limit
No limit
No limit
No limit
No limit
No limit
Limits on foreign investment Limits on foreign investment 0% 10% 20% 30% 40% 50% 60% 70% 80%
Australia
Austria *
Belgium
Canada
Czech Rep. *
Denmark *
Finland *
Germany
Greece*
Hungary *
Iceland
Ireland
Italy *
Japan
Mexico
Netherlands
New Zealand
Norway
Poland
Portugal *
Slovak Rep.
Spain
Sweden
Switzerland
Turkey
UK
United States
No limit
No limit
No limit
No limit OECD countries
No limit
Subject to 20% ratio
No limit
No limit
No limit
No limit
No limit
No limit
No limit
No limit
No limit
No limit
No limit OECD countries
No limit in EU and EEA countries
No limit OECD countries
No limit OECD countries
No limit OECD countries
The debate on foreign investmentThe debate on foreign investment
For: seven countries with largest For: seven countries with largest capitalisation account for more than 80% of capitalisation account for more than 80% of the world’s equity portfolio (OECD more the world’s equity portfolio (OECD more than 90%)than 90%)
Against: difficulty of hedging exchange rate Against: difficulty of hedging exchange rate risk over long horizon, impact of capital risk over long horizon, impact of capital outflows on exchange rate and BoP.outflows on exchange rate and BoP.
Trade-off diversification benefits and Trade-off diversification benefits and macroeconomic effects of foreign macroeconomic effects of foreign investmentinvestment
A gradual approach to relaxing the foreign investment limit seems judicious for emerging markets
””Prudent” quantitative limitsPrudent” quantitative limits
Limits on % of portfolio invested in individual securities or issuers
Limits on ownership concentration (if direct control not desirable)
Limits on % of portfolio invested in non-transparent/illiquid instruments
But can be left to self-regulation via the “prudent person rule”
OECD Guidelines on Pension Fund OECD Guidelines on Pension Fund Investment ManagementInvestment Management
Requires prudent person; allows some quantitative limits (e.g. self-investment)
Includes “expert knowledge”, “duty of loyalty” and “due diligence”
Written investment policy and risk control process
Market value preferable
