“In the US, no one doubts public pension funds are a class apart. The distinction is rarely made in Europe. Is it time to change?”
The idea that governments should be run as a business is widely debunked. Yet, if governments are not businesses, does that have consequences for their pension funds? The question is important. If public pension funds are different, should they be covered by the same rules and regulations? Is there a potential conflict of interest if the sponsor is also the supervisor and the legislator? If public pension funds are different, wouldn’t there be a strong case for co-operation among public pension funds? What would such co-operation look like?
A conference, organised this summer by APG, the Dutch public pension fund, in co-operation with IPE and the European Association of Public Sector Pension Institutions (EAPSPI) brought a large number of representatives of public pension funds from a good number of European countries together in Amsterdam to discuss these issues. High-powered speakers, mainly from pension funds, academia and public bodies thought aloud about these questions, nudged along by an active, interested public.
Public pension funds are seen as not only the capitalised pension system for the central government, but also those for international organisations, demographic reserve funds, lower governments (such as regional bodies and cities) and some public companies. This definition alone brought to light that, while in some European countries there are very few public pension funds, there are many such funds in other countries, notably the UK, Sweden and Switzerland. However, the bottom line was that such differences in organisation did not amount to a difference in governance issues. Lower government pension funds had to deal with the same specific issues as central government pension funds.
While in principle public pension funds should be similar or the same as other pension funds, in practice, being sponsored by the government can make an enormous difference, depending on the attitude of the government towards its own pension funds. These attitudes range from considering pension purely as a cost item and capitalised pension funds as a financial reserve of the sponsor to completely independent pension funds that help governments compete in the labour market, but that are nevertheless under pressure regularly to help achieve government goals in spite of fiduciary duties towards beneficiaries. No public pension fund is free of such pressure, but withstanding the pressure is sometimes more or less difficult.
Public pension funds in the EU must use government procurement rules. However, these are written with a view to compare price for a minimum quality. This makes no sense for outsourcing asset management. By retaining the offer with the highest returns at a given risk level, the winning offer will simply have the boldest assumptions and estimates, but that is no basis for actual higher returns. If a required return is specified, bids will include a risk premium, a high and avoidable cost if the pension fund can bear the risk of volatility of returns itself.
Public pension funds are wary of being compared to commercial insurance companies. They think that the flexibility of the pension deal towards beneficiaries and their social task make them incomparable and should lead to differentiated regulation, especially in the case of Solvency II. Although private pension funds support the same reasoning, the objections to Solvency II are especially stark for public pension funds. What is the use of financial solvency calculations when your sponsor cannot go broke? What does it matter if you are solvent if your sponsor can legally force you to hand over part or all of your assets? Public pension funds rather feel a need for a meaningful code of conduct for public sponsors that balances government needs with beneficiaries’ rights, than solvency requirements.
By the same token, national supervision of solvency is of limited value if the attitude and position of the sponsoring government is not taken into account. Where public pension funds are governed by social partners, trade union representatives should be a credible counterweight to the employer. However, sometimes such trade unions are non-existent or weak, while in other countries their strength is weaning. Governments should realise the importance of equitable and just governance. Where trade unions cannot fulfil their role as a counterweight to government interests, beneficiaries should be empowered to do so.
The greatest danger for a public pension fund is to be used as a reserve fund for the government budget. Replacing assets invested in financial markets by credit to the government or notional financing on the basis of a promise is just bad investment policy. Counterparty risk will rise sharply if a public pension fund is forced to finance its sponsor and it will be concentrated on the goodwill of future generations of politicians. Meanwhile, those same governments will insist that private funds take only a very limited interest in the sponsoring company. This is not a theoretical issue. Governments are regularly accused of raiding or plundering their own pension funds. Sometimes, there is no legal recourse, but even if there is, it is hard to stop a government, as recent experience in Estonia shows.
Another weighty issue is that a government that sees its private pension system impoverish will start wondering if it should not follow the private trend. This is one of the thoughts behind reform efforts in the UK. Sometimes, reforms are inevitable, due to a change in external data, such as life expectancy. However, reforms may also become a hidden way to transfer pension assets into capital for the budget. A fair division of burdens should be a prerequisite for all necessary reforms.
Surprisingly, thoughts about whether public pension funds should be active in the field of environmental, social and governance driven investments (ESG) varied. Yet, most governments are quite close in their opinion that ESG is an important consideration for pension funds. Further research in this field is certainly warranted. Is ESG a hobby government sponsors push on their pension funds, or are there solid business reasons for ESG and should it be explained better?
The participants in the APG conference found that the best solution to their specific problems was to create as much independence from their sponsor as possible within their legal framework. Co-operation among public pension funds could create a new, strong stakeholder who would find its fiduciary duties paramount.
A specific way to organise this is fiduciary management. Fiduciary management would also create advantages of scale that would lower cost. Public pension funds could use fiduciary management to buy sophistication from other public pension funds, creating a network where there specific problems are understood and acted upon.
Evidently, the discussions have not finished. Governments in general and especially the EU must be convinced of the necessity to see public pension funds in a different light before more thought can be given to measures specific to public pension funds. The conference felt that there was a need to continue the discussion, involve governments more and investigate ways of co-operation. It is too early to predict how the thought process will continue. However, it is clear that a continuation of the discussions is called for.