A new round of Quantitative Easing (QE) targeting £50 billion of infrastructure, Housing Association and PFI loans from UK banks, with onward sale to defined benefit pension funds, could help repair pension fund deficits and spur economic growth by improving banks’ capital ratios and easing credit, according to Pension Corporation, a leading provider of risk management solutions to defined benefit pension funds.
Pension Corporation recognises the wider benefits of QE, but the programme in its current form has run its course. It is now detrimental to defined benefit pension funds and their corporate sponsors.
An Asset Sale and Purchase Programme (ASAPP), by avoiding buying Gilts and instead supporting the banks, should be the next form of stimulus. This could free up infrastructure assets as investments for DB pension funds and in addition may achieve the following:
- Lower defined benefit pension fund deficits by more than £40 billion on a structural basis, easing the deficit burden on corporate sponsors. This contrasts with old QE which might lead to deficits rising by £40 billion
- Avoid pushing real yields even more negative, which would compound Financial Repression
- Develop infrastructure as a real asset class for pension funds, a core aim of the Government
- Help banks repair their balance sheets, a requirement under BASEL III
The Pension Corporation concept, ASAPP, would directly address the stressed area of economy – the financial system, allowing banks to be more certain of the value of their assets and making it easier for them to lend. The Government could make ASAPP conditional, for example on a commensurate rise in credit lending and / or target a specific sector such as infrastructure.
Under ASAPP, these loans would be sold by banks at par and then purchased by pension funds at the real, lower market value. Banks are trapped into valuing these loans at par, which could be up to 20% greater than the real market value. A straight sale or writedown is unpalatable in the current political environment.
However, pension funds need these long-dated bond-like assets with a positive real yield to match liabilities and close deficits.
Pension Corporation estimates that up to £100 billion of contributions could be paid by corporate sponsors to pension funds over the next three years1. These deficits have been enlarged by the QE programme - every 1 basis point Gilt yield drop increases DB deficits by £2 billion (assuming no other asset price moves). ASAPP would help reverse some of this damage.
Mark Gull, Co-Head of Asset-Liability Management at Pension Corporation, said: “Pension funds have long-dated liabilities and should be encouraged to go into long-dated investments. Instead of pension funds being collateral damage in the race to shore up the economy, policy should utilise them in a growth oriented solution.
“Policy should instead focus on freeing up the banks to lend and where possible easing the burden on companies by bringing down pension fund liabilities. ASAPP avoids the policy error of pushing real yields even lower, so compounding Financial Repression and increasing the pressure on corporate sponsors. It should also be recognised that the banks themselves are the best credit easing facility we have and therefore the best hope of spurring economic growth.”
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