Iceland: Dominant force
Measures have been proposed to reduce the risk posed by the prominent role of pension funds in Iceland’s economy
• New risk management provisions, asset categories and quantitative limits were brought in for pension funds with the October 2016 Act, along with prudent-person principle
• Pension funds can now hold 20% of a company’s share capital – up from 15%
• Transitional period to implement changes ends at the end of 2020
• Set of recommendations published aimed at lowering perceived risks of pension fund dominance in Iceland as corporate owners
• Recommendations include pension funds raising target allocations to foreign assets in the long term and a duty being introduced to report on their communication with investee firms
As Iceland’s pension funds absorb changes in investment regulation that were brought in a year ago, the debate around their dominance of the island’s economy is paving the way for possible new rules on how funds operate as corporate owners.
Two batches of new investment regulation, which took effect at the beginning of July 2017, tweaked asset allocation rules and added new requirements for environmental, social and governance (ESG) investment reporting. The October 2016 Act – number 113/2016, entitled: Amending the Act on Mandatory Pension Savings and on the Activities of Pension Funds No 129/1997 – brought in new risk-management provisions for pension fund investment and changed asset category classifications as well as quantitative limits. The 2016 Act also stipulated that pension fund investment should be based on the prudent-person principle.
Before the new rules came into force, Icelandic pension funds were allowed to invest their assets into 11 different categories with individual limits, and had to adhere to ceilings on exposure to single equities as well as foreign currency and counterparty risk. The legislative change left the asset categories broadly unchanged for pension funds, but directed restrictions instead to groups of assets involving similar risks.
The new rules have decreased the proportion of an individual investment fund a pension fund is permitted to hold to 20% from 25%, although for UCITs funds the limit remains set at 25%.
However, pension funds can now own 20% of an individual company’s share capital – a threshold that has risen from 15% under the previous regime – and the underlying assets of UCITs and investment funds will no longer be included in these limits.
While the new regulations on investment are now in place, there is a transitional period for pension funds to make the changes to their operations, which ends in December 2020.
Pension funds are also now required to cover environmental, social and governance matters in their annual investment strategy.
Early this year, a report was published on the subject of the economic and competitive risks associated with the size of Icelandic pension funds relative to economic output. The funds’ assets are now equivalent to about 150% of the country’s GDP.
The report was produced by an expert group chaired by the chief executive of Almenni Pension Fund, Gunnar Baldvinsson. It set out recommendations aimed at lowering the perceived risks of the funds’ dominance as corporate owners in Iceland.
Pension funds have increased their ownership of companies in Iceland over the last 10 years, not least because they stepped in as buyers when the country’s main banks collapsed during the devastating financial and economic crisis of 2008.
The foreign capital controls that were imposed to save the economy at that time are another factor which forced the pension funds into higher proportions of domestic investment than they might otherwise have chosen. While those controls were lifted in 2016, it is thought that it will take the funds several years to reallocate their assets to their desired level of international diversification.
Baldvinsson has said the group did not consider it necessary to propose any changes to Iceland’s Companies Act to alleviate the ownership concentration problem. Instead, the group considered that rules should be established requiring pension funds to put formal strategies in place about their ownership policies.
In its report, the group also recommended that pension funds raise their target allocations to foreign assets in their long-term investment policies to increase diversification. Furthermore, pension funds should be obliged to publish a report at least once a year giving information on their communication with firms they invest in, including their voting behaviour at shareholder meetings.
Baldvinsson’s group also called on the government to consult on permitting a portion of an individual’s pension contributions to be directed into housing savings. Icelandic pension funds announced in the summer of 2018 that they were implementing the third and last planned increase in the employee pension contribution.
The changes were agreed in January 2016 by the Federation of Icelandic Employers and the Confederation of Employers.
The employee contribution has previously risen by 0.5 percentage points in July 2016 and a further 1.5 points in July 2017. This final increase was 1.5 percentage points, bringing mandatory contributions to a total of 15.5%, divided into 4% from employees and an employer contribution of 11.5%.
History will be kind to Icelandic pension funds
As he left the job, Þorbjörn Guðmundsson, who retired earlier this year as chair of the Icelandic Pension Funds Association (IPFA) and board member of the pension fund Birta, bemoaned public negativity towards the pension fund sector in the wake of the country’s financial and economic collapse 10 years ago.
But in a farewell speech at the annual general meeting of Birta, Guðmundsson predicted the pensions sector would be seen more positively in years to come. Recollecting the time of the economic collapse itself, he says: “I don’t think we feared for the pension system as we did for the banks, but we knew straight away that the fund members’ rights would deteriorate.”
At Sameinadi, where Guðmundsson worked at the time – and which subsequently merged with Stafir to form Birta – he says the pension fund had been honest with members from the beginning, explaining the situation at fund meetings. “[Member] rights were reduced and we have not been able to return to members what was lost,” he said, adding that he was personally disappointed the fund had not been able to do so.
“Certainly, pension funds were the part of the nation’s financial system that survived when the rest of it collapsed, which is in a way interesting,” he says. “The public is still focusing on the consequences, that is the loss of rights, rather than the fact that the pension system survived.”
“In general the pension funds seem to be unfairly criticised,” says Guðmundsson. “In the long run words of scholars and history itself will probably be more positive,” he said.
“The position of pension funds in the collapse will be considered and the fact that they worked more or less properly and paid out indexed pensions,” Guðmundsson said at the AGM in Reykjavik.