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Pensions in Central & Eastern Europe: Unwanted child no longer

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Romania’s privatisation programme is providing domestic pension funds with more investment opportunities, finds Carlo Svaluto Moreolo

Last June, the RON1.95 (€440m) IPO of energy company Electrica was the largest ever offering on the Bucharest Stock Exchange. Through the deal, the Romanian government extended a privatisation track record that saw a number of IPOs successfully completed during 2013. 

The IPO of Electrica was part of the government’s asset sale programme, backed by the IMF and the EU, which is contributing to the exchange’s strong growth, as well as providing local institutional investors with regular opportunities. 

Energy minister Razvan Nicolescu was later reported as saying that more deals would follow, particularly the privatisation of power utilities Complexul Energetic Oltenia and Hidroelectrica. 

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Among the investors who have benefited from these deals are Romanian pension funds. Lucian Anghel, CEO of BCR Pensii and chairman of the Bucharest Stock Exchange, says: “Pension funds played an essential role in the success of recent IPOs and SPOs of state-owned companies on the exchange, acquiring between 15% and 30% of the shares sold in the deals.”

According to Anghel, the domestic pension funds hold over €700m of Romanian equity on the exchange and make up for more than 10% of total trading volumes. 

Marcus Svedberg, chief economist at East Capital, the Stockholm-based asset manager focused on Eastern Europe, believes that the participation of domestic pension funds in the Bucharest Stock Exchange brings benefits that feed back into the wider economy and support the country’s pension system overall. 

Svedberg says: “Everyone benefits from increasing local institutional capital, as it reduces the country’s reliance from ‘hot’ foreign money that has a tendency to leave. One of the easiest ways to increase the share of domestic capital is through stimulating the pension system. This also solves the other big issue, which is long-term pension savings and financing.”

The combined assets of the eight Romanian mandatory second-pillar funds have reached €4.2bn and have returned an average of 11.2% since their inception in 2008. Membership has topped 6m. 

The voluntary third-pillar system, launched in 2007, is made up of 10 funds with 335,000 members and €221m of assets under management. Although, the asset growth has been slower, the sector has returned 8.2% since inception.

This shows that Romania is developing one of the most successful pension systems in the region. There were worries in 2013 that political support would be withdrawn and that the system would a similar fate to Poland and Hungary, but this fear has been dispelled.  

The outcome of the recent presidential election, which was unexpectedly won by Klaus Iohannis of the Christian Liberal Alliance, does not appear to have a potentially damaging impact on the industry. 

Mihai Bobocea, board adviser at Asociatia pentru Pensiile Administrate Privat din Romania (APAPR), the country’s pension fund association, recalls a time when Romanian pension funds did not enjoy the support they currently do. 

He mentions the case of a government official, who described the fully funded pension fund system as an “unwanted child” of which no one wanted to claim paternity. “This ‘unwanted child’ has grown to such an extent that its existence cannot be ignored,” Bobocea says.

The system is set to grow both in terms of members and contributions. The measure to increase the contribution level by 0.5% each year until it reaches 6% in 2017 is still on track. 

But APAPR has set a number of priorities for the future development of the system. One key priority, says Bobocea, is to adopt legislation that establishes more appropriate rules for the payout phase.

“Currently, people leaving the system for whatever reason can only get their pension as a lump sum,” he says. “This should be a temporary measure until we develop a solid legislative framework for annuities.”

Another priority is to create an investment framework more conducive to diversification. At the moment, Romanian funds invest 95% of their assets domestically. 

Bobocea says funds are engaged in a diversification process, but admits that, so far, they have only partially invested away from home because of indirect limits to their investible universe.

Such “triggers”, as Bobocea calls them, derive from regulation. By law they are required to have a fixed portion of “safe” instruments in their portfolios, but at the same time they cannot use interest rate or FX swaps. 

This means they have to avoid currency risk, and naturally keep a large amount of Romanian government paper in their portfolios.

There is also a requirement to trade only on regulated markets. This, Bobocea adds, has kept the funds’ away from corporate credit, since the volume and liquidity of the OTC corporate bond market in Romania is too small.  

Regulations that require funds to report and maintain a low risk profile have also forced them to keep the level of equity exposure at 20%. Bobocea says these indirect limitations have become burdensome and force funds into sub-optimal solutions. He adds that APAPR has been lobbying with the government to have them changed.

As well as diversification, pension funds are looking at operational efficiency, and some believe regulatory costs could be reviewed. 

Raluca Tintoiu, chief executive of the ING Pension Fund, a second-pillar fund, believes that the balance between regulatory requirements and the cost of meeting them could be improved.  “We feel that among the many mandatory checks, there are some that are very relevant and others that could be relaxed,” she says. “Some of the weight of regulatory fees on our business could also be lifted.”

Experts also point out that the third-pillar system could be significantly improved. “The size and impact of the voluntary system should be increased. It is still sub-scale, and the demographics of the country are still worrying,” Tintoiu adds. “We should not rely on the first and second pillar only. We should increase the attractiveness of the product – it is a commercial product and we need to be mindful of that.”

Bobocea explains that bureaucracy and the lack of tax incentives make it difficult for companies to set up third-pillar corporate pension schemes. He believes the system is over regulated and unfriendly, and that it makes little economic sense for employers to set up these funds. “It is hard to convince employers to stay in the system,” he comments. 

The implication is that this environment, unless improved, threatens the existence of the third-pillar system.

These facts suggest that for Romanian pension funds, it will be key to maintain a positive dialogue with lawmakers in order to skew the regulatory environment in their favour.

It may be easier to do so in Romania than in other countries, where sluggish economic growth pushes the pension emergency down the list of priorities, in a counterintuitive way.

Today, Romania has all the positives that other countries in Europe are looking for – GDP growth, inflation, budget deficit close to zero, and a low public debt to GDP ratio.

Anghel says this is the result of proactive economic policy during the crisis. “The government took very tough austerity measures during the crisis, including cuts to public salaries and higher taxation, which supported economic imbalances.” 

The icing on the cake is that the country will be promoted from frontier to emerging market status, which opens the possibility for hundreds of institutional investors from around the world entering its financial markets. 

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