Natasha Browne looks at how UK schemes could be affected by a Greek departure from the European Union
At a glance
- A Grexit could spark inflows into UK gilts
- Weakened gilt yields would hurt struggling DB schemes further
- It could open renegotiation on IORP II
Ten-year Greek bonds are yielding double-digit returns as the country's ministers look to renegotiate the terms of their bailout with the Troika – the International Monetary Fund (IMF), the European Commission and the European Central Bank (ECB) – this week. Since Syriza came to power at the end of January, fears over a Greek exit, or Grexit, from the European Union (EU) have intensified.
There were concerns that other periphery economies in the eurozone would resent the EU if Greek Prime Minister Alexis Tsipras managed to win any concessions on the debt deal. But the government's success has been muted and it continues to tread along a fine line of Eurozone stability.
A Grexit would be a very worrying development for UK pension schemes, however. While it would weaken European and global equities more generally, it could also drive a flight to safety into gilts as investors looked to move their cash away from European bonds. This would drive yields down further, increasing pressure on defined benefit (DB) schemes already struggling to close their funding gaps.
Previous figures from the Pension Protection Fund (PPF) showed the total deficit of schemes in its 7800 Index reached a record high of £367.5bn at the start of 2015. And over the 12 months to March this year, data from JLT Employee Benefits (JLT) showed private sector DB deficits ballooned by 66% to £269bn. Separate research also found FTSE 100 employers had cut deficit recovery payments by 23% just as deficits swelled by almost 50%.
Experts are divided on how well prepared markets are for a Grexit. Aon Hewitt global head of asset allocation Tapan Datta (pictured) says a disorderly exit would be damaging. But the consultancy is working on the basis that Greece will reach an agreement with its creditors.
Datta says: "Our sense is there is going to be some give and take. So Greece will agree to reform, but in return Greek creditors will have to make life a bit easier for the country both in easing austerity and potentially reducing the debt burden by lengthening repayment terms. That would be a negotiated agreement that we don't believe will particularly impact the markets adversely."
Although the yield on Greek bonds reflects the risk that the country will default, Datta explains that markets are not pricing in a chaotic exit from the eurozone. He adds: "Were it to happen, I think it would be potentially quite an unpleasant surprise. But we do think the likelihood of that happening is quite low."
Matt Tickle, an investment consultant at Barnett Waddingham, says there will be little impact on pension schemes if markets have predicted the outcome accurately. However, he is not convinced the market has priced in the right level of risk. Tickle says: "The argument is that everyone knows what the risks are with Greece, and that if it happens it won't affect anyone else.
"I'm a little sceptical of that. To me that feels somewhat optimistic a scenario. It's one of those things that people say is priced in. An almost comparative is the Fed rate rise.
"Everyone goes, ‘well the Fed is going to raise rates, it's all priced in'. But I would stick it on the money that when it actually happens, there will be a market event happening on that side of things. So my guess would be if there is a Grexit, there would be a market impact. But it may be more muted than it would have been in the past."
Tickle explains that at the very least a Grexit would create market volatility, which would hit funding levels. He adds: "If you've got safe haven flows coming into the UK that's going to have an upward effect on sterling. I struggle to see Grexit as being anything other than not very good whichever way you look at it."
A positive renegotiation
A calamitous Greek exit from the eurozone could create bank failures, explains Squire Patton Boggs partner Philip Sutton. He says this would impact on schemes because of who their counterparts were on trades and derivatives.
"There could be potential problems there both for existing deals and potentially for future trades that they may be looking to place. They might look to place future trades with banks that have less euro exposure, for instance," Sutton says.
But there is one potential upside for UK schemes. The draft revision of the Institutions for Occupational Retirement Provision (IORP) II directive has been a bone of contention for British pensions since its inception. Most recently the Association of Consulting Actuaries (ACA) warned a proposed change to the directive could "kill" European cross-border schemes.
But Sutton says a chaotic Greek exit might create a weakened central institution in the EU. He adds: "That may give the UK some greater leverage to seek amendments that it would like to see in the IORP directive.
"This could be to get rid of it all together as a concept, which I think would probably please a lot of people greatly in the UK. Or certainly at least to weaken its more strident and problematic components."
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