DENMARK – Denmark's financial regulator has given pension funds until the middle of this year to set out exactly how they value their alternative investments, such as infrastructure and renewable energy projects.
In a letter to the country's lateral pension funds and life insurers, the Danish FSA (Finanstilsynet) said market conditions for alternatives had led to uncertainty over valuations and solvency calculations.
It said the supervisory boards of the pension funds and life insurers must submit statements addressing various aspects of alternatives valuation by 1 July 2013.
The regulator said: "The market conditions surrounding alternative investments is considered to give rise to model risk – [in other words], uncertainty about the correct valuation and consequently the actual accounting and solvency value."
The statements from pension funds and insurers will have to give information on seven points outlined by the regulator.
The points call for information on the alternative investments themselves, how often and how they are valued, how the relationship between risk and return is assessed and how the institutions quantify solvency requirements for the various alternative investments.
The current low level of interest rates in Denmark and the euro-zone, coupled with the fact it could last for some time, had increasingly challenged labour-market pension funds and life insurers, the FSA said.
It added that more and more companies were shifting parts of their investment portfolios from traditional assets to alternatives, including infrastructure, renewal energy projects and structured bank loans, as well as new growth markets.
The institutions were aiming to reap a higher investment return from these assets compared with traditional investments while expecting the benefits of a more diversified portfolio, it noted.
"The higher expected return from these alternative investments is partly due to the fact that the market these assets are traded in is not as deep, liquid or transparent as the market for traditional investment products," it said.
Investors demand a liquidity risk premium for this risk, it pointed out.
"Another characteristic of alternative investments is that they are typically long term, which gives rise to other risk premia," the regulator said.
The other risks associated with these investments, such as credit risk, political and currency risk, all had to be compensated by risk premia, it said.
According to accounting regulations, where there is no relevant market, the fair value of financial instruments must be determined using a valuation technique, the watchdog said.
This has to take in all factors – including current observable market data – that is likely to affect fair value.
"In this way," the regulator said, "it should be ensured that investment assets are valued at the price that would result from a transaction on the accounting date between knowledgeable, willing parties operating according to normal commercial considerations."