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Italy: Freedom beckons

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A much-needed liberalisation of pension fund investments in Italy is forthcoming, according to pension regulator COVIP and finance ministry-owned pension think-tank MEFOP. COVIP and MEFOP have both announced that the revised version of ministerial decree 703, which sets the rules on what assets Italian pension funds can hold in their portfolios, is finally going to take effect. However, there are no clear signs that the government intends to enact new rules that Italian pension funds have anticipated for almost two decades. 

In this year’s COVIP annual report speech on 28 May this year, chairman Rino Tarelli said the new regulation was ‘imminent’. His words echoed an earlier statement from MEFOP, which said the adoption of the new 703 law was “only a matter of time”.

The announcements came after the Council of State approved the revised version of the law earlier this year. The new text was finalised after a public consultation that ended in June 2012, and subsequently submitted to the Council of State for approval. 

However, government representatives have not spoken officially about the matter. At the yearly pension event Giornata Nazionale della Previdenza, which takes place in Milan in May, deputy-minister Pier Paolo Baretta did not give any clear information on when the change would take place or what is stopping it going through. 

 The current version of the law, which was approved in 1996 after the reform of the second-pillar system, imposes strict limits on the assets Italian pension funds can acquire. These include a cap on investments in emerging markets and a ban on derivatives and alternative asset classes. Experts believe that such stringent limits are linked to the slow development of the pension sector. 

The industry has waited for almost two decades for a new set of rules. Lawmakers have tried several times to change law 703 since 2004, when a first set of changes submitted to the Council of State was approved. Liberalisation was overshadowed by the 2005 reform, which changed rules on employers’ contributions to the second-pillar system. 

Because of Italy’s frequently short-lived governments, implementing the changes has never been a top priority. Most attempts over the past 10 years have been curtailed by frequent cabinet reshuffles or resignations. 

The go-ahead by the Council of State means that many of the current restrictions on pension fund investment can be lifted. MEFOP says the text of the new law means pension funds are no longer required to use benchmarks as the foundation for their investment strategies, in contrast to current practice.

More importantly, according to MEFOP, quantitative restrictions will decrease in favour of a shift towards management models and risk control capabilities. In a document released earlier this year, the think tank said: “The central idea is that, beyond quantitative restrictions, generally any kind of investment is admitted as long as the fund is able to manage, when investing directly, or monitor, when investing through a mandate, the development of the investment.” 

MEFOP said that COVIP will monitor the process through an ‘investment policy document’, which every fund is required to file. COVIP made this prescription in 2012 along with the requirement that funds develop suitable internal structures designated to manage and monitor portfolios. 

The new laws liberalise investment in mutual funds and introduce instruments such as bank deposits and derivatives. According to the new rules, these instruments can be used for hedging purposes as long as contracts are entered into through a central counterparty. 

Short selling remains prohibited, and certain quantitative limits are retained. In particular, funds will be required to allocate a minimum of 70% of assets to listed instruments, which includes open collective investment schemes regulated under EU directives. Investment in closed funds and alternative funds will be limited to 20% of the portfolio and 25% of fund assets.  

Other limits are as follows – up to 5% of the portfolio will be investable with a single institution or 10% through institutions of the same group. In the currency markets, non-euro exposure will be restricted to 30% from two thirds of the portfolio.

At a glance

• A new law 703, which restricts Italian pension fund investments, is imminent.
• Investment strategy will be based on governance and risk management rather than benchmarks.
• Quantitative restrictions will be curtailed but at least 70% of assets must be in listed instruments and closed-end funds are restricted.
• Non-euro exposure is limited to 30% of the portfolio.

One of the most significant changes is that Italian pension funds will finally be given the right to invest in emerging markets, which was almost entirely precluded previously. In particular, funds will be able to access markets outside the EU provided that they are ‘comparable’ to the home market.

Many welcome the new law as they hope that it will bring significant progress. Andrea Canavesio, partner at Mangusta Risk says the new law represents an improvement because it moves from a restrictive model to a principle-based one. “In the new regime funds will be allowed to do many things, so long as they demonstrate that their governance structures are suitable,” he says. “This is a huge milestone.” 

However, Canavesio points out that the current rules do not prevent funds from diversifying entirely. The 703 law, he says, had to be interpreted in a restrictive sense in order to comply with subsequent rules in law 252 of 2005. He explains: “As it is, the 703 law admits many asset classes – the only true limit is on emerging markets. The legislation that posed the strictest limits was law no. 252 of 2005, which still applies today and which specifies that funds can only set up linear management models. Law 252 technically allows many things. However, the problem is that almost all pension funds’ statutes refer to an article of the law saying that pension fund assets can be invested through mandates with either asset managers or insurance companies. This leaves out all the other instruments, such as mutual funds, closed funds and other alternatives. This in turn means restricting investment in specialist asset classes, which is fundamental for any portfolio.”

Alessandra Pasquoni, head investment consultant at Towers Watson Italy, adds: “The main thrust of the new law is that it moves from a quantitative to a qualitative approach, opening allocation to new investments. However, it focuses its attention on instruments rather than asset classes. Under the new regulations pension funds will be allowed to invest in collective investment schemes, both regulated and not regulated, including closed-end funds. 

“Our clients have been preparing for this, and most of this work took place after the regulator published its guidelines on the need to increase governance, with which they have to comply. When the law takes effect, investors will also be able to enter illiquid markets, but the new rules also make more liquid strategies, such as smart beta, more easy to adopt.”

Others are not convinced that the new rules will bring about significant change in the market, unless funds show a real commitment to becoming better equipped for investment in alternative asset classes. “Many in the sector are very cautious about alternative investments, even if the new rules promise to open up to this asset class, says Filippo Battistini, head of institutional and fund buyers at Allianz Global Investors in Italy. 

“We would need to understand how these investments would be made. Buying into a fund that invests in alternative assets assumes liquidity. The market already offers alternative strategies through UCITS that have daily NAV, and they are as liquid as traditional investments. But it remains to be seen whether funds have the will to invest in internal capabilities that are able to evaluate these strategies correctly. This is where pension funds are more careful. They need to understand whether and how they can build capacity to evaluate, manage and monitor these types of investments. I do not see clear signs that the sector is willing to take up this challenge.”

If and when the new rules become a reality, the extent to which they will help pension funds become innovative investors remains to be seen. Because Italian funds did better than their European peers during the financial crisis, many believe that portfolio strategies should not be revised. But what clearly emerged from the figures released with COVIP’s annual report is that Italian pension funds are still biased heavily towards domestic sovereign bonds. 

The figures showed that, at the end of 2013, half of overall pension fund assets were invested in domestic fixed income. Corporate bonds took 11% and equities 16.1% of assets. Interestingly, only 1.7% and 0.8% overall was invested in domestic corporate bonds and domestic equities, respectively. Italian pension funds had 12.6% of their assets invested in mutual funds, 3.4% in real estate, 1.8% in alternative assets and 5% in cash.

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