Financial markets

Financial Market Trends No.88, March 2005


Please find below an overview of each of the articles published in the March 2005 issue of Financial Market Trends:

Highlights of Recent Trends in Financial Markets

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Corporate Pension Fund Liabilities and Funding Gaps

The fixed nature of pension benefits under corporate defined benefit (DB) pension plans imply that plan sponsors face financial and potentially biometric risks. A large number of OECD countries have such DB pension schemes, whereby employees receive a specific payment upon retirement and for which sponsoring employers are responsible to some extent for meeting any shortfall in pension funding relative to liabilities, although, across countries, these schemes vary in importance. Recent financial market developments, including in particular the post-2000 equity market correction and declining interest rates have illustrated the vulnerability of DB plan sponsor companies to financial risks. While it is difficult to form a judgement about the exact magnitude of the funding gaps that have arisen, estimates of such gaps were considered to be of sufficiently large scale to raise concern amongst policymakers. Policy responses run the gamut from relief measures intended to lessen temporarily the financial pressures on sponsoring companies to increased solvency requirements for pension funds to increased authority for prudential regulators. Recently, there has been progress in reducing pension fund deficits in many cases resulting from the recovery in financial markets after the post-2000 downturn, however, the obligation to fill these gaps could represent a serious drain on resources that would otherwise be available for investment in coming years. Structural problems still persist and regulatory frameworks for private pension arrangements may need to be adapted in the near future to ensure adequate retirement incomes, although the temptation to over-regulate must be avoided.

Overview of Advances in Risk Management of Government Debt

This article is based on a new OECD study, Advances in Risk Management of Government Debt, that provides an in-depth overview and analysis of risk management practices of OECD debt managers. Risk management has become an increasingly important tool for achieving strategic debt targets, and is now an integral part of a wider strategic debt management framework based on benchmarks in most jurisdictions.

Risk management should be seen as an integral part of a wider strategic debt management framework based on benchmarks. A strategic benchmark plays a key role in the control of risk. The benchmark in its function as management tool requires the government to specify its risk tolerance and other portfolio preferences concerning the trade-off between expected cost and risk.

The risk management policy framework constitutes the critical connection between the formulation and implementation of debt management decisions. This risk framework includes in most countries market, credit, and operational risk, while only in relatively few OECD countries attention is paid to the risks related to contingent liabilities (although there is a growing interest in exploring their role in this policy area).

Debt managers need to have a view on the optimal structure of the public debt portfolio. Ideally, they should be able to assess how a portfolio should be structured on the basis of cost-risk criteria so as to hedge the government’s fiscal position from various shocks. The optimal debt composition is derived by looking at the relative impact of the risk and costs of the various debt instruments on the probability of missing a well-defined stabilisation target.

Emerging market debt managers are generally facing greater and more complex risks in managing their sovereign debt portfolio and executing their funding strategies, than their counter-parts managing sovereign debt in the more advanced markets. At the same time, many emerging markets are not in the position to benefit from international or domestic efficient risk-sharing. In view of these structural obstacles, debt and risk management (including the specification of a strategic benchmark) need to be integrated into a broader policy reform framework.

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White Paper on Governance of Collective Investment Schemes

Collective Investment Schemes (CIS) have been one of the most significant developments in financial intermediation during the past few decades. OECD data indicate that CIS assets have been rising sharply as a share of national income and a share of financial assets in most Member countries. In addition to functioning as an effective vehicle for individuals to implement their preferred investment strategies, CIS already play a major role in providing for retirement income. This role is likely to grow in coming years. Overall, the experience of the investing public as well as policy makers has been highly positive. CIS have enabled even fairly small investors to participate in the strong growth of capital markets in the past two decades. CIS make it possible for relatively small investors to obtain diversified investment portfolios and CIS have been instrumental in raising the financial sophistication of the population.

Over the years, both regulators and the CIS industry have realised that it is important to maintain robust systems to avoid conflicts of interest and to protect CIS investors. More recently in the context of the current review of governance in the corporate and financial sectors by the OECD, as well as in response to a number of reported cases where CIS have fallen short in fulfilling their duties to investors, officials concerned with the structure and regulation of financial systems in OECD countries have been increasingly interested in the governance of CIS.

The purpose of this paper is to suggest those elements that constitute a robust regime of governance for consideration by policy makers and by the CIS industry. The paper covers six areas: I. The legislative and regulatory framework; II. rights of investors; III. the role of the private sector; IV. market discipline and market infrastructure; V. transparency and disclosure; and VI. the internal governance of the CIS.

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Highlights of OECD Financial Outreach Activities in 2004

Following the end of the “Cold War”, the OECD has, since the early 1990s, been conducting “Outreach” activities (i.e. policy dialogue and capacity-building cooperation activities with non-Member economies), first with the Central and Eastern European countries in transition, and now extending to many other emerging economies. These “Outreach” activities have of course included financial sector reform, as the financial sector is often considered one of the key sectors in assisting these economies’ developments. The OECD’s efforts in this area have focused on, and continue to give primary attention to, capital market reform (including corporate governance) as well as insurance and pension market policies and reform on a regional basis; they have been recently targeting Asia, as this region is the most dynamically growing among the emerging economies.  This article describes the general background for the financial “outreach” activities as well as highlighting some of the activities in Asia and elsewhere.

Global Pension Statistics Project: Data Update

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