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Special Report

ESG: The metrics jigsaw


Sweden: Business as usual?

Rachel Fixsen looks at how the Swedish buffer funds have reacted to the flawed and ultimately shelved attempts to reform and consolidate them 

At a glance

• The reform process of Sweden’s AP funds, launched in June 2011, collapsed in December 2015.
• Funds continued to work hard during the intense public debate around the reform.
• Co-operation continues between the buffer funds both formally and informally on some aspects of their work.
• Reforming the system could resurface in the future.

Four-and-a-half years of uncertainty concluded for Sweden’s AP state pension buffer funds last December when the political will to reform the system collapsed.

The government withdrew its proposed reforms, which could have seen two of the five funds closed, after it failed to agree with opposition parties on the future of the changes. The funds affected — AP1, AP2, AP3, AP4 and AP6 — together manage assets totalling SEK1.2trn (€130bn).

Although the reform has been dropped the public, professional and political discussion around it contained many ideas that were supported by various parties.

So have the AP funds reverted to business as usual now, or have they learned lessons from the whole debate?

Far from being distracted by the reform process, it was notable that the AP funds kept working, according to François Xavier Douin, head of institutional business in the Nordic countries for JP Morgan Asset Management. “They continued to hire people, sometimes at a very senior levels, and they were consistently saying, sorry, but we can’t wait for this reform,” he says.

The reform process provided an incentive to prove their effectiveness so as to ensure their future survival. “Generally, what the funds have done is not really explained by the reform process itself, but by the drive to continuously improve the way they invest centred around issues such as active versus passive, greater or lesser allocations to private equity and credit and so on,” Douin says.

The AP funds themselves confirm they kept working assiduously during the process, and are scathing towards aspects of the proposal. According to a joint statement from the four biggest funds AP1 to AP4, it was: “compromise based on a previous compromise and had weaknesses in numerous key areas.”

It lacked cost and consequence analyses of the proposed new governance and organisational structure for the AP funds, they say. If implemented, they say the proposal would have transferred power from the independent AP fund boards, currently governed by the Swedish parliament, to the government and a ‘superboard’. 

“The proposal would have increased the risk of short-term political micromanagement over the AP funds’ capital — approximately SEK1.2trn — which today is prohibited by law,” the funds said.

“For the AP Funds, the decision [to shelve the plans] means that the organisations again can focus wholeheartedly on our mission, how to best serve the Swedish pensioners and the long-term stability of the Swedish pension system. 

“Of course, uncertainty over a prolonged period is negative for any organisation, even though the AP funds during this difficult period have still been delivering good performance and results to the pension system and also have been working diligently integrating and promoting ESG in investments,” the funds said.

Have lessons been learned? Yes, they say — that a large amount of capital, such as that managed by the AP funds, attracts the desire of many people to influence how it is invested. But they do see merit in some of the proposals, or the ideas behind them.

“Using a prudent person principle in its conventional form and definition would probably work well for the AP funds and would be an interesting alternative to the current quantitative investment restrictions of the AP funds,” the funds continued  . As it stood, however, they say, the proposal is unconventional in definition and implementation. 

Among the reforms was the suggestion that AP6 merge with AP2, creating a pool of unlisted assets within the buffer system.

AP6 operates differently from the first four funds, with its SEK23.6bn portfolio consisting completely of unlisted assets. AP funds 1-4 argue that the excellence centre idea would have been a costly experiment with pensioners’ capital: “It would have increased the risk for increased costs and negative risk/return effects on the AP funds’ investments”.

The funds point out that they already co-operate today, both formally and informally. Examples of this are the funds’ Ethical Council — where the funds work together on promoting and supporting changes in the ESG work of listed companies.

The AP funds have also worked together over real assets, with the first four AP funds jointly owning real-estate company Vasakronan. AP2 and AP6 jointly owned the property company Norrporten, until its 2016 sale.

One insider says that if the funds want to avoid further political pressure to reform the system, they would be wise to resolve the issues that were driving the process. These include increasing efficiency and cutting costs.

But leaders at the buffer funds are likely to have their own priorities, he says. If these involve believing that diversification into other asset classes is more important than trimming costs, this is what they will do.

It is also arguable, though, that the AP funds will be wary of increased co-operation over assets. Although this could create economies of scale, it could negate the value of maintaining inter-fund competition within the system.

Some say it is hard to argue against the extra costs involved in having separate organisations effectively performing the same task.

Nicklas Fahlström, an investment consultant at Wassum, says if he were asked for advice on how to structure a €100bn state pension fund, he would say there should be one entity — a board — making decisions on investment strategy and guidelines, and a single national pension fund responsible for making short and medium-term investment decisions within those guidelines.

“If I told the state to set up four pension funds — copying the Swedish structure — making all investment decisions independently from top to bottom I am confident they would kick me out of the room on the suspicion that I had vested interests,” he says. “It’s a structure that reeks of over-diversification and multiplication of costs,” he says.

In practice, he says, it would be impossible to argue for such a structure as it carries few benefits from a non-political perspective.

Fahlström says it is a shame the reform was shelved, particularly because the funds would have benefited from more flexible investment guidelines. “Any administrative co-operation and cost cutting they can think of is of course beneficial and there is already room for that in the current legislation,” he says.

For those working at the AP funds, he acknowledges that the review phase must have been difficult, but adds that he is sure the funds work hard and do their best even in uncertain times. “This is also why we think competition between the AP funds doesn’t brings benefits – they would work hard and do their very best even if there were no competition from other AP funds,” he says.

Although many must be glad that the reform process is over, Fahlström points out that the relief might be temporary. “In the end, the reform of the AP funds is a political matter so it can certainly surface again,” he says.

Swedish funds prefer tailor-made stability

A group of big Swedish pension providers has called on the government to create rules to ensure the financial stability of occupational pension funds that are tailored to the sector rather than imposing Solvency II-type capital requirements.

The pension funds — Alecta, AMF, Folksam and its public sector pensions subsidiary KPA — wrote a joint letter in April to the Swedish Ministry of Finance. It put forward reasons why the government should consider a new regulatory framework in place based on the traffic-light system currently operating.

The providers argued that a system along these lines should be used to judge providers’ financial stability from 2019, not the insurance regulation of Solvency II.

If their suggestion is followed, and the future framework does follow the lines of the traffic-light system, this would let pension providers keep the mark-to-market balance sheets they now have.

The traffic-light system involves stress tests for credit, equity, interest-rate, real estate and currency risks.

Folksam has said the letter was meant to show that the sector is prepared to accept risk-based capital requirements.

The traffic-light system is a value-at-risk measure on the balance sheet, Folksam says. It is similar to Solvency II but has the advantages of being tailored to conditions in Sweden.

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