For example, index-tracking strategies, including through ETFs, will tend to increase asset correlations and herding in investment flows (Bolognesi and Zuccher (2008)). The use by asset holders of a small pool of consultancies for investment advice may also generate correlated investment strategies. And the use of short-term performance mandates for fund managers is also likely to amplify pro-cyclical swings in asset allocation and asset prices. Accounting Rules: The 2000s saw the introduction of Financial Reporting Standard (FRS) 17 in the UK and Statement of Financial Accounting Standard (SFAS) 158 in the United States. This fundamentally changed companies’ accounting practices in respect of their pension obligations. In particular, companies were required to value pension assets at fair (that is, mark-to-market) values, with liabilities typically discounted using a corporate bond rate. Pension surpluses and deficits then needed to be recorded on balance sheet. This change in accounting rules reshaped company and pension fund behaviour. For example, in a downswing, risky asset prices and safe rates tend to fall, raising measured deficits. Faced with this, pension funds will have an incentive to sell risky assets and purchase bonds to better match their assets and liabilities (Amir et al (2010)). But this will  BIS central bankers’ speeches  5  itself tend to drive down yields further, boosting market-valued liabilities and thereby encouraging further matched bond purchases in a pro-cyclical spiral (Plantin et al (2008)). A similar dynamic affects insurance companies. Between them, FRS 26 and 27 specify valuation conventions for measuring insurers’ assets and liabilities.

It shows a high correlation, with rises in equity prices inducing reallocations into equities. This suggests a potentially significantly pro-cyclical swing in portfolio behaviour. For example, a 10% rise in the S&P on average increases the equity portfolio share by over one percentage point – or around $ billion given the scale of US life insurers’ balance sheets. 6 If done quickly, this could be a potent procyclical amplifier. Similar patterns are evident among life insurers in other countries. A second piece of indirect evidence comes from the behaviour of regulators. There have been several incidences over recent years of regulators loosening regulatory constraints to forestall concerns about pro-cyclical behaviour in a downswing. For example, UK regulators loosened regulatory constraints on insurance companies in the early 2000s following the bursting of the dotcom bubble. This was due to fears of selling pressure on equities being amplified as insurance companies de-risked their portfolios as they neared regulatory constraints. Pension fund regulators have taken similarly-motivated actions recently due to depressed real yields boosting the market value of liabilities. A third piece of evidence comes from analysing the impact of ICPF asset allocation decisions on asset prices. In particular, at the Bank we have analysed the impact of purchases of longterm UK indexed-linked debt by UK ICPFs since the early 1990s (Zinna (2014)). Over this period, the combination of accounting and regulatory rules led to large cumulative purchases of long-term government debt by ICPFs. At the same time, long-term real yields fell from around 4% to around –1%.