After years of first pillar predominance and waiting on the powers that be, draft legislation for Malta’s second and third pillar are due to be published in June. EU accession and the coming of the directive has driven this sunny island retreat of 400,000 inhabitants to strive for new levels of sophistication in pension and investment matters. Because of Malta’s size and relative lack of experience at all levels the
ride may well be rockier than its coastline, but an ambitious government and a buoyant contingent of money managers gives some reason for optimism.
“After a number of years of national debbate, we seem at last to be moving forward on private pensions,” says Kenneth Farrugia, general manager of Valletta Fund Management, a subsidiary of Bank of Valletta Group. “At a recent press conference the prime minister who is also the minister of finance announced that draft legislation would be tabled in parliament before the summer recess and enacted by the end of the year. Pension schemes will very much reflect the pension schemes abroad which means that we will have a three pillar system like that found elsewhere in Europe.”
The government has indeed been hard at work and the results appear encouraging. “The implementation of pension reform in Malta is gathering,” says Joseph Agius, deputy head of HSBC Fund Management in Malta, and he adds that “it appears that the authorities are committed to pass the required legislation possibly as early as June this year.”
Agius points out: “It is being proposed that a second pillar scheme can also be set up as a trust so basically contributors now have two options – set up a scheme as either a trust or a contract. A scheme administrator, typically a life assurance company, might be appropriate in either case.
“We believe the prospects for the second pillar pensions are good as the level of mandatory contributions are gradually and progressively increased by the authorities. These are also indications that the government will review the adequacy of the contribution levels from time to time.”
He adds: “A second pillar scheme will be set up as a trust which changes the whole scenario with regard to registration of scheme administration. The employer would ask a trustee to set up a scheme as a trust and a contract would be drawn up between the trust and the administrator – typically an insurance company.”
It is planned that there will be an initial contribution of 1% by both employer and employee which will be diverted from the contribution to the main social security fund.
“This will be possible provided government finances get into shape – and it looks as though they will this year,” notes Alfred Mifsud, chairman of asset managers Crystal Finance Investments based in the Maltese capital Valletta. “But it is not really the time to be loading significant new costs onto employers and employees.”
If finances are in shape by the end of the year then the legislative framework will have to move in quite quickly. “Yes that is something that is possible here,” says Mifsud. “It is a small parliament, so things could be ready by that time. Malta will be adopting the EU directive on pensions in full.”
The first pillar is a pay-as-you-go system which takes a contribution
of 10% of salary from both employee and employer featuring a cap on the contribution level. “It will not be possible to opt out of the state scheme, as some of the contributions are used to finance other areas of expenditure,” says Farrugia.
Farrugia notes that the second pillar may be mandatory or voluntary as the final decision has not yet been communicated. “The level of tax benefits that will be afforded to contributors will have a significant impact on the take up,” he says. “Critical to the success of pensions business will be tax base behind them, albeit the tax breaks have not as yet been finalised.”
So what kind of opportunity does the new second pillar represent for asset managers? “Even though it is just a diversion of funds from the first pillar I think it is an interesting start. But I think the second pillar will be mainly for bigger players,” says Mifsud. “The smaller players will benefit more from the third pillar – if the appropriate tax incentives are given. I am confident that they will be forthcoming which could produce results quickly.”
Farrugia said: “We expect total inflows of MTL12.3m (€28.7m) in the first year of the second pillar, based on a total ‘carve out’ contribution of 1% from employers and employees. The white paper states that both the employee and the employer contribution would increase by an additional 3% by 2025. This means that eventually the pensions market will increase by MTL45m annually which for a small market like Malta is quite substantial.
In Malta fund management first became an industry in 1995. “Between us and HSBC we have about MTL700m of assets under management in asset classes that include money market, fixed income, equities and real estate,” Farrugia notes. “The government recently introduced the concept of the venture capital fund in Malta. But at this stage investors are not interested in private equity or hedge funds.”
The banks dominate the asset management industry in Malta. There are two major banks: HSBC and Bank of Valletta. BOV is in the process of being privatised. “The equity stake which is being sold is 40% so no majority stake, although a substantial minority would be enough to have control, but most banks would be more interested in buying a majority stake as they would hope to put their brand on the bank,” Mifsud points out.
Vince Borg, pension manager at HSBC Life Assurance in Matla, believes that one of the main contenders in the second pillar market will definitely be companies like his. But there are some other players in the local market who would naturally become involved in the administration and asset management in connection with retirement business, he says. “I also would not exclude the possibility of foreign players becoming involved following the implementation of IIORP directive in Malta.”
He believes that client education may be an issue because like other places there is a segment of the population which in not that financially sophisticated, but he points out: “In the final recommendations of the Pensions Working group, it is proposed that the maximum exposure to equities should be capped at 35% of the contributions. This recommendation may emanate from the fact that the authorities are adopting a cautious stance in the light of this being the first attempt at investing in the second pillar.”
Farrugia is also cautious on this point: “I don’t think the new second pillar opportunity will attract international providers to Malta because of its size and the administrative costs.”
It is encouraging that the level of sophistication of the average investor has increased significantly over the last 10 years. “Today banks have transformed themselves into integrated financial service providers including fund management brokerage and with that has come the investor sophistication - regarding what level of risk would be most appropriate, for example,” says another player.
Others believe that client education may be an issue because there is a segment of the population which is not that financially sophisticated. One commentator points out: “The MFSA is aware of this as is the pensions working group. For this reason they are considering that they may impose limits on investments in equities. We don’t agree that they should restrict the equity content in all cases because if you have people who are in the younger age bracket it would make more sense to have a higher exposure to equities. But when the final draft of the white paper came out there were a number of limits including a maximum of 30% equities.
“The Maltese government and the regulator would like to be cautious because it is our first attempt at investing in second pillar schemes. They were also influenced by the pensions working group which conducted comparison of different pension regulations across Europe and found that even in the most developed economies there are countries which impose limits on the amounts invested in equities.”
One of the main challenges in introducing schemes is the island’s very small stock exchange. “There are only 13 listed equities on the stock exchange and around 13 corporate bonds,” says Farrugia. “Government bonds issues have has declined almost to zero partly because the government wants to reduce debt to GDP. So there is a lot of money in the market without a place to go. Money will tend to go to eurobonds. Real estate is less of an option today because prices have gone up significantly over the last five to 10 years because of the lack of suitable alternatives.”
A further challenge facing the industry from an investment perspective is an underlying culture of caution. “What has had a bigger impact here has been the Argentinian default because people were invested in emerging market bonds to a larger extent than in equities,” says Mifsud. “Views are changing because the market is moving; we have had some decent returns on equities on the local market so I am seeing people investing in equities which until a year ago thought they would not consider.”
Another possible cause for concern is that the savings ratio has dropped dramatically. But Mifsud points to an impressive pool of accumulated past savings. “Much of it is in straight bank deposits and would be available for more sophisticated investment should the right fiscal incentives be given.”