The Pensions Regulator (TPR) is working to "enhance" the Bank of England's monitoring of how schemes use non-bank leveraged loans amid warnings they may not be able to absorb losses in a stress scenario.
The watchdog, working alongside the Bank of England's Financial Policy Committee and the Prudential Regulation Authority (PRA), is keeping an eye on potential liquidity demands and losses generated by non-bank leverage, as well as the potential systemic risks from funds' use of derivatives and repurchase agreements.
According to the BoE's Financial Stability Report, published today (11 July), pension funds, insurers and investment funds hold around 40% of the total global leveraged loan market, with around a quarter of these through collateralised loan obligations (CLOs).
While the "riskier tranches" are typically held by investment funds, the central bank is concerned about how quickly these loans could be sold in a stressed scenario without affecting market prices, leaving funds with liquidity mismatches.
Over the last 10 years, defined benefit (DB) schemes have consistently been increasing their allocation to bonds, of which leveraged loans are a part, with the average scheme having a 59% allocation in March last year, according to the Pension Protection Fund. It is not clear what pension funds' total exposure to leveraged loans is.
In particular, open-ended funds have significantly higher holdings of leveraged loans than in the period before the financial crisis, the bank said. Around $250bn (£199bn) of these assets are in open-ended funds now, compared to just $20bn in 2007.
The bank's report added that "higher corporate leverage could amplify economic downturns", with a larger corporate debt to gross domestic product ratio associated with deeper recessions. During the financial crisis, the estimated loss rate for leveraged loans was almost twice the loss rate on loans to large businesses overall, the bank said.
A downturn in this market could lead to large-scale redemptions in this market, then causing sales of illiquid assets "that may exceed the ability of dealers and other investors to absorb them", and causing a knock-on effect on the wider corporate bond market, "transmitting stress to other parts of the financial system, and disrupting the availability of finance to the real economy".
Professional Pensions has approached TPR for more details on the enhanced monitoring in this area.
COVID-19 has changed the landscape for emerging markets (EM) debt, injecting a new dimension of pandemic-related economic uncertainty. In this report, the Eaton Vance EM debt team outlines our view that strong fundamental analysis and country selection is more important than ever.
There has been a growing focus from institutional investors on social benefits when investing in real estate, according to research by Alpha Real Capital.
Consumer complaints against firms for misadvised DB transfers also rising
Moira Warner looks at what changes to the Judicial Pension Scheme actually mean.
Questions remain unanswered around defined benefit (DB) scheme funding, according to analysis by Lane Clark & Peacock (LCP).