On Apr. 18, DEN FSA private equity investments inspection statement.
DEN FSA published statement on functional inspection of private equity investments in the pension fund for social workers, social pedagogues and office personnel.
And a statement on the pension fund for nurses and medical secretaries.
As part of the inspections, DEN FSA reviewed selected private equity investments.
Background
In Oct., Nov. 2023, DEN FSA conducted functional inspection of Pension Fund for Social Counsellors, Social Pedagogues and Office Staff, with private equity investments focus.
Functional inspection included pension fund's organization, resources, investment strategy and processes with a focus on how the pension fund lives up to the prudent person principle in relation to identifying and handling risks including ESG risks.
Prudent person principle is laid down in Insurance Business Act, section 175.
The principle - part of Solvency II regulation - requires the companies to invest their assets so that the customers' interests are safeguarded in the best possible way.
Implies, among other things, that companies must only invest in assets where they can identify, measure, monitor, manage, control, report on the associated risks.
Follows from SLV2 article 275 that companies must take sustainability risks into account when identifying, measuring, monitoring, managing, controlling, reporting and assessing risks in connection with investments; DEN FSA can also refer to guidance on alternative investments, good investment processes per prudent person principle.
Also in Oct., Nov. 2023, DEN FSA conducted functional inspection of the Pension Fund for Nurses and Medical Secretaries, where focus was on private equity investments.
DEN FSA Inspections
Pension Fund for Social Workers, Social Pedagogues and Office Personnel offers its members average interest products; the pension fund has around 134,600 members and investment assets worth DKK 113bn. as at the end of Sep. 2023.
The fund's investments are handled by PKA A/S - management company in the PKA community; investments in private equity are made as capital fund investments and co-investments through strategic partnerships, including through IIP Denmark P/S.
This is a capital fund manager owned by the fund, with other PKA community funds.
These are control investments based on active ownership in small unlisted firms in various sectors (buyout incl. value-add infrastructure) and small unlisted start-ups seeking capital to grow their business (venture) - called private equity investments.
In addition, explained that these are evergreen investments that are expected to be held for a longer period of time than typical private equity fund investments.
The pension fund's investments in private equity amount to c. DKK 18bn as at end Sep. 2023 corresponding to around 16% of the total investment assets.
Pension Fund for Nurses and Medical Secretaries offers members average interest products; c. 136,000 members, investment assets worth DKK 202bn at end Sep. 2023.
The pension fund's investments in private equity amount to around DKK 30.3bn as at end Sep. 2023 corresponding to approx. 15% of the total investment assets.
Both represent a significantly larger share than the average for the pension industry.
Investment Policy, Guidelines
Both pension fund's strategy is that investments in private equity should contribute to attractive risk/return ratios and to risk diversification in the entire investment portfolio, as well as to the pension funds' objectives for responsible investments.
DEN FSA found that the board of directors' investment policy, guidelines do not provide sufficient guidance for investments in private equity; entails risk that the pension fund makes investments and assumes risks contrary to the board of directors' wishes.
The regulator thus ordered board of directors to ensure investment policy, guidelines better define desired risk profile for investments in private equity, provide clear instructions for the executive board's authority to make private equity investments.
Among other things, the board of directors must ensure more clarity on investment strategies, approaches, and on the extent to which investments can be made in funds, funds-of-funds, single/co-investments, including which must be submitted to board.
Board must also ensure more clarity on how ESG considerations will be integrated into pension funds' private equity investments and how ESG risks are to be identified, assessed, managed so decisive factor for investment is to safeguard member interests.
DEN FSA recognizes ESG risk management is an area where tools, data still evolving.
Emphasized importance of the pension funds continuing to monitor development, work on developing methods and processes for identifying and measuring ESG risk.
Reporting to Board of Directors
DEN FSA assessed that regular reporting to the board on fund's investments in private equity does not provide board with sufficient overview, insight into the investments.
Assessed, among other things, that reporting should comment more on pension funds' most significant private equity investments in terms of whether private equity funds are developing as expected, what is driving the development; and highlight any matters concerning/important to private equity funds' development and risks.
Reporting must also include ESG considerations and risks to a greater extent.
Ordered pension funds to strengthen regular reporting on private equity investments.
Return/Risk Assessment
DEN FSA found that the pension funds calculate a risk/return ratio for all investments in private equity, which is included in the pension fund's investment decision basis.
The calculation is based on liquid leverage-adjusted small cap benchmark index and underlying sector index; for the underlying investments in overall private equity capital funds, required rate of return is also calculated based on required rate of return model.
This is based more on identification and measurement of individual investment's significant and specific risks; as this does not apply in the same way to overall private equity funds, DEN FSA assessed that the pension funds does not sufficiently measure the specific risks of the overall private equity funds, including ESG risks.
The pension funds have been ordered to ensure that all material and specific risks, including ESG risks, for all private equity investments are identified and included in the measurement of risks and assessment of the risk/return ratio as part of the basis for assessing whether the assets are invested in the best interests of the members.
Assessment of Results
DEN FSA found that the benchmarks used by the pension funds as measure and basis of comparison for assessing the results achieved by investments in private equity do not sufficiently take into account additional risk premium in the unlisted investments.
The regulator therefore ordered the pension funds to use relevant benchmarks.
Principles for Risk Calculation
DEN FSA found board of directors' investment guidelines contain a framework that delimits desired risk against private equity fund managers, but calculation of the framework is not defined, which creates risk of investments being made that involve a counterparty risk towards private equity fund managers, contrary to board's wishes.
DEN FSA issued an order to ensure more clarity about the frameworks.
Documentation
DEN FSA found the pension funds' due diligence and ongoing evaluation of the pension fund's strategic partnerships in private equity area are not formalized or documented.
DEN FSA ordered the pension funds to establish written procedures for this, and document due diligence, evaluation performed; DEN FSA ordered the pension funds to establish internal procedures for collection, documentation of information for the purpose of monitoring and assessing investments in private equity and to ensure adequate documentation of discussions and decisions regarding the investments.
Resources
The study states the pension funds' investments in private equity are predominantly made through strategic partnerships, including through IIP Denmark P/S.
DEN FSA found the pension funds have relatively few investment and risk employees to monitor the pension funds' investments in private equity and to continuously take a critical approach to the specific private equity investments of varying nature and risk.
Investment in private equity plays key role in pension funds' investment objectives.
Applies, among other things, to the objectives for responsible investments, which are to be achieved by integrating ESG considerations into all investment decisions.
Managing ESG considerations, risks is a relatively new area, requires resources.
DEN FSA ordered board of directors to reassess if the pension funds have an adequate number of employees, competencies to handle the funds' private equity investments.
