Danish pension funds over the last two weeks have executed a flurry of swaptions, amounting to several billion euros in notional size, to hedge exposure to guaranteed annuity plans. Danica Pension pulled the trigger on the largest deal, having spent a premium of EUR75 million on an option to enter a receiver constant maturity swap, according to senior swappers at a major U.S. and a European derivatives house. A premium of that size was estimated to equate to a notional size of between EUR3-4 billion. The funds are believed to have come to market now because the fall in global interest rates and equity markets has left them with substantial liabilities on fixed-rate annuities. Officials at Danica declined comment and press officers did not return calls.
In the swaption, Danica has the option to receive 5% fixed if the 20-year CMS rate falls below that level, according to the swappers. Danica and other Danish funds have sold products in which they are liable for a minimum annual payout, often 2.5-5% before tax. When interest-rates first started to fall the pension funds moved assets into equities to boost returns, but a further downturn in the equity markets has forced funds to tap into reserves, according to London-based traders. Danish pension funds first started to enter these positions in the summer (DW, 9/9). But since the Sept. 11 terrorist attacks fund managers have lost confidence in a quick recovery in the U.S. economy and global equity markets and have started to hedge more aggressively.
"There's been a big demand on the 25-year part of the curve because of the Danish hedging," said Meyrick Chapman, a derivatives strategist at UBS Warburg in London. As a result, 10-year swap spreads tightened three basis points to 28bps last week.
