Denmark’s Evolving Private Equity Scene and Regulatory Landscape

With a sustained period of low interest rates creating strong headwinds for returns in bonds and other traditional asset classes, many of Denmark’s pensions and insurance companies notably increased their exposure to alternative asset classes in recent years.  In 2015, around 16-17% of pension funds held by members of F&P — the Danish Trade Association for insurance and pensions — were invested in ‘unlisted’ assets. Fast forward to today, and that figure has risen to approximately 23%.

Even with rising interest rates post-2022, Danish pensions and insurers remain bullish on private equity returns and broadly plan to maintain or increase their alternative allocations. A 2023 survey by F&P revealed that Danish pensions plan to keep their allocation to unlisted assets steady over the next 3-5 years, with infrastructure and private equity attracting the most interest.

With Increasing Allocations to Alternatives, Regulation Has Followed

Private equity investing is a complex and resource-intensive endeavor, requiring more attention than traditional, more passive portfolio management. Institutions must meticulously vet fund managers, diligently oversee portfolios, and continuously evaluate a range of risks to construct a healthy, sustainable portfolio. Moreover, the lack of standardized reporting and range of depth of disclosure of alternative asset classes complicate the ability to form a cohesive view of a portfolio, often necessitating substantial resources for data acquisition and analysis.

With every 9 or 10 Danes in the workforce retirement held in a pension plan, regulators have quickly stepped in to examine the potential impacts of growing private equity and infrastructure allocations on these institutions’ constituents, establishing various rules and regulatory frameworks to increase transparency across several key areas:

Risk Management

Risk management is at the forefront of the Danish regulator, the Financial Supervisory Authority’s (FSA) priorities. The organization has taken a keen interest in the internal frameworks pensions, insurance companies, and other PE fund allocators use to maintain robust risk management and the adequacy of their resources for effectively managing alternative asset portfolios. Specifically, the FSA requires pensions and insurance companies to adhere to ‘prudent principle rules’ that outline guidelines for risk identification, ongoing risk management, and governance frameworks.

These rules state that funds can only invest in asset classes and companies in which they can:

• Identify the risks tied to an investment, covering general risks common to most investments and specific risks unique to the particular company or sector. These risks can span operational, financial, geographical, legal, and other macro and micro factors.

• Measure and monitor risks to determine any impacts they could have on returns, keeping track of how they develop on an ongoing basis to continuously re-evaluate various investments.

• Manage risks by taking action when necessary as risks develop or materialize, such as initiating follow-ups with managers, divesting from assets, and implementing operational changes in situations where the LP has a controlling stake.

• Report on risks and ensure all relevant data is collected, processed, and reported at the appropriate level.

Capitalization Requirements and Valuations

In 2020, pensions supported 40% of Danish retirees’ income, and this share is expected to increase to 55% in 2040 and 60% by 2080, requiring optimal asset allocation to support payouts. As a result, the FSA requires pensions (and insurance companies) to meet strict capitalization requirements, which are calculated based on the inherent risks in their portfolio. Broadly, the more risk a pension or insurance company incurs, the higher the solvency capital requirements it must maintain.

Valuations are ultimately the main tool used to forecast future payouts in private equity and infrastructure portfolios. Therefore, if valuations are overvalued or undervalued, it affects the dynamics of pensioners paying into and cashing out of the system — new customers might get a “discount” upon joining if some investment assets are undervalued or pay too much if assets are overvalued.

In the wake of the pandemic, the large discrepancy between private and public portfolios led the FSA to investigate pensions’ policies and guidelines for updating the valuation of unlisted assets. As a result, they implemented requirements for pensions and insurance companies to have clear, well-documented processes for updating valuations and re-evaluating valuations with appropriate frequency.

How Danish Pension Funds Can Use Technology to Comply with Regulation and Better Manage Private Equity Portfolios

Over the past several years, the FSA has conducted extensive inspections across the country’s pensions and insurance companies’ alternative investment portfolios, highlighting inconsistencies in board policies and guidelines. Two pension funds, the State Registered Nurses and Medical Secretaries Pension Fund and the Social Workers, Social Pedagogues, and Office Pension Fund, recently received letters from the FSA pointing out their unusually high private equity allocations relative to the country’s other pensions —15% and 16%, respectively against the regional average of 8%. 

The FSA noted that the existing board policies did not adequately reflect the level of private equity investment, ordering the companies to adjust their investment policies and guidelines to reflect their private equity strategy. Similarly, the FSA instructed Industriens Pension — with a private equity allocation of roughly 14% — to consider whether additional staff might be required to manage their private equity investments effectively.

With the Financial Services Authority paying close attention to Denmark’s pension and insurance companies, technology plays a key role in easing operational strains from heightened compliance demands and delivering significant time savings in several use cases:

Identifying, Managing, and Reporting Investment Exposures

Most LPs receive reporting from their GPs at the fund level. As a result, aggregating and tracking exposure to specific investments, currencies, geographies, sectors, and more at scale has traditionally required intensive manual data collection. For example, understanding exposures to specific companies typically requires calculating ownership manually across all of a fund’s positions, a challenge often compounded by disparate naming conventions for companies across different managers. 

As the FSA begins to scrutinize institutional resource allocation, having modern technological infrastructure that automates these insights is increasingly valuable for those seeking to optimize their resource management. By replacing manual Excel-based processes with advanced technology, Danish LPs can seamlessly understand their company exposures and risks across multiple dimensions, streamlining risk assessments and enhancing their ability to navigate market and company disruptions. 

For example, during critical, unexpected events in companies, sectors, or geographies — like the FTX collapse or the onset of the Ukraine War — LPs with robust technology can quickly assess their exposure to at-risk companies and geographical regions.

Cash Flow Forecasting and Commitment Pacing

To comply with capitalization and solvency requirements, pensions and insurance companies must carefully manage their private equity cash flows to maintain adequate liquidity. Additionally, these institutions must maintain or achieve the private equity or infrastructure allocation designated in their investment policy or mandate.

Cash flow and commitment pacing models built from their private equity or infrastructure portfolios’ cash flow and net asset value (NAV) data can provide crucial insights into this balancing act. These models forecast cash flows for an institution’s private equity portfolio, helping them plan for capital calls, distributions, and other dynamics. Further, with these cash flow insights in hand, they can map out future commitments to align with desired allocation targets and anticipate how NAV fluctuations might affect the cash flow profile of their private equity investments against the other asset classes of the portfolio.

Strategy Shift

Another top priority for the FSA is ensuring that pension and insurance companies align their investments and allocations with their outlined mandates and guidelines. Apart from co-investments and directs, LPs don’t have control of the composition of underlying companies that ultimately define their risk profiles. While they can allocate funds to managers aligning with their investment strategies, they ultimately need insights into when strategy shifts occur to maintain portfolio alignment with their mandates and investment strategies. Yet, obtaining a comprehensive understanding of such shifts can be arduous, particularly when critical insights are dispersed across an array of documents and Excel files.

By centralizing private equity and infrastructure portfolio data in a single source of truth, LPs can gain a consolidated view of their portfolio, more efficiently understand whether a manager’s underlying portfolio aligns with its marketed investment strategy, and readily identify and address any deviations.

Request a demo to learn how leading private market investors leverage Chronograph to automate reporting, identify exposures, manage cash flows, and gain unparalleled data transparency.