(Adds remarks on low rates, paragraphs 9-13)
By Marie-Pier Cayer
QUEBEC CITY May 15 Interest rates are likely to
stay low for an extended period, posing a major challenge to the
pension industry, Bank of Canada Deputy Governor Lawrence
Schembri said on Thursday.
"By far the biggest challenge faced by defined-benefit
pension funds since the financial crisis has been the low level
of long-term interest rates," Schembri said, noting that low
rates had reduced solvency ratios.
"These ratios have now partially recovered, as low interest
rates have boosted equity prices, but interest rates are likely
to remain relatively low for an extended period as the Canadian
and global economies slowly recover," he said in the prepared
text of a speech he was delivering in Quebec City.
He welcomed the fact that many pension funds searching for
yield had made alternative investments in real estate, private
equity and infrastructure but said liquidity and credit risks
had to be prudently managed.
Increased longevity may in some cases require adjustments to
contribution rates and benefit levels, Schembri said, addressing
the Pension Investment Association of Canada.
He decried what he termed "short-termism" investment
strategies, whereby some funds may be prompted by fair-value
accounting and solvency rules to shorten their investment
horizons to minimize volatility. Such strategies may be costly,
and fortunately most funds are instead committed to disciplined
rebalancing, he added.
Schembri said new resolution regimes for financial
institutions seen as 'too big to fail' may provide attractive
equity-like investment opportunities for pension funds.
Such big banks and other institutions will have to issue
large amounts of "bail-in" debt and preferred share instruments,
which can be converted to common equity to absorb losses if the
bank gets in trouble.
The Bank of Canada has kept its benchmark interest rate at 1
percent for 3-1/2 years and said as recently as last month that
even lower rates cannot be taken off the table at this stage.
Asked about the effect on assets, he acknowledged that one
of the channels through which monetary policy works is by
boosting asset prices.
"So by keeping rates relatively low, we're encouraging
substitution toward assets that would likely go up in value," he
He cited the example of the U.S. Federal Reserve's purchases
of government bonds, with people taking the funds they receive
and reinvesting in other assets, which pushes their prices up.
"With that reinvestment, you see increases in wealth, which
help sustain the recovery," he explained.
In regards to pensions, the challenge confronting
defined-benefit plans has caused some funds to move to
defined-contribution plans, which shift the risk to the
beneficiary from the company.
Last month the Canadian government proposed a third way as
an option - a targeted benefit plan that would be hybrid of the
(Writing by Randall Palmer; Editing by David Ljunggren and