Italy: Uncertainty reigns supreme
The Italian pension sector is facing a period of overdue reform, the second-pillar needs strenghtening and the restrictive law 703 hampers investment decisions. But Carlo Svaluto Moreolo wonders if the government has any desire for change
An uncertain political future looms over Italian prime minister Silvio Berlusconi’s
government, and the question of how the country is going to cope with its ageing population remains unanswered. Pension and investment professionals employed in the second-pillar provision system are bracing themselves for a revision of the law that is long overdue. However, amid this grim scenario, the annual report of the Italian private pensions regulator, Commissione di vigilanza sui fondi pensione (COVIP), published last month, offers hope that Italy’s second-pillar system may finally be developing.
First, the losses suffered by Italian pension schemes during the financial crisis of 2008 were recouped by the end of 2010. Specifically, during 2008, 8% of Italian private pension schemes formed after the 2006 reform package recorded negative performances, compared to an average of 20% in OECD countries. This is due, according to COVIP, to the strictly regulated environment within which Italian pension funds work.
During 2010, second-pillar schemes performed positively, growing on average 3%, slightly higher than TFR (trattamento di fine rapporto, or the severance pay workers are entitled by law), which grew by 2.6%. Open pension schemes, accessible to workers of any industry, performed better, growing by 4.2% during 2010. PIPs (individual pension plans) also did well, growing 3.8%, although certain products of this kind, which were biased towards equities, have yet to recoup the losses recorded during 2008.
What disappoints in the data released by COVIP is membership figures. There has been a marked slowdown in memberships compared to the post-year reforms. In the first three months of 2010, membership of the second-pillar system has increased by 1.3%.
But at the end of 2010, 5.3m workers in Italy had a private pension plan, which is a mere 4.3% more than the previous year. This represents roughly 377,000 new workers joining the second pillar system, and while the figure is higher than the 321,000 which joined in 2009, it is still a small increase considering the potential market. At this stage, the 5.3m workers who have joined the second pillar system represent less than a quarter of the potential market.
The COVIP report also pointed out another worrying figure regarding the increase in workers suspending contributions, due to the effects of the recession. The number who have stopped paying contributions was 1m at the end of 2010, compared to 840,000 in 2009, and the number has quadrupled between 2007 and 2010.
Filippo Battistini, head of institutional business for State Street Global Advisors Italy, however, maintains that the assets are growing at an interesting rate, especially when compared with the number of members. However, he believes that the investment strategies of Italian occupational pension schemes are not diversified enough, because of the investment constraints faced. He says: “The Italian pension system resisted the crisis, partly because pension schemes have prudent asset allocations”. He also confirms what is indicated in the last COVIP report: “They’re exposed to debt securities that have an average maturity of 3.5 years, and this means the turnover rate is high. They have to sustain high transaction costs, and their strict monitoring policies mean pension schemes put asset managers under scrutiny over the short term.”
Battistini adds: “This is somewhat linked to the governance of the occupational pension funds. Boards of directors are overhauled every three years and they do not have enough time to judge managers’ performance in an appropriate way and this, sometimes, is not consistent with the investment horizon of these institutional counterparts which should be over the medium/long term.”
Battistini emphasises how some fundamental aspects of the debate on the second-pillar system in Italy were barely mentioned in the COVIP report. He says: “COVIP has talked explicitly about the requirements for some schemes, which are expected to solve the organisational lacks that are affecting their governance.” For instance, there is no clear distrubution of roles and responsibilities between the different bodies within the pension fund. Moveover, COVIP has clearly stated that the documents that describe the investment policies are not always adequate and they will have to indicate the duration of the invested capital versus the liabilities, the expected turnover, the expected gross return and the maximum acceptable loss. Let alone that the smaller ones may not have enough resources to do so, the regulators didn’t anticipate anything regarding the necessary modification to the 703 law, which everybody is expecting.”
The 703 law establishes the assets Italian pension schemes can invest in and is quite restrictive, leaving Italy behind other countries in terms of the complexity and variety of investments made by pension schemes. While a debate has been going on for years behind the scenes, no formal decisions have been taken so far to address these limitations.
Battistini concludes: “There had been proposals to give tax breaks or other forms of fiscal relief to people, to encourage them to invest in the second-pillar system. But labour minister Maurizio Sacconi has made it clear that there are no resources to provide these tax breaks.”
Sacconi has instead emphasised how consolidation could be the key to a significant improvement of the system. At the moment, Sacconi points out, there are more than 500 pension schemes, most of which are small, and mergers are necessary to achieve economies of scale. Talks, rather than negotiations, are ongoing in the transport and the co-operatives sector, where workers are split between several funds. However, even in this case, consolidation moves are blocked by political machinations. Any merger requires the trade union and employers’ representative associations that founded the pension schemes to agree on every detail, and this has proven to be difficult, if not impossible to achieve.
Still, Battistini affirms that for an asset manager, this is an interesting market as assets are growing at attractive rates. State Street Global Advisors, which re-entered the Italian market in 2007, has quickly gained a foothold, managing 12 mandates for seven different schemes, and has become one of the largest players in Italy in terms of market share and assets under management (AUM).
Monica Basso, head of institutional investment in Italy for Pioneer Investments, also paints a mixed picture. “It is difficult to provide an optimistic vision, Italy is a rather static market. There have been great educational initiatives recently, such as the ‘Savings Day’ organised by COVIP, but there is no co-ordinated action at the governmental level. If the authorities decided to act, especially, given the danger that especially young people will collect a pension too small when they retire, workers may start realising the necessity of joining the second-pillar system.”
Perhaps differently from others, Basso is not convinced that the 703 law is a bad one. “I only partially agree with the premise that the legislative environment is inadequate,” she says. “What you see in Italy is a very solid structure, which the prudent management of investments of Italian schemes reflects. It is true that the norm should be revised, as the financial markets have changed since 1996, when it was approved. But we have also seen the benefits of having such a law, especially in the industrial sector. Even when obsolete, laws serve a purpose and can be a good starting point. The new draft for the 703 law establishes that if a scheme wants to invest in certain types of assets, it has to have a monitoring structure in place. And at the moment, having a precise law is a plus point.”
Basso, however, has a strong opinion on the development of the second-pillar system so far. “In the development of the system in Italy we have, perhaps involuntarily, appointed the second pillar system to provide a general welfare function. The data that shows poor membership rates and poor growth has to be read in this way. This is the real problem. If the citizen has less liquidity, because for instance of the slowdown in the industrial sector, he or she will ask for an advance on the TFR, or will stop paying into their pension scheme. We should be able to assign this welfare function to other institutions.”
As total assets are steadily growing, asset managers remain interested in the Italian market. Competition is fierce, but there are structural difficulties for them that prevent them from doing their job. Basso points out: “Most pension schemes have decided to split their assets into different compartments, but the result is that the more ‘aggressive’ compartments have seen fewer people join. Asset managers have to manage amounts of money that are not sufficient for the kind of investment they are required to make. We try to be efficient, and develop a fiduciary relationship with our clients. But, for example, while boards decide the risk profile they want to implement disinterestingly, they should make these decisions based on the characteristics of the industry they represent.”
Within this confusing scenario, certain types of institutions have moved towards modernisation. The most reassuring trend in the Italian institutional market concerns banking foundations, which have began looking seriously at liability-driven investment (LDI). This is not only a push towards modernisation as it is driven by the necessity of providing for old investors while seeing new ones inject smaller amounts of money into their funds. However, it is a positive development that opens new possibilities for asset managers.
“This is an interesting trend,” says Battistini. “The sector is dominated by local advisers, but with banking foundations taking the liabilities management approach, they are showing greater awareness. A large part of the portfolio of these institutions is immunised, and while they look at riskier assets that promise higher returns in the long term, they naturally switch their attention to liabilities.”
Marco Fusco, country executive director for Italy at State Street Global Advisors, adds: “Finally these institutions are looking at their portfolios correctly. We are at the early stages, but finally they are looking seriously at liabilities. They have also incentives to do so, coming from the new inter-ministerial directives on real estate. What is important is that this is not a flash in the pan, and that these approaches are implemented.”
Smaller asset managers, with expertise in absolute return strategies, may have a headstart in the race to win LDI mandates. Michele Gesualdi of Kairos Partners, a Milan-based asset management firm focused on absolute returns, says: “It is from the Casse di Previdenza, or banking foundations, that we have more requests. These institutions have realised that their prospective returns are uninteresting, since such a large portion is invested in debt securities. Investors are looking for alternatives. We believe an absolute return strategy suits the needs of investors in a changing market, and UCITS instruments especially are the best to implement this strategy.”
Some encouraging trends show that the Italian second-pillar market has the potential to attract asset managers to the country. However, it is unclear when pension schemes will have more freedom to invest, and more workers are going to be willing to join them. The future of the current government is also unclear, it suffered two powerful blows in May 2011’s local elections and four referenda, with opposition parties gaining ground. However, while it has not done much in the last three years, the following two years of the legislature may be the time to act on pensions. There are rumours that the government might act as early as this summer, with a review of the 703 law.