Pension and insurance regulators in Europe are unwittingly hampering the European Central Bank (ECB) in its efforts to get the euro-zone economy growing again, according to bond manager PIMCO.
Harley Bassman, executive vice-president and portfolio manager in PIMCO’s Newport Beach office in the US, said: “For the ECB’s QE to be fully effective, macro policy coordination is needed.”
Like Aron Ralston in the film “127 Hours”, the euro-zone economy is currently wedged into a financial ravine that requires drastic action to escape, he said.
“Without surrendering their independence, insurance supervisors and pension regulators could revise or temporarily suspend some of the more stringent reserve capital charges to allow for greater duration gap variability,” Bassman said in what he called “an open letter” to the euro-zone.
Bassman added that, in conjunction with the deferral of capital gains on the sale of premium bonds, such a revision by the regulators might well encourage diversified and broader holdings of equity investments.
He said that, in both the US and Japan, wide-scale monetary easing policies by central banks had had the necessary conditions for asset substitution to accelerate monetary velocity, in that there had been “political and regulatory synergy” to facilitate the flow of funds.
“It is this synergistic coordination that is missing in the euro-zone and must be resolved,” he said.
The ECB is on a path to inject money into the financial system, but, unlike in the US, in Europe most long-term assets are held by heavily regulated pensions and insurance companies.
“While one can appreciate the good intentions of regulators, insisting that the maturity of assets should closely match that of their liabilities, the unintended consequence has been to encourage asset managers to buy fixed income securities as rates decline regardless of price, instead of transitioning to potentially superior long-run investment opportunities,” he said.
Bassman explained that, because long-dated fixed coupon bonds have more “convexity” than shorter-dated bonds – and with rates already below their cost of capital – many managers have run a gap in their asset-liability management (ALM).
“Unfortunately, as interest rates declined in anticipation of QE, the ALM gap widened, and, so as to not run afoul of various regulations, ever more bonds were purchased,” he said.
Even though the ECB wants portfolio managers to sell their sovereign bonds to the ECB and recycle those funds to other assets that will support economic growth, those hamstrung managers are effectively anticipating the bank’s policies and partially muting their effectiveness, according to Bassman.
“What would be helpful is policy coordination between the ECB, the European Insurance and Occupational Pensions Authority (EIOPA) and the Dutch National Bank (DNB), tempering the impact of Solvency II and other regulatory measures in the short to medium term,” he said.
This would cover about 80% of euro-denominated pension and insurance and pension assets, he added.