The Dutch pension fund (PF) system is in the middle of a transition phase, from Defined Benefits (DB) to Defined Contributions (DC), with the transition impacting 99% of members between Jan25 and Jan28. In the new system, PFs will likely need less duration, having in particular to reduce exposure to (ultra) long-dated swaps & bonds as young members will be assigned low risk-free exposure. This suggests a likely reduction in investments in long-term (≥25 years) government bonds and interest rate swaps under the new pension contract. We estimate that funds will reduce their holdings in government bonds and interest rate swaps with a maturity of 25 years and longer by roughly €100-150 billion. By comparison, €900 billion is outstanding in (semi-)government bonds with such maturities, and the net position of interest rate swaps is over €300 billion. In the post covid period, Dutch PFs increased their interest rate hedging to protect their funding positions. It is the duration of the swaps portfolio that appears to have risen meaningfully, from the €500-600bn in pre-COVID times, to possibly as much as c.€900mln/01 currently. Post the reforms, Dutch PFs will invest less in bonds due to reduced DV01 needs as well as removal of constraints on capital charges. We estimate that duration needs would be reduced by €50-140mln/01 for the PFs in the Jan-26 wave. We believe that for the funds switching in Jan-26, the extent of the increase in the received swaps positions seen over the last few years will mean those are likely to be the first unwound. Market Implications: Both the scenario of reduced govt bond holdings or that of a barbell in highly liquid & more risky investments could drive a reduction in Dutch govt bond holdings. We also look for an initial out performance of bonds versus swaps in the long-end of the curve as the focus of initial unwinds centers on swaps. With the first big wave seeking to unwind their hedges en masse in end Dec when liquidity is typically poor, investment banks and brokers may struggle to match up sellers and buyers, freezing up the system. The supply-demand imbalance for longer-dated swaps is already significant. With a pipeline of pension funds needing to unwind swap positions, market players such as hedge funds seeking to profit could let this play out before stepping in to take the other side of the trade. That could lead to a rapid steepening in the curve. Hence, we remain cautious on long end DM yields especially EGBs going into year end.
