Some pension funds do trade derivatives – it really dpends on the exact type of pension fund. On the whole they are not big users of derivatives though, as they are what is known as “real money” and will overwhelmingly tend to match their liabilities buy buying bonds with cash.

The biggest users of interest rate derivatives by far are banks and hedge funds, followed then by corporates and pension funds for specific hedging purposes.

Just a Q. You say:

“Derivatives are only traded between large financial institutions and some very large corporates, mostly because the barrier to entry is very high, as you need a good enough credit rating (and enough cash) to get ISDA docs and CSAs signed.”

How does that square with this from the Intelligence on European Pensions and Institutional Investment magazine:

“Barclay’s attempts to manipulate the LIBOR rate between 2005 and 2009 could affect UK pension funds “negatively”, depending on their derivatives trades, but it is still too early to assess the full impact of the scandal, a number of consultants have said.” (http://www.ipe.com/news/libor-scandal-could-hit-pension-funds-depending-on-derivatives-trades_46403.php?s=LIBOR registration needed)

Tim somewhere above suggested that pension funds wouldn’t be involved in this kind of interest rate derivative stuff (and indeed that it might be illegal) but the IEP coverage seems to tell a different story. Is it that it is the pension funds’ own fund managers are accredited/cahflowed in the way required, and that they (with the PF boards’ consent)were playing the derivatives market (and presumably losing because of lack of access to pre-trade info)?

Derivatives are only traded between large financial institutions and some very large corporates, mostly because the barrier to entry is very high, as you need a good enough credit rating (and enough cash) to get ISDA docs and CSAs signed.

@ Sunny mainly

We CAN easily have a look at how much LIBOR was manipulated….as bloomberg (amongst others) keeps historical data for it, and also historical data for OIS, which is where overnight funding *actually* happens. The LIBOR-OIS spread would change dramatically if there was serious manipulation.

Looking at the REAL LIFE data though, pre-Lehmans, the LIBOR-OIS spread gently dropped (from 15bp to 10bp between ’00 and ’07 for example), with very little volatility. Given LIBOR is an ESTIMATE of were banks can borrow, and that the volatility to the LIBOR-OIS spread was within the bid/offer spread of the two itself, it does suggest that any manipulation had little or no effect, and the net effect was to REDUCE borrowing costs.

The 800tr figure you bandy includes mortgages, but they are a SMALL part. I don’t have time to get all the data together for the entire world, but outstanding mortgage debt in the US is apprx 13.3tr, and the US has the largest housing/mortgages market in the world. Of that 13.3tr not all of it will be tied to LIBOR.

http://www.federalreserve.gov/econresdata/releases/mortoutstand/current.htm

I’d guess that the figure for the world didn’t add up to more than 10% of the total amount of outstanding derivatives, and that only a minority of that mortgage debt was actually tied to LIBOR.

That 800tr figure is mostly derivatives, traded between financial houses and large corporates, and a huge percentage of that number will be offsetting contracts, as that 800tr figure is a total nominal amount, and doesn’t take into account the massive offsets there are in the market.

Please, Sunny, please, for once in your life before you start ranting away, do some simple research – otherwise you end up looking like a fool.

It’s not the politicians who enable that behaviour – it is the businesses and the executive/shareholding class that want it that way.

@51

You misread me – steveb has it right. The naivete is not in believing that it *should*, the naivete is in believing that it *does*, for the reasons explained above.

It’s put very succinctly in the movie [i]”Dogma”[/i] when rogue angel Bartleby addresses the board of a corporation clearly based on a US fast-food giant:

“With the exception of Miss Pryce, there is not a decent human being amongst you. Do you know what makes a human being decent?

(beat)

Fear. And therein lies the problem. None of you has anything to fear
anymore. You rest comfortably in seats of inscrutable power, hiding behind
your false idol, far from judgement – lives shrouded in secrecy even from
one another. But not from God.”

In short, when the individuals that run a corporate entity have amassed so much personal wealth that they are shielded from the consequences of their actions (as has always been the case – even during the postwar period, when regulation was embraced wholeheartedly), then they have nothing to fear and will behave in a manner that reflects that.

When the human mind unleashes behaviour betraying no fear of consequence, such behaviour is known as psychopathy, and if caught, the human who behaves in that manner will end up prosecuted and imprisoned or even executed. Since the ’80s, corporations and the wealthy have behaved in such a manner and instead are feted as examples to admire and emulate. There’s something deeply wrong with this state of affairs.

I think fund managers trading swaps is misleading. Fund managers need to engage in hedging strategies to balance their liability mismatches and that requires a counterparty who will assume the risk that they can’t bear. An ageing customer base causes significant difficulty for pension funds trying to match assets with liability many years into the future. Shifting their portfolios away from equities to a fixed income bond bias is one of the ways they address the ageing population dilemma. However, there are not enough long-dated bonds for everyone to buy bonds to close the mismatch. Moreover, with a bond bias they are exposed to interest rate risk. Small changes have big effects when liabilities are calculated many years into the future. Therefore, they can engage in interest rate swaps, inflation swaps and CDS with investment banks to hedge their exposure to risk. Furthermore, if they buy foreign fixed income bonds they assume foreign currency exposure which they will also hedge with an investment bank.

Buying equity CDS protection can be tricky for a pension fund. It is expensive illiquid and can send out a dodgy signal. Buying the CDS of a company is effectively shorting that company. What kind of message would it be sending out if the BT pension fund is effectively shorting BT. However, that is where most of their exposure lies. Therefore, in recent years we have seen a huge shift towards fixed income bonds and at the same time hedging of that exposure to risk.

Here is the Danish national pension fund making a huge return from their strategy of hedging their risk.
http://www.efinancialnews.com/story/2012-02-01/atp-26-percent-return-2011

Some information that may interest you.

http://www.actuaries.org.uk/system/files/documents/pdf/swapsmadesimple.pdf

https://institutional.vanguard.com/VGApp/iip/site/institutional/researchcommentary/article/PensionPlansExploreIntRateSwaps

I’m afraid I don’t understand your answer – was it 1.5%? – okay so overnight lending markets might disappear and banks will have to fund themselves some other way, I’m sure various changes will occur, but what’s going to be the likely bottom line impact on how much firms and households have to pay to borrow? Let’s talk in terms of annual rates of interest. The impact might not be constant across all classes of borrower, but let’s ignore that. Didn’t that EU report that estimated the impact on growth do so from an estimated change in the cost of capital?

It’s serious, it destroys any pretence investment banks have to be trustworthy providers of services to their clients, I’d like to see bankers jailed and the whole fabric of banking torn up and rebuilt. I don’t think it’s trivial at all.

I just don’t think it materially affected the most of us, in this case. I think it was about players in the City casino cheating.

There’s not much reason why a pension fund manager would enter into an interest rate swap. Certainly not as a speculator, running up large positions: that would almost certainly be illegal in fact.

Bu yes, I did mean that derivatives are, by definition, zero sum amongst all those who play with derivatives. Whatever one person wins another must have lost.

The benefit to the society as a whole is that it moves risk around.

Luis:

“The comparison is the FTT is an interesting one. Does anybody have an estimate for the impact of the FTT upon borrowing costs? How does it compare to the libor fixing.”

Yes, I did this sum years back. The FTT will be charged on overnight lending. At what is it? 0.1%? 0.05%?

No one is going to lend overnight if the tax is higher than the interest that can be earned from it. Obvious, eh?

250 banking days in a year? Libor is, before interest, 25% on an annual basis, or at the lower rate there’s 1.5% built into it.

Doesn’t look good.

Despite Employment Tribunals agreeing that staff were treated badly, the High Court said that they are powerless to help because their is noting stopping this in law.

Now, to rub salt in the wound, Government officials and the local MP simply try to kick the issue into the long grass, by claiming that it’s not in the public interest to do anything about this matter, whilst refusing to have the Directors struck off, failing to introduce new laws to outlaw these kinds of sharp practices, and not even bothering to call for an inquiry into this scandal.