Kazakhstan’s pension reforms are a success and the country has a sophisticated financial set-up, writes Iain Morse

Kazakhstan reformed earlier and on a more ambitious scale than other former Soviet republics. Between 1992 and 1998 a new, off-the-peg financial services industry was created in this resource-rich central-Asian republic. A banking system, stock exchange, insurance industry and Chilean-type pension system were established with the help of the World Bank. This infrastructure has since been improved and is credited with meeting international standards.

“Overall the Kazakh achievement is impressive,” says Alexei Fedotov, director, CitiBank securities and fund services, Russia and Kazakhstan. Key reforms in 1993 split the banking sector into two tiers - the National Bank of Kazakhstan (NBK) comprises the first tier; all other banks comprise the second. The tenge was introduced in November 1993 as the national currency replacing the rouble. The NBK sets tenge interest rates, runs a deposit insurance scheme for second-tier banks and serves as regulator.

The domestic banking sector is concentrated. The four largest banks, Kazkommertsbank, Halyk Bank, Bank TuranAlem and ABN Amro (Kazakhstan), account for around 60% of total sector assets, valued at $100bn (€74bn). Halyk has by far the largest retail presence, with branches throughout the country. It also has a key role in implementing various development programmes run by the government, providing government loans to various domestic industries. This year the NBK will launch a US dollar sukuk, or Islamic bond, with an initial issuance of $500m.

However, the political system is autocratic: President Nursultan Nazarbayev has been in power since the end of Communism. He was re-elected in a series of landslides by an electorate of six million people, and the economy is vertically integrated.

A number of large Kazakh companies have listed on the London Stock Exchange (LSE), attracting global banks such as CitiBank, which have established local subsidiaries. But care is needed in determining their largest shareholders; these are oligarchs related by family membership in a small Kazakh elite.

The NBK also serves as regulator for the Kazakh Stock Exchange (KASE), established in 1992. Kazakh securities have a current market capitalisation of around $94.8bn, of which some $63bn is in equities and $31.8bn is in bonds. The exchange lists 350 securities; 104 equities and 246 corporate bonds. Daily trading values on the exchange are quite small, averaging $3.23m in equities and $4.75m in corporate bonds. “While some limits are placed on foreign shareholdings in some key industries this market is very open to foreign investors,” adds Fedotov.

All trades on the KASE are made in delivery versus payment (DVP). Investors must use a local broker with access to the KASE trading system via their custodian. If one of the parties to a trade is a client of a custodian then the custodian has an option to confirm or cancel a trade on T+0. The main role of the custodian is to monitor the execution of the client’s order by a broker. As soon as a trade is confirmed by the custodian, all the relevant data required for settlement is forwarded electronically by KASE to the CSD.

The CSD can block the trade if, for example, the seller does not have the relevant securities on account with the CSD. Payments are made via the NBK; the CSD permits the transfer of securities once the relevant monies have left the buyer’s account. All trades on KASE are on T+0; there is no netting and clearing in the settlement system of the CSD.

In contrast to Russia and the Ukraine, foreign investors show a little less aversion to settling onshore in Kazakhstan, but ‘cashless’ OTC settlement remains an option. Once again, custodian banks must be involved in this process. OTC settlement can be accomplished via a registrar or via the CSD. Both parties to a transaction must provide the registrar with instructions, respectively ‘deliver free’ and ‘receive free’, which are recorded on paper.

The role of the registrar is to reconcile these instructions in their paper ledger systems. As an alternative, the CSD can settle without cash payment and DVP. Settlement is made after matching instructions arrive at the CSD. Local brokers are instructed to make trades by custodians, who after issuing the relevant instructions receive confirmation of matching from the CSD before confirming settlement to their clients.

There are three cash payment systems in Kazakhstan, offering considerable flexibility to market participants. The primary system is the Kazakh interbank money transfer system; the system’s clearing house is a subsidiary of the NBK. All money transfers from KASE cash trades are made by the CSD via this system. Payments take less than five minutes.
There is a second system for retail payments using the same infrastructure as the first but with payments cleared at end of the day. A third system of direct transfers between banks is used for a wide variety of commercial transactions.

Pension reforms
Kazakhstan’s pension reform commenced in 1998 with the adoption of a standard three-pillar World Bank model. Statutory contributions were set at 10% of gross salary per employee with tax relief on fund income and capital gains. The former Soviet system is now virtually superseded with a majority of the 15.5m population - average age 30.7 years - in second pillar money purchase pension schemes.

There are 15 pension funds licensed and operating in Kazakhstan. Three are ‘closed’, the others ‘open’. Members can switch providers twice in a year, while charges levied by the pension management companies are capped at 1% of fund value. At retirement, members can choose to either draw a pension from their fund or purchase an annuity from an insurance company. The pension management company selects and manages the relevant investment portfolio, while a separate custodian must be appointed to safeguard assets.

The custodian can be - and usually is - of the same banking group that owns the pension management company. Ten banks, including local subsidiaries of HSBC, Bank Center Credit JSC, Halyk Savings Bank, Eurasian Bank, ATF Bank and CitiBank, provide custody services. A number of these banks either also own pension fund management companies or at least provide asset management services or unitised funds.

The Halyk Savings Fund is the largest of the funds with assets of over $217m split between over two million members. Next come GNPF Pension Fund and PAMO Pension Fund with assets of just over $50m, GNPF over one-and-a-half million members. Halyk has over 31% of all second pillar pension assets. Some corporates, notably the LSE-listed Kazakhmys PLC, and Neftegaz - both in natural resources - have their own schemes.

Some mergers have taken place between pension funds; this year the Astana Pension Fund was formed from the Amanat and Eurasian Pension Funds. And there are several small funds run by banks. These include Atamaken, run by Nurbank, Grantum, run by Kazkommercbank and Otan, run by ATF Bank. Each scheme has assets of less than 3% of total pension assets.

Funds are subject to a range of regulatory controls. Investment policy for each fund must be set by the fund’s board at a formal annual meeting. Funds are not allowed to issue member guarantees, nor can they use derivatives except for hedging portfolio risk. Transactions must be made through international settlement systems like Euroclear or Clearstream, with simultaneous delivery and payment. Taken together, these regulations are intended to minimise risk and ensure robust governance.

Investment restrictions also apply. Not less than 47% of pension fund assets must be invested in bonds issued by the Kazakh ministry of finance and the NBK. A further 33% can be invested in securities issued by domestic ‘private sector’ corporate issuers, although in a vertically integrated economy some of these issuers are under the effective control of the state. Out of this total, by far the largest share - 25% of current pension assets - is invested in corporate bonds, almost all denominated in tenge. Of the remainder, around 8% is in non-domestic equities, 2% in bonds issued by foreign banks, 1.2% in foreign government bonds, around 1.5% in gold, the balance on deposit with domestic banks.

Funds can set their own scheme-specific asset-allocation policy within this framework. For instance, the GNPF pension fund allows up to 60% of its fund assets in domestic government bonds, up to 35% in equities, 80% in all bonds, 30% in cash deposits, and up to 35% in pooled equity funds. In fact, it keeps over 64% of assets in domestic bonds and deposits and more than 7% in gold and other precious metals.

The Kazakh pension system is widely regarded as an example of how emerging economies can make successful pension reforms. The only problem with it is that a high percentage of assets is invested into domestic debt issued by the state.

The NBK has issued euro-denominated bonds as a means of diversifying portfolio risk, but the problem remains. As in some other emerging economies, the pension system partly finances government borrowing.