US regulator a threat to capital value of corporate bonds says Aon

Regulatory changes in the US are likely to reverse the fortunes of corporate bonds as a popular investment vehicle and as such could deal a blow to pension schemes according to Aon Consulting.

The firm says over the past year one of the major shifts in investment attitudes for pension schemes has been to exchange low yielding government bonds for higher yielding corporate bonds because of the higher returns currently being offered by corporate bonds relative to historic levels during credit crunch market conditions.

It warns that corporate bonds are likely to be a casualty of the regulatory changes the Securities and Exchange Commission (SEC) is trying to introduce for US credit rating agencies. This will have serious consequences for the funding of pension schemes holding corporate bond investments.

Chris Erwin, investment principal at Aon Consulting says: “Having missed the danger of the sub-prime crisis, credit rating agencies are being forced by the SEC to adopt new methodology that will mean companies will have to pay for their bonds to be rated, whether they like the outcome or not. In the short term the credit rating agencies are trying to fight this change to their business model, however ultimately this severely raises the risk of a large number of downgradings.

“Credit rating downgradings can have a severe effect of the price and yield of individual corporate bonds. Indeed, this was the case recently when a prospective buyer for a leading building society withdrew after two credit rating downgradings in a month.

“For corporate bonds it would mean prices would fall and yields would rise. This would give further scope for annuity issuers, as they are only concerned about the stream of income, not ratings.”