IRELAND - New funding regulations could encourage Irish pension schemes to concentrate their fixed income investments in a small number of risky counterparties, Towers Watson has warned.
The prediction comes after last week's publication of the Social Welfare and Pensions Bill, which allows for pension funds to offset an increased funding reserve of 15% of scheme liabilities by holding both cash and EU-issued bonds.
The Bill is expected to pass into law by the end of the month, ahead of the Pensions Board issuing its guidance.
Speaking with IPE, Towers Watson's Joseph O'Dea noted that the Bill's approach did not reduce the risk to which a scheme would be exposed, but simply lowered the amount of capital needed to meet regulatory requirements.
"It does encourage concentration of risk in a relatively small number of counterparties, and, indeed, it may encourage a concentration of risk in the more risky counterparties," he said.
The investment consultant also argued in favour of Irish schemes being able to use other investment-grade bonds in the same manner.
"At the moment, you have the strange scenario that you could hold, say, Spanish, Italian, Irish and Greek bonds and be required to hold less capital than if you were holding US, Norwegian, Japanese or Australian bonds hedged back to euros," he said.
His comments come after the country's National Treasury Management Agency announced plans for an annuity bond, with fixed income specialist Glas Securities saying the issuance could lead to €2bn in new funds for the exchequer over an 18-month period.
The bonds would be used as the basis for the new sovereign annuity, allowing schemes to buy out liabilities at a significantly cheaper rate than at present, as it could incorporate sovereign debt from any one of the EU member states.
At present, Irish schemes use investment-grade euro-zone bonds, such as the German bund, to measure liabilities.
Discussing the issuance, an NTMA spokesman said: "The NTMA is not prescriptive about any particular term for these bonds, but, based on industry needs, it anticipates that they will be for a range of maturities of up to 35 years."
However, O'Dea dismissed the impact of the annuity bond.
"The impact of the proposed issuance of up to €2bn is unlikely to be particularly significant," he said. "In aggregate, if they were all taken up, they would probably increase funding levels by the order of 0.5%.
"The problem we are talking about is the conflict of interest that is encouraging pension funds to lend money to the Irish government by requiring them to hold less capital if they do so."
The consultant added that, while the government was not mandating where scheme assets should be invested, they were "certainly" encouraging a pattern of investment.
Aon Hewitt had previously warned that new powers granted to the minister for social protection under the Bill gave the department a "blank cheque" to increase the funding reserve to as much as 50% without parliamentary vote, with the industry quietly concerned the measure could be used whenever the exchequer needs additional financing.