On the Record: How does regulation affect your activities?
This month three pension funds explain how the changing regulatory landscape affects their activities
Greater Manchester Pension Fund UK: Peter Morris, Director of pensions
• Location: Manchester
• Invested assets: £13.2bn (€18.7bn)
• Membership: 286,419
• UK local government pension scheme (LGPS)
“The regulations governing funding of UK Local Government Pension Schemes (LGPS) do not specify how liabilities should be valued. However, they do specify that maintaining a constant contribution rate is desirable, and that the actuary has to pursue that. Also, the regulations require the actuary to work towards securing long-term cost effectiveness and the solvency of the fund. This influences the methods and assumptions adopted in valuing liabilities.
The discount rate is set by looking at the yields available on government bonds of a term consistent with the term of the liabilities, and making an allowance for the additional returns that the fund can expect to receive over the long term.
The lack of prescription by the regulator, in terms of how liabilities are calculated, means there is some flexibility to make allowance for extraordinary market conditions that may exist. The drawback may be that, because each LGPS fund sets its own assumptions it is difficult to consistently assess the liabilities of the LGPS as a whole. Measuring LGPS on a like-for-like basis is being addressed.
GMPF aims to achieve a long-term real rate of return slightly in excess of the actuary’s assumption, which is a challenging target given the prospect of lower returns on many asset classes. To put it in context, a 1% additional investment return is worth more than 8% of current employees’ pay.
In terms of what assets LPGS can invest in, the current rules could be less prescriptive. By comparison, private sector pension scheme investment regulations are set up on the basis of a Prudential framework. A similar approach would be an appropriate basis on which to design new LGPS investment regulations.
There are a number of potential investments that might be appropriate for an LGPS fund but that are not permitted under the regulations because of the particular way the regulations are drafted. However, an alternative approach that fits the regulations can generally be found. Most limits on investments have not constrained our activity.
In the past there was not a great deal of headroom for an upward increase in strategic allocation to private equity and infrastructure investments through limited partnerships. Then, in 2013, the UK government increased the limit on investments in partnerships to 30%. This new limit gives us plenty of scope to invest in alternatives, particularly infrastructure.”
Migros-Pensionskasse Switzerland: Christoph Ryter, CEO
• Location: Zurich
• Invested assets: CHF 21bn (€19.8bn)
• Membership: 81,644
• DB pension scheme for employees of the Migros group
“Pension fund regulation in Switzerland is relatively flexible. The regulator does not prescribe which method of valuing liabilities pension funds should use.
At the Migros-Pensionskasse, and Swiss pension funds in general, the board of trustees is responsible for setting parameters, such as the discount rate or the kind of mortality table. Because we are not forced to use a mark-to-market method, we apply a fixed discount rate. This may change from year to year, according to market conditions and changes in actuarial assumptions.
In recent years, the discount rate has been lowered gradually from 4% to 2.5%. Since every pension fund has to employ an external actuary to value the liabilities, they need to take their judgment into account.
But we are not in a fixed, limiting environment and there is room for manoeuvre. For instance, we use generational mortality tables rather than periodic tables, as the latter do not take into account future increases in life expectancy.
The only limitation is represented by a maximum discount rate published yearly by the chamber of consulting actuaries, which pension funds must not exceed. If they do, however, they have five years to bring it back to an acceptable level.
The regulations so far have not influenced our asset-allocation strategy. There is a limit to investment in alternative assets which, in theory, cannot exceed 15% of the portfolio. A recent rule change has meant that more assets, which used to be considered as fixed income, are now classified as alternatives. There are exemptions for funds that justify exceeding that limit.
The new rules regarding disclosure of asset management costs have not affected our investment approach to a great extent, although obviously they make reporting more burdensome. The regulatory change that has had the most significant impact in last year is the requirement for pension funds to exercise their voting rights as shareholders of companies. This increases the workload for pension funds, but since pension funds are hardly majority shareholders of companies, the influence they can have has been overestimated. I am not sure that this change is having the desired impact. However, more transparency is a good thing, and time will tell whether pension funds’ votes will actually matter.”
SEB Pension Denmark: Jørn Styczen, CIO
• Location: Copenhagen
• Invested assets: DKK90bn (€12bn)
• Membership: 275,000
• Provider of guaranteed and non-guaranteed DC plans
“Danish life companies such as SEB Pension will be required to implement Solvency II rules from 1 January 2016, and the regulatory environment will change as a result. However, there will be little change in the method used for valuing liabilities. It consists of a discount curve that is based on the euro swap curve plus an add-on for Denmark, and includes an ultimate forward rate (UFR).
In Denmark, we are used to such changes having implemented the transitory regime (mark-to-market valuations on both assets and liabilities, stress testing, Solvency 1.5 and after that Solvency 1.75). The core idea of the new regime is that pension funds should be responsible and capable of understanding, measuring and managing their ability to take risks, particularly when they offer guarantees. In order to establish whether the risk taken is appropriate, assets will be stress-tested relative to the risk capacity of the company. This is a positive development, as a pension fund needs to hold risk capacity in order to take risks in the first place. For some companies, the new regime may be quite limiting. At SEB Pension, we feel we are in a favourable position, as we have a very solid balance sheet. That means that stress testing will not limit our current investment strategy.
But the new regime does bring certain limitations we believe are too much. A perfect example is triple-AAA rated CLOs. Capital charges for these assets will be high, and we will be required to cover 100% risk of default if the assets are not risk-retention compliant. That is an issue as it limits the amount we can acquire before we stretch our balance sheet too much. For us, this is the least welcome measure.
That said, there could always be disagreement on the appropriate level of risk-weighted capital charges for individual asset classes, but the most important aspect is reaching a good risk allocation. You need a balanced proportion, otherwise there is a danger of encouraging herd behaviour.
I believe, all things considered, that policymakers have struck a good balance. However, there are still some idiosyncratic rules. For instance, the stress levels of non-rated bonds in relation to different levels of rated ones. The regime does not limit our current investment strategy, but in case of future market stress the investment strategy could be affected.”
Interviews conducted by Carlo Svaluto Moreolo