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World’s Top-Ranked Pension Funds Probed for Hedge Fund Use

Denmark, home to the world’s top-ranked pension system, will toughen oversight of the $500 billion industry after regulators observed a surge in risk-taking linked in part to more widespread use ofhedge funds.

The Financial Supervisory Authority in Copenhagen will require pension funds to submit quarterly reports on their alternative investments to track their use of hedge funds, exposure to private equity and infrastructure projects. The decision follows funds’ failures to account adequately for risks in their investment strategies, according to an FSA report.

The regulatory clampdown comes as Denmark deals with risks it says are inherent to a system due to be introduced across the European Union in 2016. The new rules will allow pension funds to invest according to a so-called prudent person model, rather than setting outright limits. In Denmark, the approach has proven problematic for the only EU country to have adopted the model, said Jan Parner, the FSA’s deputy director general for pensions.

“The funds are setting up for their release from the quantitative requirements, but the problem is, it’s not clear what a prudent investment is,” Parner said in an interview. “The challenge for European supervisors is to explain to the industry what prudent investments are before the opposite ends up on the balance sheets.”

Denmark, which has almost two years of experience with the approach after its early adoption in 2012, says a lack of clear guidelines invites misinterpretation as firms try to inflate returns.

EU Agenda

The new framework comes as European policy makers look for ways to spur a recovery by making some assets cheaper to hold. The European Commission on Oct. 10 decided to set a lower charge on asset-backed securities than the European Insurance and Occupational Pensions Authority recommended. The rule, which reflects the cost for funds of holding assets, means insurers face a 2.1 percent charge on AAA securities, compared with EIOPA’s 4.3 percent recommendation. For BBB assets, the charge will be 3 percent, versus 17 percent proposed by the EIOPA.

Denmark is telling its industry, rated the world’s best three years in a row by the Melbourne Mercer Global Pension Index, to take a conservative view on what a “prudent person” would invest in.

Underlying Risk

“Supervisors are not saying no, but we have to warn them not to get too enthusiastic,” Parner said. “There’s a concern that funds underestimate the underlying risk and get too high a concentration in certain areas, exposing funds to credit risk, which is cyclical and which funds haven’t previously had.”

Danish funds and insurers have overestimated the value of alternative investments they made while failing to adequately account for the risks, the FSA said in a February report.

Pension funds held 152 billion kroner ($26 billion) at the end of 2012, or about 7 percent of their balance sheets, in equity stakes and other assets sold on markets the FSA characterized as illiquid, opaque and thin. The agency said they need to account better for those risks and ordered reports from the third quarter. PFA, Denmark’s biggest commercial pension fund, said today it invested in a shopping mall in western Denmark as part of a strategy to increase its presence in retail properties.

Asset Valuation

“The industry needs to look further into the risks involved and the ongoing valuation of these assets,” Parner said.

The prudent person principle is part of a sweeping overhaul of insurance regulation that’s been more than a decade in the making. Solvency II, as the framework is known, will give companies greater flexibility to invest while tying capital requirements to the risk they face of being unable to meet their liabilities.

Effective at the end of next year, the directive sets risk-based capital requirements for insurers, mirroring reforms in banking. It also places greater weight on risk management by funds and regulators’ role in monitoring it.

“We’re moving away from a prescriptive setup,” Parner said. “More work has to be done Europe-wide in this area to be ready for the launch of Solvency II.”

To contact the reporter on this story: Frances Schwartzkopff in Copenhagen atfschwartzko1@bloomberg.net

To contact the editors responsible for this story: Tasneem Hanfi Brogger attbrogger@bloomberg.net Christian Wienberg

That Japanese Fat Finger Can ‘Absolutely’ Happen in U.S. | Mitch Cator Blog

A funny thing happened after Michael Lewis’s book “Flash Boys” put the structure of the U.S. stock market under a microscope in March: The whole system ran pretty smoothly, at least compared with its recent past.

Sure, the electronic cat-and-mouse trading game that Lewis called a “rigged” system and others called “market making” may not have changed much. On the bright side, however, there have been no major technological meltdowns like the one that almost bankrupted Knight Capital Group Inc. or fouled Facebook Inc.’s initial public offering in 2012, or caused an almost 1,000-point plunge in the Dow Jones Industrial Average in 2010.

Now today, that nascent confidence is being undermined in a big way after 67.78 trillion yen ($617 billion) of mistaken over-the-counter stock orders flooded Japan’s equity market. Don’t for a minute believe that the U.S. market structure is fine-tuned enough to avoid a similar situation, according to Larry Tabb, founder of research firm Tabb Group LLC.

“That could absolutely happen here,” Tabb said in an e-mail. “While we do have circuit breakers and pre-trade checks for items executed on exchange, I do not believe that there are any such checks on block trades negotiated bi-laterally and are just displayed to the market.”

The Japan trading error is creating so much buzz that even the Drudge Report is tweeting about it. It’s easy to see why, given the numbers: $617 billion is bigger than Sweden’s economy, after all, and orders for more than half of Toyota Motor Corp. (7203)’s shares were caught up in the mistake.

‘Fat Finger’

The trade orders were canceled before being executed, but to many traders that may offer about as much solace as the fact that the guy who jumped the fence at the White House was tackled before he got to President Obama’s bedroom.

The term “fat finger” being used to describe the error has become a sort of catch-all description for some type of human error: errant keystrokes by a trader or programmer. And while in the U.S. we haven’t seen any fingers fat enough to cause headlines like these, neither has the fragmented U.S. marketplace been completely free of problems this year.

Just a month ago, a technical error at CME Group Inc. prompted a four-hour trading halt at the world’s largest futures market, preventing buying and selling of contracts tied to major stock indexes, Treasuries, oil and gold. In May, a trading error at Barclays Plc caused split-second swings in dozens of U.S. stocks including AOL Inc. and Caterpillar Inc., people familiar with the matter told Bloomberg News at the time.

No human system is perfect and every day computer systems that interact with the markets are being upgraded and modified, said James Angel, a Georgetown University finance professor who studies market-structure issues.

“As Darth Vader said in one of the Star Wars movies, ‘Don’t put all your faith in technology,’” Angel said in an e-mail.

To contact the reporter on this story: Michael P. Regan in New York at mregan12@bloomberg.net

To contact the editors responsible for this story: Chris Nagi at chrisnagi@bloomberg.net Nick Baker

Australian dollar could fall to 73 US cents: analysts

Economists at one of the major investment banks say the Australian dollar could fall as low as 73 US cents.

UBS economists Scott Haslem and George Tharenou say their application of a range of models suggests the dollar could correct lower to between 73 and 83 US cents.

That is below their own forecast, which is for the dollar to be worth 85 US cents by the middle of next year.

UBS says based on iron ore prices, the dollar would be worth around 73 US cents, while a broader commodity prices basket would put a reasonable value around 82 cents.

Using their own replica of the Reserve Bank's fair value model, the analysts say the dollar should fall to 83 US cents.

A large part of the Australian dollar's weakness is expected to be due to increasing US dollar strength.

Yesterday the Australian dollar broke convincingly below 90 US cents after the conclusion of the September US Federal Reserve meeting, which saw committee members lift their forecasts of where US rates would be by the end of next year.

The UBS economists say the story of rising US interest rates is likely to dominate currency trade in 2015.

"Most leading indicators suggest the US economy is strengthening relative to other countries, while diverging rates policies ought to be US-dollar supportive," they noted.

"Finally, the starting position of USD valuation is also favourable, with the real effective exchange rate close to a 40-year low."

China weakness weighs on iron ore outlook

While that US economic strength pushes the greenback up, slowing Chinese economic growth is likely to weigh on the Australian dollar.

Many analysts are now forecasting Chinese growth in the low 7 per cent range this year, falling below 7 per cent next.

Shanghai steel futures fell more than 2 per cent to a record low, and iron ore futures are down around 3 per cent in China today, both of which bode ill for the future prices of Australia's major export.

With slowing economic growth and a declining property market, many analysts are negative about the prospects of a sustained iron ore price rebound.

"There is no sign that demand for steel can improve in the short term," China-based Cao Bo from Jinrui Futures told Reuters.

"I don't think we've seen the worst for the iron ore and steel markets."

Such weakness in iron ore prices is likely to heighten pressure on the Australian dollar to fall.

Interest rate implications

Saul Eslake says the recent drop in the local currency from the mid-90s to below 90 US cents shows the potential for a sustained drop in the currency to happen sooner rather than later.

That would implications for the timing of the first Reserve Bank interest rate increase.

"If this were to be the case, we would likely bring forward our current forecast for the RBA to begin tightening policy from early 2016," the Bank of America Merrill Lynch Australian chief economist wrote in a research note.

"We also note that, although any exchange rate depreciation is a net positive for the economy, it would not benefit all sectors equally.

While export-exposed services sectors would be key beneficiaries, the retail sector would be among the big losers."

Stocks Rise as Investors Await Alibaba to Begin Trading

U.S. stocks rose for a fourth day following a rally in Europe after Scotland rejected independence and as corporate takeovers boosted shares. Investors also watched the first day of trading of Alibaba Group Holding Ltd.

Dresser-Rand Group Inc. rallied 13 percent as Siemens AG prepared to offer more than $6.5 billion for the company, according to people familiar with the plan. Concur Technologies Inc. jumped 18 percent as SAP SE agreed to buy the company for $7.4 billion to boost its cloud-computing business. Oracle Corp. slid 2.4 percent after Larry Ellison stepped down as chief executive officer.

The Standard & Poor’s 500 Index advanced 0.2 percent to 2,014.42 at 9:30 a.m. in New York. TheDow Jones Industrial Average added 35 points, or 0.2 percent, to 17,300.99.

“The Scottish ‘no’ vote gave some tailwind to the European markets, and we’re just trading in sympathy off of that to start the day,” Michael James, a Los Angeles-based managing director of equity trading at Wedbush Securities Inc., said in a phone interview.

Trading may be subject to unexpected swings today because of a quarterly event known as quadruple witching, when futures and options contracts on indexes and individual stocks expire.

S&P Dow Jones Indices is also scheduled to rebalance the S&P 500 in a quarterly move to adjust stock weightings. About $25 billion of shares in trades will be done as investors buy and sell to mimic the changes, according to a Sept. 7 estimate by Howard Silverblatt, an index analyst at the New York-based company.

Alibaba IPO

Alibaba, the e-commerce company started in 1999 with $60,000 cobbled together by Jack Ma, cemented its status as a symbol of China’s economic emergence by raising $21.8 billion in a U.S. initial public offering. The company and shareholders including Yahoo! Inc. sold 320.1 million shares for $68 each, according to a statement, after offering them for $66 to $68.

The sale, which values Alibaba at $167.6 billion, is already the largest by any company in the U.S., and has the potential to break the global record -- currently held by Agricultural Bank of China Ltd.’s $22 billion IPO in 2010 -- if underwriters issue more shares.

European shares rose, sending the Stoxx Europe 600 Index up 0.5 percent. Scotland’s First MinisterAlex Salmond conceded defeat after the anti-independence “No” camp garnered 55 percent of the votes.

A report at 10 a.m. in Washington may show that a gauge of the U.S. outlook for the next three to six months rose at a slower pace in August. The Conference Board’s index of leading indicators climbed 0.4 percent, following a 0.9 percent increase in July, according to the median forecast of economists in a Bloomberg survey.

To contact the reporters on this story: Joseph Ciolli in New York at jciolli@bloomberg.net; Lu Wang in New York at lwang8@bloomberg.net

To contact the editors responsible for this story: Lynn Thomasson at lthomasson@bloomberg.netJeremy Herron

Dollar falls after disappointing U.S. payrolls figure

(Reuters) - The dollar fell early Friday after government data showed U.S. employers added the fewest jobs in eight months, eroding some confidence in the U.S. economy and reviving bets the Federal Reserve might leave interest rates near zero for a longer period than earlier anticipated.

The U.S. Labor Department said non-farm payrolls grew by 142,000 last month, far below the 225,000 increase among analysts polled by Reuters USNFAR=ECI. The July figure was upwardly revised to 209,000.

The greenback hit a session low of 104.71 yen after rising to a near six-year high of 105.71 yen on the EBS trading system JPY=EBS. It was last down 0.2 percent at 105.05 yen.

The euro strengthened against the dollar EUR=EBS, last up 0.14 percent at $1.2961 after hitting a 14-month low of $1.2920 earlier in the session.

(Reporting by Richard Leong Editing by W Simon)

Paper Planes | Mitch Cator