BULGARIA - Strict pension fund regulations are hampering the development of the Bulgarian stock exchange (BSE), the International Monetary Fund (IMF) has warned.

Analysts noted in a report, after the body's latest mission to Bulgaria, the minimum return guarantee legislated on pension funds together with the risk averseness of the end consumer are creating herding tendencies around certain stocks listed on the BSE.

"To reduce the potential for the build-up of boom-bust cycles by improving the asset pricing mechanism, and thus support the sustainable development of the market, capital market regulation and supervision needs further strengthening," the IMF explained.

Valuations on some listed stocks are being pushed to high levels in Bulgaria because pension fund investment in foreign stocks is strictly limited, meaning demand for domestic stock is fueled mainly by institutional investors .

"There are indications that the pricing mechanism in the stock market is not functioning properly," the IMF pointed out.

The analysts' report added stock prices "may have been growing too fast recently" because of high demand from domestic institutional investors.

As a result, it has recommended "changes in the minimum return guarantee regulation for pension funds to alleviate incentives for herding behaviour" as well as "further increase efforts to..educate the public about stock market risks".

Furthermore, the stock exchange should be made more attractive to foreign investors by growing its market capitalization and liquidity, the IMF explained. These measures would help improve risk exposure diversification and price discovery.

The IMF acknowledged problems with herding - which has see pension funds sticking close to the benchmark - were not unique to Bulgaria but can be found in other countries with similar minimum return guarantees as well.

Demands for further investment flexbility made by the association of Bulgarian pension funds at the end of last year could also help ease the pressure on the BSE. (See earlier IPE story: Pension funds negotiate investment rules)

Among the association' suggestions was raising the equity cap from the current 20% to 30% allowing investment in IPOs as well as increasing exposure to foreign stock markets.

These changes would help pension funds capitalise on the growing stock exchange, the association noted.

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