Why pensions funds are on agenda
Over the last two years, the spotlight at investment banks has been directed towards pension funds. The banks have set up their own pensions groups to tackle the problems of liability mismatches and other risk issues. But if the banks serve corporate clients, how and why did they end up getting so involved with pension funds?
If the pensions area is where their corporate clients have a problem, they reason, then it is a bank’s job to get involved and solve it.
Keith Jecks, global head of the pensions advisory group at ABN AMRO, says the group has evolved over the last 10 years. It was set up in the late 1990s and was initially focused on Denmark, he says, because the pensions industry there had some particular characteristics which meant that funds had a need for external advice and solutions to funding problems.
After than, attention was turned towards the Netherlands, says Jecks. “Then two years ago, we set it up globally, and recruited people for the UK market,” he says.
However, it will become more important in business terms for the bank than it is now. “Pensions work is an area for derivatives that we see growing very substantially for us,” says Jecks.
In the UK, at least, the pensions funding crisis provided the catalyst for the pensions advisory services. It was the changes in accounting for pension funds, he says. Market conditions also played a role, of course, with the decline in bond yields hitting pension funds hard.
“For a typical pension fund, a 1% fall in bond yields is more damaging than a 15% fall in equities,” he says. Duration has become a serious issue, with most pension funds holding liability portfolios where the duration is 15-20 years. Bonds on the other hand, have durations of between 7-8%.
“Long-term liabilities are much more interest-rate sensitive,” he says. In a period of falling interest rates, pension funds can find themselves in real trouble. And in the last few years, there has been a combination of falling rates and the expectation that they are not going to rise,” he says.
“The solution is interest-rate swaps,” says Jecks. In Holland, as a result of the regulation that has come into force, the response by pension funds has been to begin to eliminate the duration gap, he says.
JPMorgan created its insurance and pensions group back in 2000, largely to cater for the needs of its corporate clients. “The importance and the attention our corporate clients were putting on pensions has increased, and so the amount of resources we have put behind this has increased,” says Eric Viet, head of the Europe pensions group at JPMorgan.
So the impetus for the project came from corporate clients who were saying they needed to gain a better understanding of their risk and how to manage it, he says.
The pension fund problems is the result of an unlucky combination of events. Market conditions are part of it, with the fall in interest rates, the crash of the equities market in 2001/2002 – both of which precipitated the pension funds’ funding problems. Improved mortality has also increased the cost of providing defined benefit pension plans and it is continuing to increase. At the same time, changes in accounting rules has increased transparency. Finally changes of regulation are changing the nature of the risk.
Before the regulatory changes - Dutch nFTK, UK Pension Act 2004 - corporate sponsors may have believed they had plenty of time to pay pension fund deficits, but this changed. “Effectively, the deficit became not only an accounting problem, but a cashflow and a funding problem,” says Viet.
The pensions group at JPMorgan works with corporate clients on pensions issues. “We help corporates in the implementation of their decision,” says Viet. How the decisions are implemented is not always straightforward because frequently, he says, the corporation can not take the decisions – it is the trustees who do.
It is really in the last 18-24 months that there has been a significant increase in investment banks’ activities where they are targeting UK pension funds says Nick Horsfall, senior investment consultant at Watson Wyatt.
On why this has come about, he says there is a pragmatic point that there is now simply more that investment banks can offer pension funds. The markets for inflation swaps market and credit default swaps have both grown considerably in the last decades. “There’s definitely a whole area of things which can now be done,” he says
And treasury departments at corporations are generally much more interested in the balance sheets of pension schemes now. “Up until the year 2000, the cheques (contributions) going into pension schemes were zero or quite small, but now they’re not insignificant – they’re quite large,” says Horsfall.
There is more of a focus on mark-to-market, and this heightens the mismatch between assets and liabilities. “To me, it’s very obvious that banks should be helping to find the solutions,” he says.
Mark Azzopardi heads up the insurance and pensions group within fixed income at BNP Paribas. The division, he says, is basically a pool of actuarial expertise that works with other parts of the bank to put solutions together for pension funds, life and non-life insurers.
“An important part of our marketing plan has been to hit the corporates with the facts,” he says. “There’s always been a problem, and the problem has been the mismatch between assets and liabilities.” In the past, it was possible to avoid dealing with the problem, because the accounting and actuarial conventions allowed businesses to smooth their way through it, but this has changed.
Having shown corporate clients the facts, the bank then offers to quantify the risk for the pension fund and show the company and trustees ways of managing that risk. “We try to help them to think about risk management in a more sophisticated manner,” he says.
Trustees have traditionally relied on investment consultants and fund managers who between them have helped them decide on policy and how to implement it. But in the current environment, it is much easier for the corporation to approach the trustees with a plan, he says.
There are many reasons why investment banks have become so involved in pension fund funding issues. For BNP Paribas’ part, Azzopardi says the bank is taking the opportunity to improve the relationship and offering to its clients by helping them to deal with a very key issue. “The amount of money in UK pension funds represents a third, if not more, of the total in savings,” he points out. “It’s hard to imagine any bank not helping clients with an issue of this size.”
“Banks do have very strong relationships with their corporate clients,” says Kathleen Currie, director, structured solutions at Axa Investment Management. “If they express a need with regard to their pension fund, then a good bank will be able to step in and provide that as well. The word pension is very much to the fore at the moment.”