NETHERLANDS - The Financial Assessment Framework (FTK) legislation will create a bond bubble in the Netherlands similar to that seen in the UK, a new paper has warned.
Under FTK proposals, delayed until 2007, pension funds will need to be 105% funded and demonstrate a 97.5% probability of remaining above the minimum funded status.
The paper, issued by SEI Europe and written in conjunction with Con Keating of The Finance Development Centre, advised Dutch legislators to avoid the bubble by learning from the UK situation, which it said was caused by the application of the FRS17 accounting standard, a standard underpinned by the same economic theory as the FTK.
Bart Heenk, managing director of SEI’s Dutch operation urged Dutch legislators to forge a path for others to follow which would break with the premise that a risk free interest rate is the correct way to calculate liabilities.
“Whilst we believe the system is in a state of confusion and worry there is still time to rethink the legislation and remove aspects which will be damaging,” he said.
The problem is not one of falling equity markets or increased longevity, but of the “financial economics” school of thought that holds sway with standard setters worldwide, the paper said.
The theory in use by legislators was not wrong, but too simplistic, “its simplifications and abstractions from reality lead to erroneous conclusions,” warned SEI and Keating.
The paper argued that with market prices at the heart of the financial economics approach, standard setters had latched onto a prescription of how to calculate a price without first considering how the market would actually operate. “The implicit assumption made is that value in use equates to value in exchange, and that this leads to the fixation observed on interest rates in the UK and the current yield spiral,” it warned.
Explaining that pension liabilities have little or no economic sensitivity to changes in interest rates, the paper suggested removing the “illusionary sensitivity to interest rates” by comparing future cash flows from assets and liabilities at multiple times in the future, rather than just values today.
Imbalances could be rectified over time and contributions determined by comparing cash flows before and after the introduction of new liabilities and priced by reference to the current market price of the asset portfolio, it said.
By Lisa Haines
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The ITN Limited Pension Scheme has named Trafalgar House as its administrator for an initial term of five years.