Who Needs Risk Rules? Pensions Act on Their Own

The Wall Street Journal reports:

Even before a financial-regulatory overhaul takes effect, some big investors are imposing their own rules on risk.

Several public and corporate pension funds are curtailing or revisiting their use of derivatives out of concern for hidden risks they may carry. In Oklahoma, a public pension fund replaced Pacific Investment Management Co., led by well-known investor William Gross, as one of its bond-fund managers, citing the risks of its use of derivatives whose values couldn't be cross-checked in audits.

Public pension funds in California and Maryland also are reviewing the risks of their exposure to derivatives. And state legislators in Illinois and New Jersey have introduced bills to curtail the use of derivatives by their states' pension funds, citing their role in the market meltdown.

Derivative contracts run from options and futures on individual stocks to complex swaps covering interest rates, currencies or other assets. The financial-overhaul bill pending in Congress includes new regulation of derivatives, including processing some trades through a clearinghouse, with parties posting margin to assure they can pay. The bill requires Wall Street dealers to segregate some riskier derivatives in separately capitalized subsidiaries, to make sure they can repay as well.

Karyn Williams, a pension consultant at Wilshire Associates, says some corporate pension-fund managers are trying to monitor issues like "counterparty risk" being taken by their managers in derivatives known as swaps. "There's a big conversation about risks in these pension plans," she said.

The market for self-preservation.