The UK’s central bank has warned that the herd behaviour of the UK defined benefit (DB) industry risks “amplifying” prevailing economic trends.
A Bank of England (BoE) paper on procyclical and structural trends in the insurance and pension market said that while the medium-term asset allocation of DB funds seems largely “dictated by longer-term structural shifts”, as opposed to cyclical concerns, larger DB funds seem to have implemented longer-term, post-crisis asset allocation changes that are procyclical.
“Although consistent with longer-term structural shifts in asset allocation, the continued selling of UK equities during the financial crisis by corporate DB pension funds may have further added to instability in the context of wider market moves at that time and, if taken in isolation, could be viewed as procyclical,” the report says.
The bank also noted that a number of other countries had relaxed pension regulation during the crisis, which it accepted could have “muted” the sector’s procyclical behaviour.
“This is unlikely to be optimal,” the report adds, “as it is asymmetric across pension funds, and relaxation of regulation in periods of stress does not follow a build-up of resilience as asset values rise in more benign circumstances, nor can it be relied upon by pension funds when determining asset allocation.”
The report also expresses concerns that the DB sector is prone to engaging in reputational herding – “that is, they are driven by fear of underperformance relative to their peer group to invest in the same assets at the same time as their peers”.
It notes that if such behaviour occurs at the same time as wider market trends, it could result in further procyclicality “potentially amplifying asset price or economic cycles”.
The bank was also critical about the number of underfunded DB schemes de-risking more slowly than their better funded counterparts.
“While this may have been understandable from the perspective of individual funds,” the report says, “it may not be optimal from a systemic perspective, as it implies that stronger pension funds were not taking advantage of their ability to purchase risk.”
It concludes that the absence of activity from the better funded schemes could have otherwise had a stabilising role, acting as a countercyclical buffer during times of stress.
Andrew Haldane, executive director of financial stability at the BoE, previously opined that while the bank did not believe the ‘too big to fail’ rule applied to asset managers, it nonetheless thought there was genuine risk stemming from a large asset manager becoming distressed.