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Pension fund consolidation brings risk

Pension fund consolidation remains among the most significant trends in the UK and the Netherlands. Other European countries are also experiencing or debating consolidation. In many cases, regulatory authorities have been driving the process. But individual pension funds have also seen the merit of creating larger organisations. For pension funds, the main benefit of mergers is the chance to take advantage of economies of scale. For regulators, overseeing fewer and more resourceful organisations is easier. 

However, there is much more at stake than more efficient pension fund management and oversight. First, it is dangerous for regulators to try to shape the structure of a market beyond certain limits. 

Second, pension fund consolidation has implications for the functioning of financial markets. 

In the Netherlands, the number of pension funds has fallen from about 800 in 2005 to just over 300 currently, and it is expected to fall further. The regulator has even indicated a target for the number of pension funds of about 100. In Britain, Local Government Pension Schemes (LGPS) are organising themselves into regional pools to maximise cost efficiencies, which could create a handful of large individual asset owners.

Is it possible for regulators to successfully identify and enforce the ‘correct’ number of participants in a market? It is a matter of theory versus practice. Of course, a relatively simple model can suggest what that number should be. But models are no more than simplified versions of reality. In practice, the market will take matters into its own hands and come up with a number that might be different from what theory dictates. 

Regulation, of course, should attempt to fix market failures. But even those can be difficult to identify. Granted, in both the Netherlands and the UK the system is failing to achieve satisfactory and sustainable pension outcomes. But this may not be the result of a higher-than-necessary number of pension funds. Other elements play an important role. These include developments in the labour markets and the wider role of the welfare state, as well as the obvious problems with lack of growth in the economy.

In conclusion, it is difficult to improve on market outcomes by restricting the number of pension funds. Restricting the number of pension schemes may achieve some cost and oversight efficiencies but there may be other higher costs. Just consider financial market structure and liquidity. The systemic implications of reducing the number of Dutch pension schemes by another two-thirds could be considerable.

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