Pensions In Central & Eastern Europe: The freeze continues
The Russian private pension system is set for a repeat of 2014, with 2015 contributions directed to the first pillar in order to ease the strained budget of the Pension Fund of Russia (PFR).
Under the mandatory second pillar – in place since 2002 – 6% of of salary from the 22% pension contribution, has been invested in either non-state pension funds (NSPFs), the fund run by state-owned Vnesheconombank (VEB), or at the PFR, but privately managed. The NSPFs manage around RUB1.1trn (€16.7bn) in assets for 22m members, while VEB manages RUB1.9trn.
In addition to the contribution moratorium, the NSPFs had their contributions frozen for the second half of 2013. These funds, currently lodged at VEB, were to be unblocked once funds converted from non-profit to joint-stock-company status, gained accreditation from Bank of Russia, the central bank and industry regulator, and signed up to a guarantee scheme.
According to Vladimir Potapov, CEO of VTB Capital Investment Management, the frozen 2013 contributions amount to RUB500bn, the 2014 contributions RUB240bn and those for 2015 RUB300bn. The finance ministry has drafted a law to transfer approximately RUB500bn of pension savings from accounts managed by VEB to non-state pension funds. This will start in 2015.
Meanwhile, last November, the State Duma passed a law on the 2015-17 state pension fund budget envisaging the transfer of RUB526bn in pensions savings to NSPFs in 2015 (comprising 2013 contributions and VEB transfers), a further RUB358bn in 2016, and RUB395bn in 2017.
At a Glance
• The moratorium on 2014 second pillar contributions to non-state pension funds is to be extended to 2015.
• The funds await the return of 2013’s frozen contributions.
• Market turmoil looks set to hit returns.
• The second pillar system could become voluntary.
The release of the 2013 funds should influence Russian capital markets. “They amount to approximately 10% of the local government bond market and 11% of the local corporate bond market,” explains Potapov. “There should be some positive impact on the corporate bond market. However, the total amount of liquidity in the system will not change as those funds have been previously invested in government bonds and bank deposits by VEB.”
The 2014 and 2015 contributions, however, have been sacrificed, despite their small proportion. “Russia’s consolidated budget revenues for 2014 are likely to be approximately RUB25trn or around 35% of GDP with a deficit in the range of 0-1% of GDP,” says Potapov. “Compulsory contributions account for around 0.5% of GDP and 1.4% of consolidated budget revenues, but they could be key for the budget deficit.”
The conversion and accreditation process is viewed as a positive development. “This will bring more transparency to the whole pension system,” explains Anton Rakhmanov, CEO at Sberbank Asset Management.
“In the past, a lot of pension funds were part of so-called financial industrial groups, with part of the assets belonging to those groups,” Rakhmanov continues. “It was very difficult to understand whether the mark-to-market and performance was correct. Those funds that complete the process [of joint-stock conversion, accreditation and membership of the guarantee scheme] will become extremely transparent, and it will be easy for future pensioners to choose which fund to join.”
According to a recent central bank statement, as of late November, 44 of the biggest NSPFs, accounting for 90% of assets, had their joint-stock status approved.
However, industry practitioners remain sceptical because of ever-changing policies. “There is some uncertainty over the clients signed in 2013 and whether the assets on their individual accounts will be transferred to the pension funds,” says Alexander Lorenz, member of the supervisory board of Raiffeisen Pension Fund, and chairman of the insurance and pensions committee at Russia’s Association of European Businesses. “We are hoping that we will receive the underlying assets in the first quarter of 2015.”
“It has been promised, but taking into consideration the pension system changes we’ve seen from the government, we would like to see proof – by action, not promises,” added Rakhmanov.
“The whole idea of joint-stock conversion and accreditation to the guarantee fund was to weed out those who were not following their fiduciary responsibilities and not managing funds in the interests of the individual accounts holders,” continues Lorenz. “From our perspective, it’s been a carrot and stick approach, but we’ve been cheated of the carrot. The government looked for the weakest link in cutting budgetary expenditure and has adopted the position that the public is indifferent to the second pillar, while the NSPFs are not capable of managing their assets properly, delivering poor returns compared with VEB.”
In addition to changing policies, pension funds have had to adapt to the turmoil on the Russian capital markets following the Ukrainian crisis, international sanctions, falling oil prices and a tumbling rouble. The central bank sees GDP growth falling from an anaemic 0.3% in 2014 to zero in 2015, and a meagre 0.1% in 2016.
“We’ve switched to being conservative,” adds Lorenz. “We went out of equities quite a long while ago, and are now focused on fixed income, bank deposits and mortgage bonds, which are also giving us an attractive return.”
“In 2014, we have seen an outflow out of Russian capital markets from international investors, first because of the macroeconomic deterioration due to the fall in oil prices, and second because the geopolitical situation,” says Rakhmanov. “This has had a multiplication effect – on the Russian rouble, which has fallen again the dollar and euro, and in the Russian eurobond market, with the increase in CDS spreads against US Treasuries.”
Liquidity across the capital markets has been affected, exacerbated by the block in inflows to the pension funds. “Liquidity has not dried up completely, but it has seriously deteriorated because of capital outflows,” says Rahkmanov. “It’s difficult to see it improving without any inflows from other portfolio investors.”
These factors have inevitably been detrimental to pension fund value, Rakhmanov adds, even if the funds pursued a conservative strategy and only invested in OFZs (Russian government bonds). Here, the longer end of the yield had shifted up to 10-11% by mid November 2014, from 6-7% at the start of the year. With 2014 official annual inflation heading for nine percent, Rakhmanov believes it would be difficult for funds to generate real returns.
Poor returns could prove dangerous to the second pillar and there have been rumours that the second pillar system may be made voluntary.
In August 2014, the labour and social protection minister Maxim Topilin – one of the leading government officials spearheading the 2015 contribution freeze – described the system as inefficient and ineffective. Other bodies, such as the finance ministry and central bank, see pension funds as integral to the development of the capital markets, even more so with the evident capital flight.
Lorenz says: “[Making the second pillar voluntary] is a very short-sighted approach, because it was introduced to alleviate demographic pressures, which are only getting worse. But, given the partial reversals of other second pillar reforms in central and eastern Europe, the Russian government can rightly point out that other countries have done this.”