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ERAFP’s Desfossés: ECB policy a 'trainwreck in slow motion'

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“Upside down” regulation and the European Central Bank’s (ECB) interest rates are a threat to the survival of European pension funds, according to Philippe Desfossés, chief executive of ERAFP, France’s €25bn public pension fund for civil servants. 

Commenting on the French government’s plans to allow insurers to move their occupational pension business out from under Solvency II to a new regulatory framework, Desfossés said pension funds had to “deal with issues far more challenging” than Solvency II. 

Muc more pressing, according to Desfossés, is the low-return environment making it more and more difficult for pension funds to cover their liabilities.

“From a fiduciary perspective, I cannot buy government bonds now because I’m buying something that is paying less than what I have promised on the liability side of my balance sheet,” he said.

If the ECB keeps interest rates at the current level, “you will see the nuts and bolts of all pension funds and life insurers blasted away”.

“How can life insurers and pension funds survive in an environment where money is being paid to the debtor?” Desfossés asked. “For me, it’s a trainwreck in slow motion.”

But the central bank is caught between a rock and a hard place because, if it normalises rates, “the problem won’t be so much with pension funds but with debtors, especially governments”.

The “huge problem” facing pension funds is that they have pledged to make payments based on a fixed interest rate but are unable to invest in assets that generate returns matching their commitments.

“So, in France, to talk about Solvency II alternatives […] that’s not the issue,” he said, calling instead for a redesign of the “whole architecture”.

“You have to put in place real pension funds, and by that I mean some sort of collective defined contribution scheme and not some sort of 401k à la française.”

More fundamentally, current regulations are encouraging pension funds to waste their long-term resources by investing in shorter-duration assets, he said. 

“If ERAFP invests in French bonds today, not only does it not get returns but that investment means destroying the wealth of the pension fund by reducing our coverage ratio,” he said.

He criticised that, while banks were financing long-term projects with short-term money, pension funds with liabilities of up to 30 years were encouraged to invest in short-term bonds. 

“It’s totally upside down,” said Desfossés. “We are wasting precious long-term capital. Pension funds don’t issue money, banks do – and that’s why they are much more dangerous.”

He suggested that, to help pension funds restore their funding ratios, they be allowed to increase their exposure to volatile or illiquid assets.

Regulatory constraints limiting such investments would have to be relaxed, he said.

“In parallel,” Desfossés added, “pension funds, when they have cash issues, should be able to get direct credit from the ECB as long as they can prove they have set a credible recovery plan.” 

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