Business as usual
A new pensions law came into force at the beginning of the year. It created a new legal vehicle to host pension funds, the organisation for financing pensions (OFP), and transposed the EU pensions directive into Belgian law.
The OFP carries tax advantages over the existing vehicles, the non-profit organisation (ASBL) format used by most corporate schemes or a mutual insurance company. "Both were subject to a 25% withholding tax," says Jan Longeval, director and chairman of the executive committee at Degroof International Asset Management (DiAM). "To optimise their tax situation pension funds had to limit their investments to those where they had capitalised UCITS available. The OFP is not liable to withholding tax."
In addition, the implementation of the pensions directive has led to the scrapping of traditional quantitative restrictions on pension fund asset management and their replacement by the prudent man principle.
"The new investment guidelines are prudential with hardly any restrictions," says Kristof Woutters, pensions specialist at Dexia AM. "Previously they were quantitative with a whole series of restrictions."
The new legislation comes after the Vandenbroucke Law, which came into effect at the beginning of 2004 and was intended to encourage the emergence of sector pension funds to boost the second pillar.
So one would expect that recent months have been a hectic time for the Belgian pensions sector. Well, apparently not.
"I don't see much change," says Koen De Ryck, chairman and managing director at Pragma Consulting. "The majority of pension funds are still DB-type plans, the overall allocation to equities remains relatively high while bonds are mostly underweight compared with a strategic benchmark allocation and there is little interest in alternatives."
"There are not a lot of new RFPs coming out, so people are rather happy with their asset managers," says Francis Heymans, institutional sales and marketing director at Petercam Institutional AM. "In addition, most Belgian pension funds are rather small and they cannot afford to have a new search for asset managers each and every year."
"There is very little happening," agrees Benoit Fally, managing director at SSgA Brussels. "Perhaps it's because the returns have been decent enough so the pension committees are not being pushed to look for new techniques. The allocation has been right and the asset managers that pension funds have been using have been fine."
However, in Belgium's neighbour the Netherlands, the consultations prior to new pensions legislation to implement the EU directive and an accompanying revised regulatory framework, the FTK, convulsed the pensions sector for years. So why is Belgium such an island of calm?
"One of the reasons is that Belgian pension funds are by and large well funded," says De Ryck.
"They did not have the gap vis-à-vis liabilities that occurred in the UK and the Netherlands and they are allowed to fund with a 6% actuarial interest rate. That makes a big difference compared with, for example, the Netherlands where the FTK rules require the application of a market interest rate. And the current difference makes Belgian liabilities 30-40% cheaper."
"We have avoided the funding issue seen in the Netherlands, where the FTK in effect pushed pension funds to adopt liability benchmarks as opposed to using cash and security benchmarks," says Edwin De Boeck managing director at KBC AM.
"We have not seen any regulatory change that has provoked a paradigm shift. The regulator's approach is more a case of ‘you do it if you feel you have to and we will see where you get and if your financing is not where we think it should be we will ask you for a restructuring'. It is more flexible."
In part the flexibility is to further Belgium's ambition to become a domicile of choice for pan-European pension funds, De Boeck adds. "The second side of the OFP is the attempt to attract multinational pension funds to Brussels with very pronounced legal and fiscal advantages and with the regulator promising flexibility in allowing different possibilities in the management of assets," he says.
Belgium already has experience in this area. "For the past 25 years we have been a reference point for co-ordination centres, which enabled the pooling of cash assets by companies from their subsidiaries in other countries," says Pol Pierret, country manager at AXA IM. "And that carried tax advantages. It has been a successful initiative, and although the appeal is now decreasing we still have some 200 in existence."
"One of the new law's targets is to attract big investors as we did for the co-ordination centres, to have the big multinational corporates basing their central financial team in Belgium," says Olivier Lafont, head of institutional relationship management at Fortis Investments. "A lot of Anglo-Saxon groups have their co-ordination centres in or around Brussels, so they already have staff managing their liquidities. So repatriating pension assets here would be just a matter of extension."
"Belgian pension fund assets now total €15bn, minuscule compared with the €700bn in the Netherlands, for example," says Pierret. "And they account for
only 0.5% of the€3.5trn in the European market. But with this new framework Belgium could a priori assume that Belgium could manage 5% of the European market, so €200bn."
"For the Belgian pension fund industry we were mainly balanced but we expect that larger companies will come with pan-European pension plans in OFPs and search for specialised mandates," says De Boeck. "And there the competition will be international. We have been building up our knowledge of specialised mandates and are not afraid of international competition because management fees in Belgium are quite low."
But what effect will the OFP have on the domestic market? "The assets under management in the Belgian pensions industry are really rather small," says Woutters. "They could be much larger and this would not only be in the interest of the asset managers, and not necessarily the Belgian asset managers because the market is very open to foreign competitors, but also for employees and for the structure of the pensions." "It will give full flexibility to anyone in the market because it will be completely neutral from a fiscal point of view to have SICAVs or to be line-by-line in the portfolio," says Lafont. "But only the bigger pension funds will choose line-by-line. The others will stay like they are."
So does the laid-back Belgian attitude smack of immobiliy? Marnik Van Impe at Hewitt Associates Brussels says no. "It is very clear that because it removes the tax advantages to invest in mutual funds the new pensions law puts quite a different angle on investments," he says. "Although it might be a little early to say what the exact impact of this will be on investment managers, it will clearly have an impact."
Longeval agrees. "You need to look at the situation with a certain degree of nuance," he says. "The Belgian market is not the most vibrant in the world, it is not the sort of market that will jump on the latest bandwagon coming out of the City of London. However, it's not that there is nothing going on."
"In the Netherlands the new law was discussed over three years; in Belgium the new law was made in three months," Woutters notes. "So although there has been little movement so far, it will come. We recently ran a roundtable with the biggest pension funds and they said that the new legislation represented a huge change but they first have to digest it, they have to wait for the dust to settle. They will do something but not in a hurry."
And unlike in the Netherlands the new law has generally been welcomed. "When I started in 1985 we complained that there was no level playing field between pension funds and the insurance industry," says De Boeck. "Pension funds were handicapped because they had to pay withholding tax, and in addition were structured through an ASBL and had to pay a tax of 0.17% on the assets. The OFP provides the solution we asked for 20 years ago."
"So can pension funds gain 17 bps each year?" asks Woutters. "Yes. Is it difficult? No. Will everybody do it? Yes. But they have a five-year transition period in which to take the step. It has been indicated, although we have not yet seen the details, that during this period the old structure will also enjoy the OFP tax treatment so that people don't have to hurry into the new structure."
Will having an extra 17 bps to play with and a new structure be reflected in changes to asset allocation? And if pension funds went into SICAVs as a tax-avoidance strategy they should one expect them to switch out of them now?
"Some 80% of Belgian pension funds were investing through SICAVs," notes De Boeck.
Longeval agrees with Lafont that while the OFP means that pension funds could move out of SICAVs into direct lines it is a question of size. "The average size of a Belgian pension fund is about €50m, and if one were to replace an investment fund that is on a medium balanced portfolio with direct lines, there would be some 3,350 lines in the portfolio," he notes. "How could a €50m pension fund administer and account for all the dividends, stock splits, corporate actions and other transactions for that many investment shares and bonds? It doesn't really make sense because they don't have sufficient size to bear the cost."
"Pension funds did not only turn to SICAVs solely for tax reasons, they also offer economies of scale and provide risk diversification," says De Boeck. "For example, we had a SICAV for Belgian government bonds with 25 lines where investors were on the curve at every place they wanted, which would not otherwise possible for smaller pension funds."
And new legislation is expected to give SICAVs a new lease of life. "In March or April a law will come into effect enabling the creation of institutional SICAVs," says Longeval. "Currently, SICAVs carry an annual tax of 8 bps and fees to the banking commission, which means about 10 bps a year. Institutional SICAVs will only be taxed at 1 bps. The OFP doesn't have any of these costs but a comparison of 1 bps with the cost involved in having to administer and account for more than 3,000 lines in a portfolio is a no-brainer, a pension fund should go for the institutional SICAV."
"There will be a move out of SICAVs at least for US assets because of a new taxation agreement between the US and Belgium," suggests Fally. "Belgian pension plans investing in US equities will not pay tax on US-sourced dividends but I anticipate that SICAVs will be taxed at between 15% and 30% on the yield. So assuming an average yield of 2% it means that 60 bps per annum on US assets will go to the Belgian government. Some 50% of the Belgian pensions market is equities, so€7.5bn, and 40% of that will be in US equities. So a rough back-of-the-envelope calculation would put the amount at €3bn."
"If you take a pension fund with MSCI world as an equity benchmark, meaning more than 50% in US equities, it makes a 50 bps difference," says Pierret. "But in the market this is not yet widely known as it was only decided on recently and the tax treaty with the US has still to be ratified by both parties."
But when it is known, will there be a rush to boost the US equity allocation? "No, I don't think it would make the US market more interesting," says Fally. "Most people investing in US markets want the exposure because they believe that it encompasses the best companies in the world and they more or less follow an MSCI cap-weighted approach. The tax treatment won't increase the allocation dramatically especially when there is a question mark over whether the US economy will have a hard or soft landing. And most pension plans hedge the dollar back to the euro and so I don't believe that they would invest massively in the US just because the dividends are a little more attractive."
Well surely the new sector pension funds have had an impact on asset management.
"They still may have a somewhat different approach," says De Ryck. "They are DC-type plans and they have to give a guaranteed return on contributions so they are more conservative in their asset allocation."
"The shift to DC from DB has not been as severe as in other countries and this is mainly because of the stipulation in the Vandenbroucke Law that a DC pension plan must give a minimum guarantee, currently 3.75% for employee contributions and 3.25% for employer contributions," says De Boeck. "So a DC plan under Belgian law would actually be considered a DB scheme in an international accounting standards environment. So it took a long time for sector pension funds to get started because they were not happy to give the required guarantee."
"Until recently it has been very difficult to guarantee 3.25% with a central rate at 2.25-2.50%," says Lafont. "Now short-term rates are at 3.50% it is a lot easier. But the challenge is to be able to structure something that will give a high probability of them at least covering their minimum guarantee because they won't take any risk with that."
"Sector funds are always looking for a safe investment strategy, and the problem is that what constitutes a safe investment strategy has to be learnt," says Johan Vanbuylen, the outgoing director of the sector pension plan for the electrical industry, FBZ Electriciens. "So apart from the big sectors like metal and construction where they started as pension funds on day 1, everybody starts up with an insurance company where there is a full guarantee and we take no risk. We pay a big price for it but it's there."
"We have two large sector pension funds, larger than corporate pension funds, and a few very small ones," adds De Boeck. "But we should have seen the emergence of many more. It is still very early stage there, negotiations between the social partners are going on but I am sceptical."
However, managers do detect some underlying asset allocation trends. "Five years or so ago a majority of pension funds were in global mandates with the bulk of the business going to three or four banks that provided not only investment but also custodian services," recalls Pierret.
"This was particularly attractive for smaller pension funds. But now there is a trend, driven by the bigger pension funds, to go from global mandates to specialised mandates. So as managers we have to deliver alpha on very specific expertises. And this has introduced another trend. While five or 10 years ago the market was driven by fees, now with 30-40% invested to deliver alpha the client needs to have active managers and the most important part of the discussion is less the fees than the alpha delivered." Fees are still a key criterion, says Lafont. "We work differently with the different segments of the market," he says. "With the larger funds we work with specialised approaches while all the others have either only one manager or two, but with the same mandate. It is mostly balanced out approach is to try to introduce the diversification and I think that this idea is coming across well. But clients are very cautious about the costs." The 2000-2003 market downturn made pension funds and their sponsors much more aware of their liabilities, says Woutters. "It was a really painful situation and acted as a wake-up call," he says. "Now the focus has shifted from the benchmark - sticking to the benchmark and beating the benchmark - to whether they can pay the pensions when they have to. And this presents asset managers with a good opportunity to come up with solutions and not just products, solutions like structures, asymmetric profiles, management through models identifying all risks. We certainly don't want to push pension funds to match their liabilities simply through fixed income streams. That can be a good solution, for example for closed funds, but it is certainly not what has to be done for most funds."
So is there a move to LDI? "There is no legal incentive to go for LDI and up to now we have not seen a lot of interest," says De Boeck. "But I anticipate some demand because we have been speaking about it to our customers, explaining the problems they would face should interest rates fall and their liabilities rise, so in fact it is an issue. But the way to do it is quite different, for example in March we will launch an LDI SICAV with different buckets of maturities, so one pension fund will buy the bucket for eight to 10 years because they have liabilities in that area and they will have the advantage of getting a tailor-made solution for only a small amount."
Heymans disagrees. "It's not happening here because there is not the need," he says. "Of course, we have a lot of international bankers trying to tell us about LDI but I don't think the investment committees of small pension funds really want to work on those kind of projects. It's more a trendy thing than a real long-term requirement."
Well, what about alternatives? "That's one element that might change," says Woutters. "Pension funds have been able to invest in alternative asset classes but with the new prudent principle it will be even easier. I can't convince clients that they have to invest 35% in hedge funds from next week, it's very important that they understand what we are doing and why we are doing it. One could turn the question around and ask is it not happening because some asset managers cannot offer these kinds of products?"
"I have not seen any serious interest in single hedge funds," says Pierret. "We have seen more appetite for infrastructure from the biggest funds because it is a new asset class between equities and bonds, is linked to inflation, is not correlated with other assets and expectations are good. Clients prefer this to hedge funds because they are no longer showing the double-digit returns seen five years ago."
So is the Belgian asset management landscape as untroubled as it seems? Woutters anticipates movement but nothing drastic: "Will there be changes? I expect so. Are people more aware of their liabilities? Yes. Will new asset classes get more attention than in the past? Yes. Will the typical Belgian pension funds split of 50% in equities and 50% in fixed income remain forever? I don't think so. I think that what we now call alternative asset classes will get more and more attention, and over time they will rise in Belgium."