HR Finance Alert

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The use of derivatives by U.S. pension funds to hedge risk will likely slow down because of the ongoing credit crisis. According to experts at Watson Wyatt, since the start of the credit crisis last year, the execution of derivatives-based liability hedging strategies has been losing pace. This is mainly due to more onerous legal conditions. Additionally, at certain points during the year, available yields were not considered attractive.

In light of recent market events, it is not surprising that some banks are now either less willing or less able to retain unhedged risk on their balance sheet. Pension funds now have to delay the execution of risk reducing strategies, which could also hinder wider adoption.

Funds that have these strategies in place can consider several different approaches: 1) ensure their documentation and collateral are robust, 2) diversify counterparties to manage the default-to-replacement risk and 3) in the event of a default, replace positions quickly to minimize possible market losses.