There's a black hole at the heart of the Greek pensions system and part of the problem is that nobody seems overly anxious to know how big it is.

"People don't realise the extent of the problem," says Nicholas Tessaromatis, general manager and CIO at EDEKT-OTE, which manages assets for telecoms provider OTE. "I see ministers guessing the extent of the system's deficit and I have heard estimates that if you lump everything together it could come to €400bn."

And as Tessaromatis is aware, the lack of clarity is not for want of discussion about the problems around pensions and asset management; indeed he headed one investigation. "I chaired a committee that finished its deliberations in 2005 and proposed measures to fill in the gaps we have between pension funds and investment managers - consultants, actuaries and auditors," he says. Since then another committee has examined the same issue but it reported in February and was overshadowed the following month by the bond scandal involving the Civil Servants' Auxiliary Fund (TEADY).

And two other committees are at work: "One that the labour minister has said would make proposals for a new investment framework for pension funds at the end of June and another that is working on the pension system, which is a much bigger problem than the management of its assets," says Tessaromatis.

In fact it is suggested that the seriousness of the problem facing the Greek pensions system has been known for some time and that such frenetic committee-setting is a way of looking active while not doing anything.

"The problem was outlined a decade ago when another committee, for the examination of economic policy in the long term chaired by Yiannis Spraos at the University of London, reported to then premier Costas Simitis," says a seasoned observer. "It so shocked people that Simitis, who wanted to get Greece into the Euro-zone and didn't want to annoy the unions and the hardliners in his own Pasok party, froze the whole thing. But then he won the election in 2000, Greece joined the Euro-zone the following January, and that was the time to fundamentally address the issue. But there were huge demonstrations against reforms, Simitis was losing his grip on the party, and he just didn't."

The Simitis government did make some reforms and refinanced the main first pillar pension vehicle, the Social Insurance Institute (IKA), through the budget. And once refinanced, IKA established two mutual funds. "But proposals to merge some pension funds were resisted, bank employees objecting vociferously, and [Simitis' successor, Constantine] Karamanlis has fudged the issue, which is why there are more than 80 pension funds and there are problems with overpriced bonds," the observer adds.

"The state pension system consists of either main pension institutions, of which IKA is the biggest, and auxiliary pension funds for various professions," explains Eleni Koritsa, general manager at EFG Eurobank AM.

A key problem is the over-generous replacement rate. Main institutions are intending to replace 70% of a retiree's former wage and an auxiliary fund another 20%.

The current plan is that the main institutions merge at the beginning of 2008.

"The basic schemes are DB and a guarantee by the state is explicitly mentioned in the constitution, says Tessaromatis. "Auxiliary schemes are also DB but it is not clear whether they are guaranteed, although people tell me that de facto they are in that it is unlikely that the government would ever allow one to go bad and not pay."

He adds: "Despite the fact that we have a pay as you go system altogether the main schemes and the auxiliary system have about €30bn invested."

"Generally pension funds have nothing to do with asset management because they are clients for sales people," says Koritsa. "In fact they are not allowed to assign asset mandates to asset management companies or to mutual fund companies. Banks, their asset management arms or the treasury sales from the dealing rooms send proposals to various pension funds. Then members of the pension fund board decide on how much they want to invest and they send faxes or call asking for prices of specific bonds. And they usually buy from the guys who have the better price. That's the best practice."

Board members are not expected to have investment expertise. In fact one of the key roles of the state system is patronage, says the observer: "It's jobs for the boys, it's probably 1,000 or 1,500 jobs for the boys. When governments change there are widespread board resignations and they are replaced by party placemen. The head of TEADY at the time of the controversial bond purchase was the son of the finance director of the ruling New Democracy Party.

"So there is no such thing as asset management for pension funds except for bonds and a balanced mutual fund established by IKA that amount to €900m and an arrangement for the employees of OTE that was established by a special law," says Koritsa. "The four big banks - the National Bank of Greece, Eurobank, Alpha Bank and the Commercial Bank - have participated in all these mandates. That's all that is asset managed."

"We were set up in 1999 to manage part of the funds of a basic scheme for OTE, the TAP-OTE fund, we are not a pension fund we are an investment management company specialising in pension fund investment, set up by law and outside the structure that exists for all other funds and were given about €528m to invest free of restrictions," says Tessaromatis. "The idea was to create a pilot fund. We are allowed to invest anywhere in the world, so we are behaving much like a pension fund that you might fund in the UK or elsewhere."

And that is exceptional. Despite the lifting of Greece's capital controls, Greek pension funds are not allowed to invest abroad. And six years after Greece joined the Euro-zone they must invest 77% of their funds solely in Greek government bonds.

"If they buy Greek government bonds it is in effect one bit of the government dealing with another bit of the government and so it does not appear as debt," notes the observer. "So Greece's debt looks better."

This allocation model was adopted for Greece's so-far unsuccessful attempt at launching a second pillar. The professional schemes were created under legislation passed in 2002 which set out that, like the main funds and most of the auxiliary funds, they could invest 23% of their portfolio in Greek equities or property and the remainder in bonds or cash, but solely in Greece.

"The second pillar is almost non-existent in Greece," says Koritsa. "Only three or four provident funds have been set up and one, for Hellenic Post (ELTA), proceeded with a very open and very vigorous tender for external managers."

When the law was passed, the postal employees' trade union, POST, pointed out to the ELTA management that its members had no auxiliary fund and were the only public employees not to get a lump sum on retirement. The result was the establishment of a provident fund, TEA ELTA.

Its manager selection process consisted of placing an advertisement detailing the specifications decided on by the ELTA board on the advice of its investment committee.

"We had interest from, among others, the top five banks in Greece and abroad," says Michael Kravvaris of TEA ELTA. "Our basic requirements from the asset managers were monthly reports detailing what has been done over the previous month, what is the current situation and what they see in the next three months, a market analysis, reports about the investment of funds and explanations of the investment choices. "The investment strategy required a maximum allocation of 20% to equities, of which up to 80% should be from the top 20 Greek blue chips and the rest in smaller market cap companies, an unlimited amount in repos and overnight bank deposits and a maximum of 70% in Greek government bonds and 20% in corporate bonds with a minimum S&P rating of BBB+. Any investment in derivatives is prohibited.

"The investment strategy is very conservative since the fund is at the beginning of its operation. The fund management arrangement started in April 2006 and for the eight months of last year our return was 3.18%, with an asset mix of 80% of the fund invested in bank deposits and the rest in equities and bonds. In the first quarter of 2007 the fund's performance was 4.6%."

But why are not more funds being established? "The law doesn't say anything about the tax system," says Kravvaris. "There is a finance ministry memo that says that for the time being it is tax free. However, the ministry has said that it will need to tax. But for now it is a grey area."

The reason for the oversight is put down to the fact that the law was based on an EU model, and that the EU, not having tax within its remit, left it out and it was not spotted in Athens until too late.

It was also anticipated that the auxiliary schemes would transform themselves into occupational schemes, says Tessaromatis. "But I don't think that is going to work due to the fact that a lot of the auxiliary funds have huge deficits because of the poor returns earned as a result of the obligation during most of the postwar period to invest in cash at the Bank of Greece, the effects of ageing and because they gave themselves such generous benefits so that their liabilities are huge in comparison with their assets. So how can you turn that into an occupational pension scheme? Who is going to make up the difference?"