Don’t hope for a Basel III scenario for IORP II

After the Basel Committee unveiled a softer version of the Basel III measures
for banking institutions in January, the European pensions industry saw the watered-down legislation as a glimmer of hope. Many crossed their fingers that Brussels would take a similar approach to regulatory frameworks currently being developed for insurance companies and pension funds.

After all, banks’ and institutional investors’ line of reasoning is not dissimilar. For months now, both have been arguing that the introduction of stricter liquidity requirements within Basel III, or capital requirements within the Solvency II and IOPR II frameworks, could limit their ability to function as they are supposed to – as lenders and investors – thereby damaging the wider economy.

For PensionsEurope, the Basel Committee’s decision to soften the liquidity coverage ratio under Basel III is good news. “This shows that the introduction of a new regulatory framework is considered in a broader macroeconomic context,” says Matti Leppälä, general secretary of the European federation. “It is very important that new rules do not hamper economic growth in Europe, especially in the current economic context.”

But there is at least one good reason why the Basel Committee’s perceived reasonableness on Basel III will come as cold comfort to those with IORP II concerns. Put simply, from Brussels’ viewpoint, the Basel rules and the Solvency/IORP rules have been set by two distinct regulatory bodies, and those frameworks are aimed at two distinct types of institutions.

As Pete Drewienkiewicz, head of manager research at Redington, points out, all of the institutions mentioned – banks, insurance companies and pension funds – have very different objectives and constraints. What is appropriate for one is not necessarily appropriate for another.

Indeed, the change in the Basel III framework focuses on liquidity buffers for financial institutions as a result of their asset-liability timing mismatch. Although IORP II is indirectly influenced – via the Solvency II regime to be applied to insurers – by Basel III, it is the longer-term capital adequacy requirements rather than liquidity that are of concern to pension funds.

Unlike insurance companies or pension funds, banks rely on short-term funding. Paul Sweeting, European head of strategy at JP Morgan Asset Management, stresses that funding liquidity and short-term access to capital markets is more important for banks. “In comparison,” he says, “insurance companies are much more likely to use long-term financing and are not so much subject to the risk of reduced access to capital markets as banks would be.”

The only positive element pension funds might find in the softer Basel III framework is on the bond side. Dave Roberts, senior consultant at Towers Watson, suggests the Basel III requirements could have an indirect effect on bond yields, especially government bond yields. “A harsher liquidity regime could have caused banks to acquire more Gilts and certain other high-quality bonds, tending to reduce the yields on such securities,” he says. This, in turn, could affect pension funds and their investments in the bond market.

Additionally, the fact the Basel Committee agreed to phase in the introduction of the full requirements for banks between 2015 and 2019 has been welcomed. Under the new Basel III structure, banks will have to meet 60% of the liquidity coverage ratio by 2015 and 100% by 2019, whereas a draft version of the measure published in 2010 required banks to comply with the full requirements by 2015.

For many, this is seen as a tacit recognition that new regulatory measures cannot always be introduced at ‘full speed ahead’. This may be something the European Commission has taken into consideration, judging from the postponement of Solvency II to 2018.

It remains to be seen whether Brussels will give similar temporary relief to pension schemes and extend the current 2013 deadline for the introduction of a draft version of IORP II.

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