Confusion reigns supreme
The Cypriot bailout may have only been a drop in the ocean compared with the Greek rescue package. But, as Jonathan Williams finds, lack of detail is a major headache for the local provident funds even three months later
Unlike the upset caused by previous bailout negotiations, the woes of Cyprus did not materially affect bond yields in peripheral countries. Ireland continued to issue short-term debt without enduring significantly higher costs, and after initial surprise that deposit holders in two of the country’s largest banks would be subject to haircuts in order to part-fund the island’s support package and the ensuing debate whether this signalled a new template for European Union-backed rescues, attention once again focused elsewhere.
This was the case for non-Cypriots. In early May, the €16bn EU-IMF bailout agreement was narrowly ratified by the Cypriot House of Representatives, but many questions remain over its impact on the country’s provident and pension funds – traditionally investors with high levels of bank deposits.
Pension funds and provident funds will not be exempted from a haircut on deposits, whereas individual bank accounts with amounts below €100,000 will be shielded.
Anastasia Anastassiades, senior consultant at Aon Hewitt says the exemption in place for individuals is resulting in some provident funds liquidating – around 80 to date of the country’s roughly 1,900, many with assets under €1m.
“It’s family businesses essentially setting up a tax-free benefit for their family members,” she says of these small funds.
“If there are a handful of family members, they do a general meeting in the family and they say ‘we will dissolve the fund and give you the cash in an account in your name, so that it’s guaranteed’.”
However, this does not solve the sizeable problem facing non-family funds. It is estimated that of the €4.5bn in assets that local funds manage, around half of them are with local banks due to the traditionally high interest paid by lenders – a relic of the island’s financial system prior to joining the single currency.
Bank of Cyprus has already imposed haircuts on deposits of 37.5%, with the arrangement to be mirrored by Cyprus Popular Bank – the lender domestically known as Laiki. This more lenient protection within Laiki will only apply to provident funds, with all uninsured personal deposits held by the liquidated bank otherwise subject to a 100% haircut.
However, Bank of Cyprus will offer deposit holders shares in exchange for their losses – losses that might still rise as high as 60% once final details have been negotiated. While the initial bailout would have seen the country contribute €6bn, the sum was soon expected to be revised upwards.
As a result of the expected cuts and imposed capital controls, only around 10% of pre-bailout deposits are accessible, an arrangement that does still allow for limited overseas investment.
“A natural way of shrinking the banking system is to invest locally and overseas,” says Anastassiades, who says the heavy reliance on deposits, thereby swamping the financial institutions with capital they were required to invest, was in part responsible for the problems facing the banking sector.
“Some of the funds that have been lucky enough to have started investing overseas beforehand – and they are comfortable enough with the idea – continue to do so within the limits imposed by the capital controls,” she says, explaining that some have only invested €50,000 per month overseas, which would still be below capital control thresholds.
The €300m Hotel Employees Provident Fund (HEPF), diversified by local standards, only had around €80m of its assets in deposits in March and its chief executive Marinos Gialeli remains hopeful that its other assets will be able to absorb some of the losses.
He says that plans to increase real estate investment are now “on hold”, but that greater exposure to alternatives, such as infrastructure, has been discussed by the board.
Gialeli says that some of the problems now facing Cyprus were triggered by the terms of the Greek sovereign haircut. “We feel we’ve been betrayed by the Europeans, because everything was started by the haircut of the Greek government bonds. Good or bad, Cypriot banks lost more than €4bn on that haircut.”
In a statement at the end of March, HEPF insisted it was the “safest financial institution in Cyprus”, crediting this stability to its diversified investment approach.
Appealing to members, it also argued that their trust was needed at a time that the stability of the country’s public social security fund was questionable.
Safety would also appear to be a concern for the benefits paid by the Electricity Authority of Cyprus pension fund. Due to the time it took successive governments to agree a rescue package, the semi-government agency’s fund lent the state €100m last December.
While the bond matured in March, trustees of the fund at the time said they would show “tangible support” by not redeeming it.
Current plans would not see pension providers reimbursed for any bank-related losses. Instead, it is expected that individual pensioners will be granted a set rate of increased payments from the state upon retirement in form of social security benefits.
The state may be taking on significant new liabilities, but Anastassiades believes that these will be tolerable, as increased payments will only amount to millions a year, and will be staged as people retire – easier to address than an immediate compensation bill.
Anger, however, remains over those not affected by the haircuts to date – such as charities, government entities and fellow large institutional investors, the local insurance companies.
“The insurance companies have been exempted from this, and will only be subject to a haircut of at most 27%, but not the provident funds,” says Anastassiades. The exemption is now being contested, with the lawsuit arguing that every exemption will simply increase the burden for those that remain.
She says that, given the uncertainty over the level of haircuts, much of her work in recent months has been assisting the local funds in designing new benefit structures and reducing the cost of employment by lowering contribution costs as Cyprus struggles with an initial increase in unemployment that can be traced back to the bailout.
“We’ve been asked to re-draft some rules, reduce some contribution rates – some of the defined benefit funds are restructuring their accrual rates,” she adds. “It’s a lot of little things we are being asked,” she says.