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Can a pension fund be too big to fail?

Will the Financial Stability Board (FSB) extend the ‘too-big-to-fail’ resolution to pension funds? This question immediately came to mind after the board decided in July this year to include nine large insurance companies in the group of “systemically important financial institutions”, arguing that those insurers could potentially pose systemic risk if they were to collapse.

Contacted by IPE in late August, Eva Hüpkes, adviser on regulatory policy and cooperation at the FSB, said at the time that the FSB was in the process of analysing what institutions, apart from banks and the nine insurers, should be included in the group. She did not exclude the possibility of extending the resolution to pension funds.

But pension experts have argued that the ‘too-big-to-fail’ resolution cannot and should not apply to pension funds. First, they stress, it would be very unlikely that any pension scheme would go bankrupt. Even when companies sponsoring pension funds go bankrupt themselves, this does not necessarily affect the underlying pension fund. Is it right to then conclude that the scheme has failed? Yes, in the sense that the fund may fail to meet its liabilities. But another question arises. From what level of underfunding can we determine that a pension fund is failing? That question is hard to answer.  

Still, in the unlikely event that a pension fund did collapse, would it really cause systemic risk to financial markets? To answer this question, we need to look at the size of each pension fund. The failure of a large scheme with several billion euros of assets under management could potentially be seen as a significant risk to the market.

“It is clear that, if a major insurer or a major pension plan were to fail, there would be some major consequences for citizens and, ultimately, one could expect some form of a bailout, depending on the composition of the pension system in the EU country,” says Mirzha de Manuel, researcher at the Centre for European Policy Studies in Brussels.

However, one could argue that, before a government would be required to intervene, a number of security mechanisms would apply. First, pension fund managers could decide to cut pension benefits, decrease pension payments or even call for sponsor support. They could also increase contributions from the employees or put in place recovery plans for a period of time if liabilities are too high.  

Furthermore, according to Thomas Montcourrier, economic adviser at PensionsEurope, pension funds are not interconnected with the financial markets in the same way banks are. They are “users” of the market, he says, in the sense that they do not issue assets to be traded. Montcourrier also points out that, contrary to banks, which are all interconnected, solvency rules differ for pension funds across Europe. “If a pension fund were going bust,” he says, “it is unlikely that this could affect pension funds in other EU member states.”

 

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