Market | British pension companies were close to collapse this week – Could the same happen in Finland?

Britain’s the financial market drifted to the brink of chaos this week.

The exact details of the panic in the British market are not yet known. However, it is known that many British pension companies ran into a sudden shortage of cash and sold their holdings to the market in the face of the crisis for several days. Among other things, according to the Financial Times magazine, there was panic soon spread into a large-scale international financial crisis.

“In the morning I was afraid for a while that this was the beginning of the end,” one banker commented on the situation to FT on Wednesday.

The start of a confusing chain of events was the British finance minister Kwasi Kwartengin the mini-budget announced a week ago. Kwarteng promised to cut taxes and increase government spending in the coming years.

The market reaction to Kwarteng’s performance was fierce.

The British pound dollar exchange rate collapsed by eight percent in a couple of days. At the same time, interest rates on British government bonds rose to record levels. The interest rate on Britain’s 30-year government bond rose from 3.5 percent to more than five percent in a few days. The changes may sound small, but are very exceptional in the currency and government bond markets.

The market turmoil calmed down on Wednesday when the Bank of England intervened. The central bank said it will buy British government bonds from the market for 65 billion pounds, or about 74 billion euros.

“If the problems in the market were to continue, it would significantly increase the risks to the UK’s financial stability,” the Bank of England reasoned emergency funding.

Media information according to the market panic stemmed from the problems of British pension investors.

Many pension companies had concentrated their investments in British government bonds. Thus, the pension companies ran into difficulties when bond values ​​unexpectedly weakened.

At the same time, the collateral requirements for derivatives owned by pension companies increased, meaning they had to deposit more money as collateral for the derivatives.

Many British insurance companies use derivatives to protect their portfolios from exchange rate fluctuations and other risks. It is known that some British pension companies also use debt leverage in their investments. Debt leverage strengthens investment returns in a rising market, but correspondingly, losses grow rapidly in a falling market.

British pension companies were therefore forced to sell their investments last week in the middle of an already nervous market. As a result, the rates plunged lower and lower and buyers disappeared from the market. The downward spiral was in full swing until the central bank started buying government bonds on Wednesday.

Could a similar downward spiral following forced sales of pension companies take place in Finland?

CEO of Eläketurvakeskus Mikko Kauton according to the British and Finnish economies and pension systems differ significantly.

“This incident started when the market reacted to the finance minister’s ‘mini budget’. The pound collapsed and interest rates on British government bonds fluctuated unexpectedly. Finland, on the other hand, is part of the euro area. It’s hard to imagine that Finland’s actions alone would sway the Eurozone markets in this way,” says Kautto.

According to Kauto, pension companies in different countries are regulated in very different ways. Therefore, the risks of pension systems are also different in nature.

Finnish pension companies such as Ilmarinen and Varma are partly funded, i.e. future pensions are only partly based on investment returns. They have solvency rules that must be followed. If pension companies’ investment funds fall close to the solvency limit, they must reduce their risks, i.e. in practice sell their holdings.

The Financial Supervisory Authority monitors the solvency and investment activities of Finnish occupational pension companies.

At least in theory, you can imagine a situation where Finnish pension companies would be forced to sell their holdings as a result of a sudden market crash.

On the other hand, in extreme situations, solvency limits may also be relaxed. This happened, for example, in 2008 during the financial crisis. Parliament passed a law at that time, as a result of which the solvency requirements of pension companies were temporarily relaxed. As a result of the law, pension investors were not forced to sell their holdings in the middle of the worst market panic, even if the solvency limit had fallen below.

Some Finnish pension companies also had problems with their solvency rules in the corona crisis of 2020. Employment pension company Elo’s solvency briefly fell below the required solvency limit. At that time, the solvency rules of pension companies did not have time to relax like in 2008, when the market crash already ended in March 2020.

Elo’s share sales woke up attention also last spring, when it sold significant amounts of shares of Finnish companies at the same time as the stock markets fell significantly. At that time, however, its solvency remained within the regulatory framework.

Finns pension assets are small compared to the British pension system. At the end of last year, the assets of the Finnish pension system were around 260 billion euros. British pension companies that ran into problems this week have assets of up to 1,500 billion euros.

As British pension portfolios are large, their effects on the market can also be extraordinary.

The moments of danger experienced in Britain this week could be due in part to the fact that many British pension companies had focused a large part of their investments specifically on British government bonds and their derivatives. Thus, when problems hit the British currency and government bond markets, the risks were realized for many pension investors at the same time.

When the British pension companies had to sell their holdings at the same time, they figuratively all rushed towards the same door, and could not fit out the door at the same time. The result was a market panic.

According to Kauto, Finnish pension assets are widely distributed in different parts of the world and in different asset classes, such as stocks, bonds and other investments. That also reduces the risks of Finnish pension investments.