US Swaps Bets Backfire, Wiping Out Billions From Funds in Chile
The pension funds used by millions of Chileans are racing to close out bets on US interest rates that backfired after the Iran war unleashed a global inflation shock, exposing them to billions of dollars of losses.
The seven so-called AFPs, private pension funds that control assets worth about $229 billion and are the sole source of retirement savings for most Chileans, piled into derivatives over the past two years that would pay off if US rates continued to fall. But they are now contending with a costly double blow: new regulations set to come into effect early next month are forcing the funds to unwind the positions just after a months-long US bond selloff pushed up yields and drove the market values of the contracts deeply into the red.
That’s forcing them to pay Bank of America Corp., Citigroup Inc. and other Wall Street banks on the opposite sides of the trades in order to break the contracts. Just a year ago, the market value of foreign interest-rate derivative positions held by the AFPs stood at a $1.4 billion gain. By September, that had swung to a $7.7 billion loss, according to figures released on Tuesday by the nation’s pension regulator.
“They’re going to have to realize the loss at some point, and that’s going to hurt,” said Felipe Alarcón, chief economist at Santiago-based insurer Euroamerica. Exactly how much the AFPs have already unwound, and how many more contracts they need to close to comply with the rules is unclear. The funds must meet a series of interim thresholds as they move toward full compliance. The pension industry’s association and the AFPs Capital, Cuprum, Habitat, Modelo, Plan Vital, Pro Vida and UNO all declined to comment.
The losses shows how broadly US President Donald Trump’s war is affecting global markets around the globe as oil hovers over $100 a barrel, rekindling the inflation that central banks were already struggling to contain. That’s caused bond prices to tumble, pushing US Treasury yields to a 24-year high, and led the Federal Reserve to raise interest rates for the first time since 2023. The jump in US rates upended the Chilean funds’ heavy exposure to swaps under which they received payments based on a fixed rate and paid a floating rate in return.
The tactic, which began as a way to increase investment returns after a wave of withdrawals during the pandemic, initially paid off. It helped drive the E funds, the AFPs’ least risky portfolios, to an average gain of 7.5% last year, their best performance since 2022. But they built up significant risk. By April, their growing position in receiver swaps left them exposed to swings of about $131 million for every one-basis-point change in yield, up from about $10.6 million in early 2024, according to a Citigroup analysis.
That started attracting scrutiny from Chilean regulators. In April, just after the onset of the US bond-market selloff, the pension regulator imposed new limits on derivative risk that kick in on Nov. 4 and effectively require funds to unwind many of the positions.
“At first, it worked very well for them because US rates fell,” said Ivan Riveros, a Citigroup strategist in New York. “The problem has been the selloff in US rates. That took them from a positive mark-to-market position to a negative one now.”The shift is exerting a growing burden on the seven private pension funds. As the funds unwind some of the trades ahead of the deadline, the losses have piled up. The E funds — which had most of the receiving positions — on average lost 10.4% this year, including a 4.9% drop just in September, when the US bond rout accelerated, according to data from the pension regulator. That month the C and D funds — which manage almost half of the pension system’s assets and also hold some of these bets — lost 3.1% and 4.2%, respectively. Chile’s pension regulator said in response to questions from Bloomberg News that the pension fun...
Source: Bloomberg Markets · Summarized by HeadlinesBriefing