Nordic Region: Good governance is essential
Pirkko Juntunen finds the chairman of the buffer fund inquiry, Mats Langensjö, pragmatic about his committee’s proposals
There was much focus on Sweden at the turn of the millennium and its bold steps to create a notional defined contribution system to cope with the demographic pressures common to most Western countries. Visitors came from around the world to investigate how they could copy Sweden’s system.
The larger part of the national pension contribution, 16% of the total 18.5%, still goes into the country’s buffer funds, the AP funds. But the reforms to bring the reserve funds into the new millennium were not so appealing. Industry professionals argue that it is unusual that four funds with the same mandates end up with very different targets for their asset management operations.
Most national reserve funds, such as those of Ireland or France, are or were a single entity, whereas Sweden uses a multi-fund structure, with five funds; four with the same mandate and AP6, which is separate and only invests in private equity. In addition, the reforms failed to take advantage of the fact that the funds do not have liability concerns, which would have lent itself to liberal investment guidelines, rather than the quantitative rules adopted.
The reasons for the less-than-optimal reforms are historic and the story goes back to the 1960s when there was a focus on corporate governance and asset management. The process was political in nature with an emphasis on protection from political influence. Decisions were made by the social and labour market partners with collective bargaining issues paramount.
More than a decade since the reform, capital markets and financial engineering have moved on. The management teams of the AP funds have been lobbying the government to overhaul the prescriptive, quantitative investment guidelines, which currently prohibit investments in commodities, for instance. In the government’s annual reviews of the buffer funds there has been increasing focus on cost cutting and performance, or the lack of it. On the back of all these factors the Swedish government, led by Fredrik Reinfeldt, instigated a review of the buffer funds focusing again on cost and efficiencies and how to better prepare the buffer funds for the future.
The government appointed Mats Langensjö – an industry veteran with prominent roles in investment consulting as well as asset management – in September 2011 to chair what has become known as the Buffer Fund Inquiry. Langensjö was advised by nine pension industry professionals.
The background of the AP funds still plays an important part in the decision process, so the directive given to Langensjö by the centre-right coalition government restricted the extent of any proposals.
One of the stipulations was that a minimum of three out of the current five funds must remain, so a single fund solution was never on the agenda, a fact which led the inquiry to propose an alternative. This caused a rift within the inquiry board. Seven of them wanted the alternative proposal to form the main proposal, which advocated a single fund solution, in order to fully benefit from the cost efficiencies created by economies of scale.
Langensjö was not surprised by criticism from his fellow inquiry board members, but argues that the proposal presented was the best option possible within the directive’s remit. Langensjö has never hidden that he also preferred the alternative proposal, if that would have been possible.
Langensjö, now CEO of Brummer Life, the pension and insurance arm of Brummer & Partners, the largest Nordic hedge fund manager, said that while the media focus has for some time been on the number of funds, an even more important issue is that of governance, where all inquiry board members were of the same opinion.
The inquiry’s recommendations for improving corporate governance include a clear division of responsibilities between the owner and the manager of assets, as well as replacing current quantitative investment rules with the prudent person principle.
In order to achieve this, a new authority with overarching responsibility for management and administration would be created. This authority, Pensionsreservstyrelsen, (the Pension Reserve Board, PRB), would be responsible for setting the investment objectives and targets together with Pensionsmyndigheten, the Swedish Pensions Agency, which is currently responsible for the on-going monitoring of the funds.
“Governance is something of a sore point when it comes to the buffer funds, because it is the foundation on which to build a robust environment for asset management and that should be the focus rather than any other broader societal issues,” Langensjö tells IPE.
He notes that currently the main point of a reserve fund is to achieve above-income index returns over the longer term. “Performance is more important than that and there should not be any ceilings on returns but there absolutely is a floor under which returns need to outperform over the longer run,” he says.
“These types of funds do not have liquidity or solvency requirements so they are able to act more freely than, say, pension funds to operate, and very much a scarce resource in this respect.”
The global financial crisis of 2008 has, however, brought the issue of performance and asset management to the fore and previous ‘absolute truths’ are being globally revaluated. But Sweden remains different when it comes to the AP funds, for historical and political reasons, says Langensjö.
Another issue close to Langensjö’s heart is ensuring that the buffer funds are better connected to the public pension system. “The financial crisis has made it clear that you need a model in place that can handle shocks to the system, with a focus on risk management,” he pointed out.
An improved governance model will also enable the funds to replace quantitative investment rules with the prudent person principle, which will improve flexibility for the asset management of the capital and thereby benefit the pension system. “By having flexible guidelines, asset management can be developed and adapted to ever-changing capital markets and thereby improve financial position of the pension system” he explained.
The prudent person principle would also abolish the need for specialised investment mandates within the system, which would mean that AP6, which only invests in private equity, would be integrated into the three new funds.
Langensjö noted that an over-reliance on the equity markets and a lack of diversification has incurred costs, in terms of a misplaced risk profile and loss of performance.
“By solving the issues of governance and investment restrictions, the issue of the number of funds will resolve itself,” he said.