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IPE special report May 2018

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S&P: DB funding at European companies to fall by 15% due to QE

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The impact of euro-zone quantitative easing (QE) on long-term bond yields and defined benefit (DB) schemes could see funding drop by more than 15%, particularly in a stagflationary environment.

The analysis of 50 corporate DB schemes in Europe showed the European Central Bank’s (ECB) €60bn a month QE plan could see liabilities increase by as much as 18%.

The report, by Standard & Poor’s, suggested Europe’s top 50 companies rated by the firm would suffer discount rate falls due to the inflation-seeking central bank policy.

However, even with investment returns of 8-12% achieved due to buoyant markets in 2014, “substantial growth” in deficits would occur due to the cocktail of average 30% underfunding and low returns on equities compared with bonds.

S&P said the fall in long-term inflation expectations would help schemes with the falling discount rate.

However, should QE fail to generate economic growth, this would then further hamper schemes.

“Funding levels for those in deficit could suffer a further 10-15% erosion if QE causes stagflation by failing to kick-start sustainable growth, warranting its continuation, but only causing inflationary expectations to move higher” S&P said.

S&P data showed liabilities for the 50 schemes peaked at more than €500bn in 2012, with the current funding ratio at approximately 70%.

Over the last year, S&P said the AA long-term corporate bond yields, commonly used in discount rate calculations, have halved to 1.45%.

“The proximate causes of these falling bond yields have included a sluggish euro area economy,” it added.

“Corporate bonds are not on the ECB’s latest QE asset purchase list, yet they have benefited indirectly from the prospective shortage of high-quality, long-duration assets as the ECB’s target asset pool covers government bonds with 2-30 year maturities.”

It said it expected a euro-zone corporate scheme to reduce its DB discount rate by up to 150 basis points – with EDF, the French energy firm, seeing its liabilities increase by €7bn due to its 1.3 percentage point drop in discount rate.

Using the calculations of inflation expectations and falls in discount rates, liabilities for corporates could rise by 11-18%.

With this, the firm said it expected corporate schemes to manage the situation by continuing a shift to higher-yielding assets, increasing contributions, lowering benefits or reducing risk with insurance products.

“In the medium term, the risk remains QE achieves nothing more than promoting stagflation in the euro area,” S&P said.

“A combination of weak growth, inducing the ECB to continue with its aggressive monetary policy stance, and rising inflation would be a treacherous combination for DB pension schemes already struggling to contain their plan deficits.”

In January, the ECB announced a €1.1trn QE programme to ensure the current deflationary pressure in the currency union ceased and moved back towards 2%.

However, investment consultants across the Continent warned of the negative impact on DB pension scheme funding due to the combination of factors.

Aon Hewitt global head of asset allocation, Tapan Datta, said the toxic cocktail of the economic situation in Europe could be worsened by QE failure to boost equity markets.

Read Martin Steward’s analysis on the ECB move to boost inflation in the euro-zone

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