Barclays Capital slams UK pension accounting rules

Barclays Capital has likened pension funds piling into long-dated index-linked gilts to the tech bubble of 1998 to 2000. And its top London strategist believes the fault lies with new accounting rules that force an unreasonably inflexible discount rate on pension funds.

Although the UK’s Debt Management Office has gained widespread industry praise for issuing the world’s first 50-year inflation-linked government bond last year, excess demand from pension funds looking for instruments to match the duration profile of their liabilities has driven long-end gilts to record lows. Since the start of this year, the real yield on 50-year linkers has fallen as low as 0.36%.

Barclays Capital’s head of global asset allocation strategy in London, Tim Bond, said a “panic stop-loss buying effect” had driven much demand for such instruments. “Pension funds have been implementing derivatives rather than switching physical assets and, as a result, equity and bond allocation weightings are actually stable,” said Bond. “It’s the banks hedging the derivatives they have put in place that is driving demand for long-dated linkers.”

Bond believes the new accounting regime that forces schemes to discount liabilities using a fixed AA-rated long bond yield is too inflexible. He said it has led to the current “massive misallocation of capital”.

Barclays Capital said the size of the UK linker market with tenors of greater than 15 years is £41 billion, compared with defined benefit pensions worth about £800 billion. With insufficient supply of these instruments, a 50-basis-point decline in yields moves the net present value of deficits by about 6%.

Bond believes that one solution would be to change the discount rate to reflect the creditworthiness of corporates. “Stronger companies should be able to use a discount rate that reflects their ability to invest in higher-risk/higher-return assets and benefit from diversification,” he suggested.

While acknowledging that discovering the discount rate would be complex, he felt that making pension rights and liabilities freely tradable would allow markets, rather than accountants and regulators, to assess the viability of pension strategies. “Using secondary prices as a price-discovery mechanism is more efficient and would encourage new entrants to the pension business,” he said.