French civil servants lead the way on SRI
The Etablissement de Retraite Additionnnelle de la Fonction Publique (ERAFP), the mandatory supplementary pension scheme of French public servants set up in 2005, is remarkable for three reasons.
First, because, in country where the pension system is principally pay as you go (PAYG) it is a fully funded scheme, making it the second largest funded pension scheme in France after the reserve fund, the Fonds de Réserve pour les Retraites (FRR).
Second, because it is a mandatory scheme, in a country where supplementary pensions schemes are usually voluntary.
Third, because it is the first pension fund in Europe to invest its entire assets in accordance with the principles of socially responsible investment (SRI).
The ERAFP is a product of the reform of the PAYG system for civil servants in 2003, the biggest reform of its kind since the reforms of 1964. The reform concluded some of the unfinished business of 1964. In particular, it resolved the issue of whether the bonuses paid to civil servants should be taken into account for the calculation of their pensions entitlement.
Bonuses are a significant part of the total remuneration package of public sector employees in France. As a percentage of gross salary, they vary from 6% for teachers to 40% for nurses, military personnel, and senior civil servants.
The trade unions representing the civil servants wanted bonuses to be included in the calculations for PAYG first pillar pensions, a demand that was unsatisfied in the 1964 reform.
"We could say that the creation of the ERAFP was, in effect, the informal counterpart of the reform of the PAYG system for civil servants," says Philippe Caïla, director of the ERAFP. "The effect of the 2003 reforms was that it will take longer for civil servants to obtain full pension entitlement because of more complex procedures. Yet at the same time, the creation of ERAFP as an additional scheme satisfied a long-standing demand on the part of the civil servants to have their bonuses included in their pension entitlement."
Caïla has been closely involved in pensions reform over the past five years. He was budgetary advisor in charge of pension reform under Jean-Paul Delevoye, minister for the civil service, administrative reform and regional development from 2002 to 2004, and is currently deputy director at the retirement division of Caisse des Dépôts (CDC).
The decision to make membership of the new supplementary fund mandatory rather than voluntary was critical to its success, he says, since it has enabled them to achieve a critical mass in terms of assets and build credibility in terms of public perception
"It was very important for us when we designed the scheme to have a very large base or foundation of assets which we could achieve with a mandatory system. There are some examples of non-mandatory pension funds in France, especially for civil servants. But it has been somewhat difficult for them to attract new members, because French people do not really understand how pension funds work.
"The creation of a mandatory second pillar is clearly a radical change from the traditional French system."
Another innovation is the ‘points' method of determining pension entitlement. The CDC, which is responsible for scheme administration, opens an account for each civil servant and calculates actuarially the accumulated points or pension rights determining the payment of the pension.
"Each year the board of ERAFP decides the value of the points," says Caïla. "The more people contribute, the more points they have. The calculation by points is a good way to manage a pension system like this, because it gives the board more levers."
However, ERAFP's most notable innovation is its decision to invest all the fund's assets according to SRI principles. ERAFP became a signatory of the United Nations Principles for Responsible Investment (PRI) in 2005, and decided to implement a 100% SRI policy within its pension operations.
Caïla says there were two principal reasons for the decision. "The main reason is that we are a public sector fund, and in a way we felt that we had to show an example.
"We represent 4.3m beneficiaries from the public services, and public services in France and the role of the public sector is very important. And one of its roles sometimes is to do what the market will not do on its own, such as SRI." However, Caïla says that
the board of ERAFP was also determined to take a pragmatic rather than a conceptual approach to SRI. "The aim was to combine public service values with the search for performance. We are a long-term investor, and that means for us that we have a long-term strategy. We want to have profits not only for next year but for the years ahead. As an investor we need a long term approach, and SRI has technically helped us to build a very long-term strategy."
The very novelty of a funded, collective second pillar pension scheme in France also provided an opportunity to introduce a radically different investment strategy, he says "We began with a ‘feuille blanche' - a white sheet of paper. Because the fund is newly created, the opportunity to put into practice something that was very different from the past was perhaps easier."
In November 2005 the ERAFP board decided to implement a full SRI policy a decision reached only after lengthy and vigorous debate, Caïla says. "There was a long and strong debate which resulted, I think, in a consensus at the end of the process. It was both a technical and political debate between the members of the board, and between the board and the members of the ERAFP team. This was a classic debate about returns and risk and the impact of non-financial issues on the investment policy. The consensus was built on the idea that inside a pre-defined universe it is possible to have financial management." In March 2006, ERAFP adopted an
SRI Charter, similar to that of the FRR, built round five values: respect for the rule of law and human rights, social advances, labour participation, the environment and proper governance and transparency.
In June 2006, it chose two extra-financial rating agencies, Vigeo in France and Oekom in Germany, to help design a detailed SRI reference system.
It also issued its first request to tender for three euro-denominated equity management mandates, and a standby mandate. The mandates will be worth between €100m and €400m for each asset manager for the period 2007 to 2010, and represent the largest SRI equity tender in France to date.
A total of 33 asset management companies took part in the tender. Of these 16 were asked to present a proposal and four were chosen - BNP Paribas AM, Integral Development AM, Robeco Institutional AM for the equity mandates and Pictet AM for the standby mandate.
One surprising feature of the request for proposal (RFP) process, Caïla says, was the relative lack of interest from the large international asset managers. "Yet there is no French bias."
The most important criterion in the selection of asset managers was the ability to understand what ERAFP wanted, he says. "We are looking for asset managers who are prepared to listen to us and are prepared to provide a service that we asking for."
The selected asset managers are expected to optimise the financial return of the funds while respecting the ERAFP SRI Charter. This means that from the start of the mandate they will exercise the voting rights attached to the financial instruments in the funds in the sole interests of ERAFP and according to defined policy guidelines.
"We want to choose an asset manager who can do the job according to the Charter of the ERAFP, that's the main point," Caïla says. "In this RFP we wanted ‘made to measure' rather than ‘ready to wear' asset management, and we were very interested in managers who have an ability to work with us with an SRI approach."
The ERAFP team will be monitoring the performance of the managers, in particular, how the different investment styles perform. "We are very interested in competition between assets managers in terms of their management style," Caïla says. "Thefour managers have exactly the same mandate so we want to follow their performances to see where the differences are. This kind of competition between management styles is a good way to manage risk and also gives us value for money."
The only assets which ERAFP manages internally are sovereign bonds which are bought on a ‘buy
to hold' basis and held to maturity. "Essentially these are areas where we feel that externalising the mandate is really not offering value for money for the fund or for the beneficiaries. All other investment instruments will be subject to RFPs,"
Further RFPs will probably follow the launch of a corporate bond portfolio before the end of the year, he says. "At present we are at a very early stage of reflection in terms of a possible investment in environmentally sound real estate, and small caps, specifically in the eco sector or with a high job creation potential. But for the moment these are not even in the pipeline.
The priority currently is feeding the mandate, which began at the end of April. This is expected to swell the asset base, says Caïla: "In terms of assets we are currently a small player, but we are growing quite quickly. At the end of last year our assets totalled €3bn. At the end of this year they will be €4.5bn.
"We have no equities today but at the end of the year we will have perhaps between 12% and 16% of equities in our portfolio. So we expect growth to be very fast. Theoretically we are expecting to reach a target of €100bn by 2040, provided the law doesn't change." The ERAFP team is likely to grow to be able to manage these assets, he says. "Big money means big oversight and we have to build a financial ability to oversee the money we provide to asset managers. First of all, we want to manage the building of our portfolio.
"What is very important to us is to have the ability to survey, report, and analyse our portfolio. We are very simple organisation today, and our strategic asset allocation is very simple, but it is going to become more complex."
The motto of the ERAFP, which has been characterised as a ‘baby giant', might be "one step at a time", says Caïla. "When you compare ERAFP with other public sector pension funds in other countries, it is clear that it takes many years to build such funds. So it is very important for us to go step by step, but with a very long-term view."