Finding a half-way house
Swiss occupational pension funds have a tradition of self-regulation. But last year the system received a body blow when the Swissfirst bank scandal came to the notice of the media, which in turn focused popular attention on potential hazards in the way people’s pension assets are handled.
In the months that have followed, legislation has been drafted to change how pension funds are regulated. In the past, regulation of pension funds has been left to individual cantons, a burden that many have found difficult to carry. As a result regionalisation of regulation, encouraging groups of cantons to combine their regulatory responsibilities, is in the pipeline.
But for some the linking of the scandal with the pensions industry was unfair. “As far as we know, the Swissfirst case was not a pension fund issue, even though the media presented it as such,” says Christoph Ryter, president of the Swiss Pension Fund Association (ASIP). “It was more a banking supervision issue because it revolved round the merger of two banks and, to my knowledge, nothing was found to establish that there were inappropriate deals between pension funds as shareholders.”
The allegations centred on share trades ahead of a 2005 merger between local banks Swissfirst and Bellevue. A number of Swiss pension funds were found to have invested in Swissfirst, whose shares had not been notable for their performance, only to sell their stakes shortly before the announcement of the merger, which saw their value surge.
A number of pension funds were investigated, a collective pension fund called First Swiss Sammelstiftung was liquidated, and the general public made aware of the practice of parallel running. This is where a pension fund manager buys a small cap stock with a low market capitalisation on his own account, buys options with a high leverage then, perhaps acting with other pension fund managers, buys the same stock for the pension fund, thereby boosting the stock price, before liquidating his personal position.
The scandal prompted the president of Switzerland’s central bank to claim there were far too many pension funds and to characterise many who ran them as incompetent.
“Our pensions system does not have a type of strong pensions management scheme that is managed externally on a stand alone basis,” says Werner Enz, pensions expert at authoritative Swiss newspaper Neue Zürcher Zeitung. “Most are run close to the company, with half of the board being representatives of the employers and the other half of the employees. So there was a heavy reaction to the Swissfirst situation because people realised that they do not have any chance to move their money out of a scheme if something goes wrong as they are tied in. People read stories about certain banks doing certain deals with certain pension funds and that added an element of emotion to the whole debate.”
And then the timing was bad, recalls Hansjörg Herzog, chief operating officer, institutional distribution Europe at Credit Suisse Asset Management. “A year ago a new law on the regionalisation of regulation was in the pipeline and was in the middle of the consultation phase when the Swissfirst affair became public. As a result, politicians and regulators came under massive pressure to do something, so they had to include something on the governance side in the legislation. Of course, almost everybody in the pension fund industry, particularly ASIP, said loud and clear that they did not need new governance regulations, just a new law on regulatory changes. But, with 2007 being an election year, the pressure on the politicians was too big; they had to do something.”
“I think that, after a while, there was an understanding that central bodies should make tougher rules about insider trading, parallel running and retrocessions,” says Enz. “We have seen certain constructs where the money ends up in certain pockets and so on. There is an understanding that the existing legal framework stipulates many things, like an ethical code that has been in the law since 2005, so there is not a major need for more regulation, just better observation of the rules and a need to be professional. But there is also an awareness that if these kinds of conflicts of interests are not tackled, something like the Swissfirst situation could blow up in your face.”
But what is missing from the mix is the exploitation of the situation for party political gains, although a general election is to be held later this month. And neither are there fears that the planned legislation will not be implemented by the next administration. This is due to Switzerland’s ‘magic formula’, a power-sharing agreement that since 1959 has ensured that the make up of the seven-strong cabinet is not the result of parliamentary mathematics but rather to the divvying out of portfolios between the four leading parties that are in a permanent coalition.
“Recent governance discussions in parliament were aimed at clearly defining what are the duties of a pension fund board,” says Urs Schaffner, head of pension fund consulting at Hewitt. “It listed their responsibilities and clarified the supervisory elements. This would have potentially resulted in an over-regulation of the entire system due to some negative individual cases. I believe that fears that there will be an over-regulation on the asset side have diminished.
“Nevertheless, governance issues overall are still very high on the agenda and some of them are to be decided in the next few months. At the moment, the highest supervisory authority is part of the executive but the structural reform will mean the separation of the executive power of the federal government from the supervisory authority. It is to divide it into two bodies, one that is part of the executive to prepare all documents for the implementation of legal changes, and an independent body for the supervision. And one idea is to further decentralise the supervisory authority.”
“There are several issues at stake,” explains Graziano Lusenti, chief executive of Nyon-based consultancy Lusenti Partners. “One is the official supervision of pension funds, and in this field two changes have occurred or are underway. The first is some tighter supervision on a more regional basis than purely cantonal, which is between cantonal and federal. It is occurring along pragmatic lines. There are 26 cantons and the eight or nine largest are big enough to have their own supervision. The rest are likely to combine on a regional basis. For example in the area around Lake Lucerne there is a regional supervision based on Lucerne and encompassing three or four smaller cantons. This trend us underway and will continue, but it is not a revolution, it’s more a matter of efficiency.
“The second element, which is now being implemented and which, for the present, only touches the pension world at the margin but might touch it in a more significant way in the future, is the creation of a federal finance supervision authority. That is a major move, which means that, in the future, banks and insurance companies and mutual funds will be under the same supervision, which is federal. There have been discussions about whether pension funds should be supervised by the same authority but, for the time being, it has been decided not to. That is a discussion that could be reopened in the future if there is a feeling that the supervision of pension funds is not adequate.”
This is not a discussion Ryter would welcome. “The weakness right now is that several cantons just don’t have enough pension schemes to be supervised, so for those cantons there is no possibility of having professional assistance for pension funds,” he says. “But while a certain concentration is very good, we are convinced that an autonomous pension fund is not the same as an insurance company or a bank. The focus of insurance company supervision was the protection of the individual client of an insurer so it is important to avoid that an insurance company be-comes illiquid and has to close its books.
“However, while there is the possibility that, under certain circumstances, an autonomous pension fund may have a coverage ratio of below 100%, it makes sense, from an economic point of view, if the pension fund has a rescue package and it is sure that, within a certain a period, its coverage ratio will return to 100% or even more.
“So the focus for autonomous pension funds is not the protection of the individual but rather to ensure that the system as a whole will function. We are convinced that the system we have in place, with pension funds led by representatives of employees and employers and organised on a decentralised basis, is able to provide adequately flexible solutions.”
Enz disagrees. “I am in favour of a centralised approach that works hand-in-hand with the supervision of banks, the funds industry and the insurance sector. Now the political big picture favours the decentralised approach and, as historically the cantons have had this responsibility, they do not want to cede it completely. But I am critical about this regional approach. I think there is a risk that we will see some distortions later on.
“We have about 2,500 more or less independent schemes that have amassed around CHF600bn [€363bn] and have been established by different bodies. But many don’t have a professional set up, the situation is risky and the Swiss national bank has criticised it. We need people who can supervise very clever traders and portfolio managers but, if you don’t have the right tools, it is a very bad starting point for making a professional business.”
However, for one asset manager who does not want to be identified, a unified supervisor would pose a commercial danger. “The key issue is not between the regulatory authority of, say, the canton of Zürich verses the canton of Sankt Gallen, it’s much more between the regulation for the autonomous pension funds versus the regulation for the insurance companies that offer fully fledged pension solutions.
“The insurance industry is lobbying heavily to have one single regulatory system, ie the insurance system, which would mean that, like the insurers, the autonomous pension funds would not be allowed to have a coverage ratio even temporarily below 100% and this in turn would mean that the insurance firms’ outsourcing offers would look relatively more attractive than that of the stand-alone autonomous pension fund. This is the game played in Switzerland.”
“It’s a delicate question,” concedes Jean-Pierre Steiner, CEO Nestlé Fonds de Pension and a former ASIP board member. “Obviously with supervision by the cantons the quality and the monitoring of those regulators varies from one canton to the other. I am not necessarily in the camp of my former ASIP colleagues as I wouldn’t mind having a well-equipped, competent national regulator. But this does not mean that it should issue more strict guidelines or whatever.
“Self regulation can still work within an overall frame. Trustee boards here are no worse than elsewhere, but they are mostly laymen and they change from time to time - there are elections or they leave the company and others have to take their place - so by definition they are never going to be experts; that’s the problem that many countries face. So maybe we need to move towards professional trustees - which is a solution with several other drawback - or to change the set of responsibilities between the trustees and the sponsor.”
“The key factor for a pension fund manager and his board of trustees is to have a good relationship first with its own audit firm and then its own regional or cantonal regulatory body,” says Herzog. “Why should the manager of a corporate pension fund mind what the regulator of another canton tells its pension funds? At the end of the day he will only be concerned about what his regional or cantonal authority thinks about certain issues. The worries are that there might be some regulatory arbitrage, for example, suggestions that it’s more liberal in one canton than in another.”
Enz has reached a similar conclusion. “The regional initiative in Lucerne was the first and we see others in the north west, with Zürich being hand in hand with Schaffhausen and maybe Basel with Solothurn and Aargau,” he says. “These first movers are probably where there is the best approach and it is with the late movers that I expect to see the biggest problems and where there is a huge risk of regulatory arbitrage.”
But Ryter does not see this as a danger. “The government’s proposal is that we have a super supervisory authority in Berne in addition to regional supervisory authorities to ensure that differences in the interpretation of the supervisory laws are not too widespread,” he says. “Rather for us it is very important that the supervision of autonomous pension funds is not identical to that of insurance companies and banks and for that reason we see the regionalisation as the best solution. And if there were a centralised supervisory authority, it is important for us that it is separate from the supervision of insurance companies and banks.”
“There are arguments for and against a centralised supervisor,” agrees Lusenti. “One of the more critical ones was that the new authority already has quite enough to do with integrating the supervision of banks and insurance companies without additionally getting involved with pension funds. But it is in flux, it is not final.”