The Dutch Central Bank (DNB) has recently provided more guidance with respect to the required capital that Dutch pension funds should hold for government-guaranteed loans. Under the FTK rules for Dutch pension funds, the required capital depends on the rating of the loan. For sovereign loans of AAA-rated EU countries the capital requirement is equal to zero.
In their recent guidance, DNB indicates that the rating of the central government can be used if a loan is guaranteed by the central government and if the guarantee is full, unconditional and irrevocable 1. Furthermore, loans that are guaranteed by an AAA-rated EU central government will also have a required capital of zero. Previously, only sovereign loans qualified for this beneficial treatment.
Treatment of guarantee funds
Loans that are guaranteed by so-called "guarantee funds" are treated in a similar way if these loans are fully, unconditionally and irrevocably guaranteed by the central government. Two important guarantee funds in the Netherlands are the Stichting Waarborgfonds voor de Zorgsector (WFZ) and the Stichting Waarborgfonds Sociale Woningbouw (WSW). WFZ provides loans for the health sector and is fully guaranteed by the central Dutch government. WFZ loans can thus be treated as solvency free (in the spread risk module) under FTK. WSW provides loans for the social housing sector and is partly guaranteed by the central Dutch government and partly by the decentralized government (municipalities). When the municipalities fail to pay their part of the guarantee, the central Dutch government steps in. The central government thus also acts as the ultimate backstop in this case.
More recently, private loans via an export credit agency (ECA) have also experienced an upswing. Examples are Atradius in the Netherlands, Euler-Hermes in Germany or Coface in France. These ECAs provide trade financing to domestic companies for their international activities and are fully guaranteed by their respective central governments. ECA loans of AAA-rated EU countries, like the Netherlands or Germany, will thus also benefit from these new FTK rules.
Impact on the required funding ratio
We now investigate the effect of the new solvency treatment of government-guaranteed loans in more detail. As an example, we consider the government-related private loan mandate that has been analyzed in Van Bragt and Lamaud (2017) 2. The required capital for spread risk for this mandate was 4.7%.
We start with the previous FTK rules, allocate 10% of the assets to government-related private loans, and study the effect on capital requirements and expected return. The results are shown in Table 1.
Table 1: Previous FTK rules - Impact on required capital and required funding ratio when allocating assets to government-related private loans. See Van Bragt (2017). Source: Aegon Asset Management.
We now apply the new FTK rules for loans with a central government guarantee. The required capital for spread risk for the example government-related mandate then decreases to 3.4%. The required capital does not decrease to zero because not all loans are guaranteed by the central government in the mandate that we consider here. Examples are guarantees by municipalities or regional authorities. The results for the new FTK rules are shown in Table 2.
Table 2: New FTK rules - Impact on required capital and required funding ratio when allocating assets to government-related private loans. Source: Aegon Asset Management.
A comparison of the results in Table 1 and 2 shows a modest improvement of the required funding ratio (with 0.1%-point). In practice, the impact will of course depend on the actual asset mix and the allocation to loans that are guaranteed by the central government.
We can conclude that the capital requirements for loans guaranteed by central governments improve significantly under FTK. Loans backed up by AAA-rated EU governments (like the Netherlands or Germany) will even become completely solvency free. Previously, only sovereign loans qualified for this beneficial treatment. This will have a modest positive impact on the required funding ratio of pension funds who invest in these loans.
1 See http://www.toezicht.dnb.nl/3/50-237391.jsp for more information.
2 See Van Bragt, D. and R. Lamaud, "Analysis of government-related private loans under FTK, Solvency II and Basel III", Regulatory Insight Aegon Asset Management, November 6, 2018. Available via https://www.aegonassetmanagement.com/globalassets/asset-management/global/isc/documents/regulatory-insight-supervision-gov-rel-private-loans.pdf.