Applying Solvency II rules to pensions could give UK defined benefit schemes an incentive to move £400bn of equities into fixed income securities such as government bonds, according to Fitch.
In a note published on May 24, the ratings agency said applying the new European insurance framework to workplace pensions was likely to involve schemes having to set up a capital buffer against asset volatility.
'Despite pensions' comparatively small share of total assets in Europe, the impact on their allocation decision could be large given the high weighting of pension assets held in equities,' it explained. The UK is home to the largest amount of DB pension asset outside insurance companies in Europe, with schemes holding £1 trillion of assets. Of this, 41.1% is currently in equities and 40.1% in fixed income securities.
According to Fitch, introducing Solvency II for pensions is likely to bolster demand for low-risk European Economic Area government bonds due to their low capital charge, as well as increasing demand for higher-yielding assets with an efficient capital charge.
Highly-rated, short-dated corporate bonds were 'an obvious choice' in the latter class, with the capital charge of a three year A-rated unsecured bond at 3.3%, compared with charged for un-hedged equities of 22%.
Any increased demand for bonds is, however, only likely to benefit sovereign or highly rated short-term corporate borrowers. 'Nor will it help the speculative-grade parts of the market, which are most in need of funding,' Fitch said. 'Capital charges increase dramatically further down the rating scale.'
While more capital may be spent on unsecured bank bonds, Fitch explained that if the fund's demand was for short-term bonds this trend would do nothing to satisfy banks' desire for stable long-term funding.
It added: 'Real estate and infrastructure may be attractive, if investments can be structured as loans rather than bonds. Insurers are already moving into these markets.'
