Looking ahead: questions for 2015
Micro-prudential or macro-prudential?
Will 2015 be the year in which regulators and supranational policy makers like the European Commission shift emphasis from repair of the financial system and prevention of individual market failures to preventing future bubbles? The crisis of 2008-09 triggered a regulatory focus on institutional systemic relevance and future crisis mitigation and this has led to noticeable herd behaviour. Rigid regulation, like Solvency II, is one culprit. Some signs look good: for instance, the IORP II Directive appears likely to become a slimline revision of the previous Directive without the holistic balance sheet; although, as we note on these pages, EIOPA does not want to stop working on it. What is the point of having individually robust pension funds but a fragile financial system with systemically low levels of investment in the real economy?
What do you mean by long term?
Ask a pension fund, an asset manager, a politician, government official or an academic what they mean by ‘long-term investment’ and you will get different answers. For some, acting in the long term may be as simple as not acting in the extreme short term – for instance, having freedom to buy risk asset classes during a downturn, or not to rebalance when markets seem well valued. Most agree that greater institutional investment in illiquid assets like infrastructure or SMEs is highly desirable. Yet regulation forces investors to chase high-quality assets, driving up prices. Investable infrastructure projects are in short supply, while ageing demographics also restrict the appetite for liquidity. For others, long-term investing is about ownership and engagement, as highlighted in the UK’s Kay Review. But these approaches require resources, and pension funds are among the less well resourced financial actors compared with banks and insurers.
Is less sometimes more?
If good governance is crucial to the success of all organisations, why are pension funds among the least well resourced actors in the financial system? Economies of scale are good, and foster the creation of larger organisations with greater resources. Yet these are hard to achieve for a variety of reasons. One is the lack of precedent or obvious logic in countries like the UK or Switzerland where there are a large number of corporate schemes. Industry-wide schemes would work well in Germany, yet they are not universally endorsed. Boards and trustees are also unwilling to surrender control unless there is a blunt policy mechanism, such as the consolidation agenda promoted by the Dutch regulator in recent years. The UK desperately needs a small number of successful and large-scale DC funds if it is to avoid a future savings crunch.
Is this a tipping point for DC?
A proposal endorsed by a group of Dutch pension experts indicates the direction of travel for the pension system: clearer ownership rights and individual accounts within a collective system that allows for sharing of some risks. While this proposal might not make it through to the final round in this precise form, there is little appetite for prolonging the debate. In the UK, 2014’s budget changes shift the focus to the drawdown phase. In countries like Denmark, pension funds use scale to offer highly innovative post-retirement solutions for members. It remains to be seen what role pension funds can and should play in this market. Individuals have a longer horizon in a DC world where investment strategy must take the post-retirement phase into account. And what is the role of long-term assets in this new DC or collective DC world?