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Pensions in Central & Eastern Europe: Growing pains

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In contrast with Croatia’s economy, the country’s pension industry is developing at a healthy pace. In the year to October 2014, the total assets of the three mandatory second-pillar funds grew by 14%, totalling HRK65bn (€8.46bn).

Changes in the regulatory framework for pension funds have been welcomed, as has been the decision to offer members a life-cycle choice. Although, the project to offer pension funds a stake in Croatian motorway concessions has faced criticism from trade unions, there is confidence among funds that it will occur next year. 

But positive sentiment about the system, has been diluted by bad news about the Croatian economy.  

A speech by Boris Vujčić, governor of Croatia’s central bank, delivered last October at a Zagreb Stock Exchange conference, was nothing short of pessimistic. 

The World Bank expects economic growth to be positive in 2015, but Vujčić lamented lack of investment and structural reforms as the causes of a prolonged stagnation.  

At a glance

• Pension assets are growing fast and now account for 20% of GDP, or about €8.5bn.

• Mandatory pension funds now offer three lifecycle strategies.

• Investment restrictions have been lifted, raising the single company equity limit to 20% and increasing the foreign currency asset threshold to 40%.

• A plan for pension funds to invest in a domestic highway concession has proved controversial.

Dubravko Štimac, president of the management board of the PBZ Croatia Osiguranje Mandatory Pension Fund, agrees on the need for structural reforms, citing the judicial system as an area where change is most needed to attract foreign investment.

Štimac adds: “It is also important that fiscal policy remains stable, and that bureaucracy becomes less burdensome for foreign investors.”

Dinko Novoselec, CEO of the Allianz ZB Mandatory Pension Fund and president of the association of Croatian Pension Fund Management Companies, believes changes to the pension system are part of a structural reform drive that will benefit the economy in the long-term, but admits more is needed.  

The pension landscape is changing rapidly, but the slow recovery is taking its toll. There has been no movement on the plan to raise contributions from the current 5% to 10%. This was agreed in the pension reforms of 1999 that created the second-pillar system. 

Damir Grbavac, president of the executive board of the Raiffeisen Mandatory Pension Fund, explains that this has been one of the major issues in the dialogue between funds and the government. 

He says: “It was not done in times when we had high growth, so it is likely to be put on hold for some time. But it is very important, and we are discussing it with the government all the time, as we believe it is essential to ensure the sustainability of the system.”

But the crucial fact is that Croatia, on the whole, seems wholly convinced about its course of pension modernisation. “There seems to be a political consensus in Croatia about the existence of a second-pillar system,” Novoselec says. “Both the two mainstream political parties and public opinion makers support the idea of having a fully funded pension system.”

Novoselec says that the new rules, which came into force in 2014, are “the most important products of this relationship”.

Starting from August 2014, pension funds offer three lifecycle choices, each with a different risk approach and criteria. 

Because of demographics, most assets will be concentrated in medium-risk ‘B’ funds. However, pension funds managers note that it will not cause a significant shift in assets.

From 2015, fees will be reduced gradually from 45bps to 30bps. This makes Croatian pension funds among the cheapest in the world, and removes “uncertainty” that allows funds to manage pensions appropriately going forward, says Novoselic.

The other changes concern pension funds’ investment limits. The regulatory framework remains strict compared to other countries, but a range of new investment opportunities has opened. Funds are now able to own up to 20% of the equity of a single company. The limit was raised from 10% previously, and this could encourage Croatian funds to invest in the domestic economy. The market capitalisation of the Zagreb stock market is low, and it has been difficult for pension funds to make equity investments without breaking the 10% limit. New alternative asset classes, including real estate and infrastructure, are now permitted. The use of derivatives can be extended to investment purposes, while previously they were used for currency hedging.

The limit to investment in non-HRK denominated assets has been raised from 20% to 40%, a change that was welcomed. To balance the investment freedoms, the regulator is requiring pension funds to develop internal monitoring and audit capabilities. 

The rules were received well. Novoselec says the law “struck a good balance” and believes the regulator is aware of the need to diversify. “If the investment universe becomes too small for us, there is a will by the regulator and the government to broaden it.” 

But funds still feel constrained, Novoselec says. “The currency limits practically mean we are limited in investing outside of Croatia, as long as Croatia has its own currency. That means that we will have to be country-biased for the next few years.”

There is a clear tension between the demand for investment in Croatia and the pension funds’ appetite and need for diversification. 

The new rules are intended to allow better diversification while encouraging domestic investment at the same time, but Novoselec notes that the government has not offered substantial investment opportunities.   

He adds: “There is an opportunity to invest in the Croatian private sector, and to expand the public sector, because there are still assets to be privatised in Croatia. Both on the private side and the public side, the pension funds’ assets are an opportunity for the Croatian economy to use them as new equity.”

There are rumours that the government will sell its stake in Hrvatska Elektroprivreda, Croatia’s main energy company, allowing private investors, including pension funds, to purchase it. 

Last year, Croatian trade unions put a spanner in the the government’s plan to relieve itself from around €3bn of debt amassed by Hrvatske Autocesta and Autocesta Rijeka-Zagreb, the motorway authority and the company operating the Rijeka-Zagreb highway.

Opposing the privatisation, trade unions collected signatures in support of a referendum to halt the project. At the time of writing it was not clear whether the referendum would go ahead as approval by a parliamentary committee was pending.  

But by the end of November 2014, consortia made up by Croatia’s four mandatory pension funds, among other institutions, were required to submit non-binding proposals for a 30 to 50-year concession. “We are still confident that it will go through,” Grbavac says.

The project is part of a complicated puzzle, whereby the Croatian government has to reduce public debt to stabilise the economy, potentially unlocking opportunities for spending in infrastructure and restoring faith in investors. 

By October 2014, the ratio of public debt to GDP had reached 78%. Novoselec argues that while the figure is undeniably high it should be compared with the country’s second-pillar pension fund assets, which are around 20% of GDP. 

He says: “I would say that there is a lack of understanding by the capital markets about the existence of a fully funded system that will support public spending by paying pensions. It is something that should be taken into account but my impression is that we are not capitalising on that.”

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