JPMorgan Chase is working on plans to create a new securities market that will give pension schemes an easy way to lay off the risk that members will live longer than expected.
Other banks, including Deutsche Bank and BNP Paribas, are also rushing to develop new securities and derivatives to hedge so-called longevity risk, creating a new asset class that some experts believe could one day outstrip the booming credit derivatives market.
Bill Winters, co-head of JPMorgan’s investment bank, said: “We expect that many billions of dollars of pension liabilities will transfer to the capital markets in securitised, derivitised and raw form. We hope to be instrumental in developing those markets.”
While previous efforts to create a market have had limited success, many pensions experts believe next year will finally see it start to take off.
David Blake, professor of pension economics at London’s City University, forecast the new market would eventually outstrip credit derivatives, which have ballooned to $26,000bn. “The potential is enormous and it will start to happen very soon.”
The area is attracting keen interest from hedge funds and Ed Giera, head of JPMorgan’s pensions advisory group, said there was enough capital seeking to take positions on both sides of the longevity trade to create a market.
The key to creating a liquid market has been to devise products that are sufficiently tailored to hedge the exposure of a particular scheme but sufficiently standardised to generate liquidity. The products could be used both by pension funds to hedge longevity risk and by life insurers to hedge the opposite risk of unexpectedly high mortality.
Mr Giera said JPMorgan’s approach was to use standard building blocks that could be combined to create tailored solutions.
“We are working on an early set of transactions that will become an interesting model for others to look at.”
JPMorgan is hoping to set the pace in the new market as it did in credit derivatives in the 1990s.
The market is expected to develop first in London, partly because of a favourable regulatory climate. In the US, pension schemes tend to be more cautious about innovative use of capital markets because of highly prescriptive pensions legislation and the threat of class-action lawsuits.
A number of new vehicles have been formed in the UK in recent months to buy out frozen corporate pensions schemes and these will help drive the development of the new market, experts say.
The US has also seen the formation of the first such company. Called Retiree Benefits, it has backing from Cerberus and Lightyear, two private equity firms, and from Amaranth, the hedge fund that was brought to its knees by disastrous natural gas bets in September.
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