In a Bank of Jamaica (BOJ) discussion paper titled, “Relaxing the Limits on Investment in Foreign Currency Assets for Pension Funds and Insurance Companies”, scripted in 2015 and now available online, the central bank expresses the fear that removing the investment cap for the two sectors will cause macro-economic challenges — threatening the Net International Reserves (NIR) and potentially destabilising the bond markets.

It has issued the paper outlining its position, inviting the response of stakeholders as one of a number of steps left to be taken before making a decision on the cap.

The BOJ has committed to a timetable for relaxing the cap on investments in foreign currency instruments for security dealers (SDs) and collective investment schemes (CIS) from five per cent of assets to at least 25 per cent by end 2015, and removing the cap by end 2016.

The initiative is part of the wider financial sector partially aimed at providing more investment options and easing a push to reduce retail repo investments.

In stating its cautious approach to the pensions and insurance company sector, which were not included in the phased removal of limits, the BOJ said these institutional investors could “easily amplify volatility in the foreign exchange market as well as precipitously diminish the NIR if a large pool of domestic funds is suddenly redirected to foreign assets. This impact would be exacerbated if the pension fund and insurance company investors’ exhibit ‘herd’ behaviour as is typical of institutional investors”.

Indeed, the central bank said it stood ready to suspend the process of raising of the foreign assets cap to arrest ensuing adverse conditions in the foreign exchange market.

“Based on end-September 2014 Foreign Currency Investment Projections (FCIPs) submitted to the FSC from insurance companies and 14 of the largest pension funds, aggregate desired foreign currency demand over the next three years is estimated at US$0.9 billion (September 2015 to September 2017). Taking into account the respective FCIPs of SDs and CIS of US$1.3 billion and US$0.4 billion for the medium term, this demand threatens the attainment of the NIR targets under Jamaica’s EFF (Extended Fund Facility) arrangement with the IMF,” the BOJ stated.

The BOJ said that while it supported the relaxation of the foreign assets cap for pension funds and insurance companies within the next three years (ie, the medium term), it remained, “concerned that expanding the eligible investors at this time or in the near future would threaten system stability.”

Factors, it noted, included the reality that “any material one-off reduction of the large holdings of domestic GOJ securities of pension funds and insurance companies, in order to increase allocations to foreign assets, would sharply adjust GOJ yields upwards possibly leading to capital strains across the financial sector.”

The paper noted that at the end of September 2014, Jamaican dollar bond portfolios of pension funds and insurance companies amounted to $170.5 billion and $206.5 billion, respectively.

The BOJ made the point as well that the need to build the NIR is a key programme objective with elevated risks to meeting near-term targets.

“Extra foreign currency demand pressures from pension funds and insurance companies could seriously threaten the BOJ’s ability to achieve this objective,” it was said.

Also threatened, it said, was reform of the security dealers retail repo transition to the Trust arrangement which could be hampered by “excessive volatility in GOJ domestic bond prices arising from a reallocation of portfolios by the pension and insurance industry”.

The central bank said that given the “illiquid maturity structure of liabilities, institutional investors — in particular pension funds — have the potential to exhibit ‘herding behaviour’ consistent with sudden shifts in portfolio allocation which could easily amplify volatility in the foreign exchange market as well as precipitously diminish the NIR”.

The BOJ said the discussion paper represented the beginning of the process towards reaching agreement on a plan for a more liberal regime.

The key deadlines being proposed by the bank were industry response to its discussion paper by 30 September 2015; the delivery of a final position paper with implementation plan completed by 31 March 2016 and the removal of cap for SDs and CIS 30 December 2016. It said the first step in lifting the cap for pension funds and insurance companies would be taken by 31 March 2017.