Portugal: Eyes on risk management
New regulations aim to strengthen awareness of risk, even though Portuguese pension funds have been less affected by the financial crisis than some, reports Nina Röhrbein
The current Portuguese pensions and investment law dates back to January 2006 and was driven by the implementation of the European IORP directive. At that time, the Portuguese authorities decided to revise the entire legal framework surrounding pension funds. A complete overhaul of the regulations of the Portuguese Insurance Institute (ISP), the pensions supervisor, began, with the aim of consolidating all the rules in one single regulation.
The last major regulatory change from an investment perspective took place in 2007 and involved a move to the prudent person-plus approach. This removed most of the limits that previously applied to pension fund investments. However, some limits still apply, hence it is called the prudent person-plus approach.
As of today, portfolio investment policy, asset allocation limits and portfolio valuation continue to be regulated by normative no 9/2007-R. The main quantitative investment restrictions are related to non-euro currencies (30%), non-regulated markets (15%) and non-harmonised UCITS (10%). There is also a 20% downside risk limit in the exposure to derivatives, which may only be used for hedging purposes or efficient portfolio management.
The 2006 decree intended for several issues to be further regulated in detail through the ISP. Among them was risk management, which was only recently regulated by the supervisor, says the Portuguese association of investment funds, pensions and asset management APFIPP.
The new normative no 8/2009-R was introduced in June. It had been prepared for some time and was not a response to the financial crisis, according to Frederico Jorge, consultant at Watson Wyatt in Lisbon. "It aims to guide fund managers on how to deal with the different underlying types of risks they face," he says. "It requires them to have the formal means to address the different risks but it does not dictate what each one needs to do."
"It is basically a reinforcement of pension fund management transparency and accountability requirements," adds Rui Guerra at Mercer Investment Consulting in Lisbon. "The new normative has set a number of general principles and rules in relation to pension fund managers' governance mechanisms, focusing on risk management and internal controls."
As a result of this legislation, all fund managers need to submit a proposal to the pension authorities by the end of September, detailing an action plan on how they will deal with these risks, which then has to be implemented by 31 December 2010 for it to take effect from January 2011.
Although 2008 was one of the worst years in terms of performance - the average loss of Portuguese pension funds was -7% - the impact of the financial crisis on pension fund investments has been less severe in Portugal than in other countries due to the relatively low exposure of pension funds to equities and corporate bonds.
As the Portuguese pension market is heavily dominated by the defined benefit (DB) pension schemes of the banking sector, funding shortfalls have been less of an issue. Portuguese law foresees that in the case of shortfalls, sponsors have to commit themselves to a plan in order to bring the funding level back to the minimum required and so sponsors were called upon to make extra contributions. No exemptions were permitted with regard to pension fund funding levels, according to APFIPP.
"The banks have not been affected by the crisis to the extent that they cannot cope with the pretty tight funding requirements," adds Jorge. "We have also had relatively high discount rates, which meant that liabilities have not increased as aggressively. This helped pension funds, meaning there was no need for action from the government or authorities. We have not heard of major problems by the other DB plans either, but then their funding is more flexible and can be amortised over a number of years. And while the defined contribution (DC) plans have been affected by losses, they tend to be immature plans with a relatively low average age of the active participants. In addition, the impact of pension funds in the full retirement replacement ratio is still relatively low, as most of the pension benefits will still come from social security in the next few years, so there is not as much pressure as if the situation was immediate."
But the minimum funding requirements and the assumptions for their calculation remain key issues at this moment and are likely to be something that the supervisor will reconsider in the short term, believes Guerra.
General elections are scheduled for September, which will influence the future of the pensions industry. "If we retain the socialist government it may decide to progress based on what it has done in terms of pensions over the last four years," says Jorge. "But if a social democrat government is elected it may want to introduce some changes to the current system. In other words, after a quiet first year in office changes would be likely."