Pension funds - the brakes are still on
For a litany of reasons, future beneficiaries of the country's new multibillion euro second-pillar pension system have been less than pleased with the state of their retirement accounts since their inception in 1999. And even as the troubled and oft-blamed ZUS is just starting to punch its weight and pay up, and EU accession is on the horizon, the nation's pensioners and fund operators will discover little to laud, at least for the next year, because of overregulation and dimmer and dimmer investment prospects.
Just as the industry is ready to strike forward, critics say, the Sejm is exploring new legislation that would further throttle vital competition among funds, although it fails to address other evident problems. And the WSE looks unlikely to welcome many new choice investments any time soon, which shuts the pension fund management companies (PTEs) out of needed local investment opportunities. Initially, too, EU accession will do little to clean up the country's system.
Pension funds are key components of the nation's economy, securities markets and overall well-being. The 17 OFEs closed out last year with €7.9 billion in assets, which is a 62% increase from 2001. Equity holdings amounted to 25.3% of total assets, bond holdings 67.4% in December. In that light, fund managers say that collectively they cannot be ignored.
Roughly three years ago the government revamped the nation's troubled social insurance programme, taking a blueprint of the system that Chile successfully implemented in the early 1980s. The result is that 11.52% of salaries fund a mandatory pay-as-you-go system, the first pillar, and a mandatory 7.2% of income is funnelled via ZUS to privately managed OFEs, the second pillar of the system. There is also a third voluntary pillar.
Since the beginning, licensed funds and managers have scrambled to win customers from this new industry, but met pitfall after pitfall in the guises of ZUS, the government and frail financial markets. Today, further amendments to the pension law are being discussed by a specially formed subgroup of the social security commission. On the table is a list of considerations, each of which elicits varying degrees of distaste in the industry.
"The pending legislation is not allowing for a long-term outlook," said Michał Szczurek, president of ING Nationale-Nederlanden, the second largest pension fund. "This causes a lack of stability."
Industry pros said that the legislation weighs on the industry because it chips away their revenue base.
"The new law calls for a very significant decrease of the income of the pension companies," said Tomasz Frontczak, chief executive of AIG PTE. "Basically, it limits our ability to conduct business. It may go to the degree that some companies are going to go out of business. It's pretty severe."
The Sejm subcommittee is vetting an option to cap fees charged for managing the funds to about 0.4%, but with a 0.2% boost for best performing funds. The management fees already cannot exceed 0.6%, but as KNUiFE, the pension industry regulator, says, there is still not enough drive for funds to increase their returns. Also, the Sejm committee is considering capping the up-front fee charged for assets transferred from ZUS at 7%.
"Pension funds were under sharp criticism from consumers because of their very high commissions and not that good investment performance," said Sławomir Solarz, deputy director of KNUiFE's research, social communication and information department.
Solarz argues that capping the fees and offering an extra 0.2% to the best performers will inject much needed incentive in the market and enable funds to yield better returns for their beneficiaries. And while he fully acknowledges the criticism that the proposals might be anticompetitive, he said that legislation could also avail the OFEs of lower operating costs to counterbalance fee caps.
That carrot is too small, say fund executives.
"What kind of a market is it if you have all the fees regulated and given by the law? How can we compete?" asked AIG's Frontczak. "This one is already regulated in the law and the end result is everyone is charging 0.6%. We think that this 0.2% is very dangerous for the system because it may create pressure on the managing companies on account of obvious shareholder pressure to go after riskier investments, which is not always better for those in the funds. This is the part that should have never happened. If the fee is lower, then obviously you're going to be under pressure."
On top of this regulation, the existing law imposes a mandatory minimum on fund returns. Opponents say that because this minimum is a weighted average it gives too much power to the largest funds in a 17-strong industry where about 65% of all assets are in the hands of three fund companies. Thus, all funds follow the asset allocations of Commercial Union, ING Nationale-Nederlanden and state-owned PZU, preventing individual strategies, lest they fall shy of the average and must pay the difference out of their own coffers.
Money managers say scrap the minimum altogether and allow the different funds to set out on their own strategies, which would promote competition. Now legislators have heeded this call in general, but certainly not verbatim. They proposed to diminish the importance of market share on the weighted average, capping the influence any one fund would have at 15%. Also, lawmakers may change the two-year quarterly average to a three-year semiannual one.
Again, they've missed the mark, the funds say, because it stigmatises big funds as if they were doing something wrong by being successful, and because two or three years is entirely too short a time horizon for the long-term investing pension funds, whose first payout won't be until 2009.
Add to these proposed changes something that is thus far painfully lacking in the amendments: a decrease in investment restrictions. There is no limit on funds' investments in government bonds, despite a 50% limit on WSE-traded equity. Within these general regulations, fund managers complain that they are only allowed to invest 5% of their capital abroad, when the stock market at home proffers few safe havens for their clients' money. And they cannot invest any in more esoteric and uncorrelated asset classes, such as venture capital, mortgage-backed bonds and hedge funds. In the West, pension funds are key drivers in the venture capital and hedge fund industry.
The problem for fund managers is that the government still considers these złoty public capital, to be invested for the public good, even though it comes directly from employees' monthly salaries and is managed by privately held companies. Further, this classification of second-pillar pension money as a public asset puts an end to managers' hopes that EU membership would allow them to buy foreign assets. Public capital, which is also counted towards decreasing the debt load, is not subject to the EU law on 100% free flow of capital.
So pension funds must stick mainly to government bonds and WSE-traded equities, the latter of which have plummeted in price since these fund mangers began investing in 1999. And the matter is getting worse as the pension system grows with greater contributions, but the WSE offers a scarcity of prospects.
"There are no large state-owned companies anymore," Szczurek said. "What really remains? Steelworks. Coal mines." PKO BP and PZU are the only companies at present he said he would consider, but their sales are so politically tied up that there is little expectation.
For the country's financial market as a whole, of which pension funds are an integral part, this has wide-reaching implications. Less than 30% of all pension fund assets are invested on the WSE. Less than 10% of the total capitalisation of the stock exchange comes from pensions. But the funds comprise about 25% of freely floated shares, those shares that regularly change hands.
"If there are no new issues and they can't invest more abroad, to some extent it might cause a spectacular bubble," said Włodek Giller, equity analyst at Erste Securities Polska. The existing problem is worsened by the fact that ZUS has finally begun to pick up the slack and more money has begun to flow into pension fund coffers, and thus more onto the exchange.
Though ZUS still owes the second pillar as much as €2.25 billion, which the funds will not likely see this year, pension company executives note that the social insurance agency has cleaned up its act. Last year ZUS contributed more than €2.4 billion, although the amount was 18% less than expected.
"Right now it's definitely better, but the problem still exists," Frontczak said. "We have evidence that ZUS transfers currently about 82% of collections."
And Frontczak pointed out that even though the EU will undoubtedly help pensions, it still won't be enough.
"I only hope that we are going to be more civilised in the EU because we are going to have to comply with the EU regulations," he said. "But a 100% free transfer of funds? It's not one that the government wants. There is a dispute. How can we say that pensions are public money? I just don't see the rationality attached to this statement."
Just as the industry is ready to strike forward, critics say, the Sejm is exploring new legislation that would further throttle vital competition among funds, although it fails to address other evident problems. And the WSE looks unlikely to welcome many new choice investments any time soon, which shuts the pension fund management companies (PTEs) out of needed local investment opportunities. Initially, too, EU accession will do little to clean up the country's system.
Pension funds are key components of the nation's economy, securities markets and overall well-being. The 17 OFEs closed out last year with €7.9 billion in assets, which is a 62% increase from 2001. Equity holdings amounted to 25.3% of total assets, bond holdings 67.4% in December. In that light, fund managers say that collectively they cannot be ignored.
Roughly three years ago the government revamped the nation's troubled social insurance programme, taking a blueprint of the system that Chile successfully implemented in the early 1980s. The result is that 11.52% of salaries fund a mandatory pay-as-you-go system, the first pillar, and a mandatory 7.2% of income is funnelled via ZUS to privately managed OFEs, the second pillar of the system. There is also a third voluntary pillar.
Since the beginning, licensed funds and managers have scrambled to win customers from this new industry, but met pitfall after pitfall in the guises of ZUS, the government and frail financial markets. Today, further amendments to the pension law are being discussed by a specially formed subgroup of the social security commission. On the table is a list of considerations, each of which elicits varying degrees of distaste in the industry.
"The pending legislation is not allowing for a long-term outlook," said Michał Szczurek, president of ING Nationale-Nederlanden, the second largest pension fund. "This causes a lack of stability."
Industry pros said that the legislation weighs on the industry because it chips away their revenue base.
"The new law calls for a very significant decrease of the income of the pension companies," said Tomasz Frontczak, chief executive of AIG PTE. "Basically, it limits our ability to conduct business. It may go to the degree that some companies are going to go out of business. It's pretty severe."
The Sejm subcommittee is vetting an option to cap fees charged for managing the funds to about 0.4%, but with a 0.2% boost for best performing funds. The management fees already cannot exceed 0.6%, but as KNUiFE, the pension industry regulator, says, there is still not enough drive for funds to increase their returns. Also, the Sejm committee is considering capping the up-front fee charged for assets transferred from ZUS at 7%.
"Pension funds were under sharp criticism from consumers because of their very high commissions and not that good investment performance," said Sławomir Solarz, deputy director of KNUiFE's research, social communication and information department.
Solarz argues that capping the fees and offering an extra 0.2% to the best performers will inject much needed incentive in the market and enable funds to yield better returns for their beneficiaries. And while he fully acknowledges the criticism that the proposals might be anticompetitive, he said that legislation could also avail the OFEs of lower operating costs to counterbalance fee caps.
That carrot is too small, say fund executives.
"What kind of a market is it if you have all the fees regulated and given by the law? How can we compete?" asked AIG's Frontczak. "This one is already regulated in the law and the end result is everyone is charging 0.6%. We think that this 0.2% is very dangerous for the system because it may create pressure on the managing companies on account of obvious shareholder pressure to go after riskier investments, which is not always better for those in the funds. This is the part that should have never happened. If the fee is lower, then obviously you're going to be under pressure."
On top of this regulation, the existing law imposes a mandatory minimum on fund returns. Opponents say that because this minimum is a weighted average it gives too much power to the largest funds in a 17-strong industry where about 65% of all assets are in the hands of three fund companies. Thus, all funds follow the asset allocations of Commercial Union, ING Nationale-Nederlanden and state-owned PZU, preventing individual strategies, lest they fall shy of the average and must pay the difference out of their own coffers.
Money managers say scrap the minimum altogether and allow the different funds to set out on their own strategies, which would promote competition. Now legislators have heeded this call in general, but certainly not verbatim. They proposed to diminish the importance of market share on the weighted average, capping the influence any one fund would have at 15%. Also, lawmakers may change the two-year quarterly average to a three-year semiannual one.
Again, they've missed the mark, the funds say, because it stigmatises big funds as if they were doing something wrong by being successful, and because two or three years is entirely too short a time horizon for the long-term investing pension funds, whose first payout won't be until 2009.
Add to these proposed changes something that is thus far painfully lacking in the amendments: a decrease in investment restrictions. There is no limit on funds' investments in government bonds, despite a 50% limit on WSE-traded equity. Within these general regulations, fund managers complain that they are only allowed to invest 5% of their capital abroad, when the stock market at home proffers few safe havens for their clients' money. And they cannot invest any in more esoteric and uncorrelated asset classes, such as venture capital, mortgage-backed bonds and hedge funds. In the West, pension funds are key drivers in the venture capital and hedge fund industry.
The problem for fund managers is that the government still considers these złoty public capital, to be invested for the public good, even though it comes directly from employees' monthly salaries and is managed by privately held companies. Further, this classification of second-pillar pension money as a public asset puts an end to managers' hopes that EU membership would allow them to buy foreign assets. Public capital, which is also counted towards decreasing the debt load, is not subject to the EU law on 100% free flow of capital.
So pension funds must stick mainly to government bonds and WSE-traded equities, the latter of which have plummeted in price since these fund mangers began investing in 1999. And the matter is getting worse as the pension system grows with greater contributions, but the WSE offers a scarcity of prospects.
"There are no large state-owned companies anymore," Szczurek said. "What really remains? Steelworks. Coal mines." PKO BP and PZU are the only companies at present he said he would consider, but their sales are so politically tied up that there is little expectation.
For the country's financial market as a whole, of which pension funds are an integral part, this has wide-reaching implications. Less than 30% of all pension fund assets are invested on the WSE. Less than 10% of the total capitalisation of the stock exchange comes from pensions. But the funds comprise about 25% of freely floated shares, those shares that regularly change hands.
"If there are no new issues and they can't invest more abroad, to some extent it might cause a spectacular bubble," said Włodek Giller, equity analyst at Erste Securities Polska. The existing problem is worsened by the fact that ZUS has finally begun to pick up the slack and more money has begun to flow into pension fund coffers, and thus more onto the exchange.
Though ZUS still owes the second pillar as much as €2.25 billion, which the funds will not likely see this year, pension company executives note that the social insurance agency has cleaned up its act. Last year ZUS contributed more than €2.4 billion, although the amount was 18% less than expected.
"Right now it's definitely better, but the problem still exists," Frontczak said. "We have evidence that ZUS transfers currently about 82% of collections."
And Frontczak pointed out that even though the EU will undoubtedly help pensions, it still won't be enough.
"I only hope that we are going to be more civilised in the EU because we are going to have to comply with the EU regulations," he said. "But a 100% free transfer of funds? It's not one that the government wants. There is a dispute. How can we say that pensions are public money? I just don't see the rationality attached to this statement."
