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Iceland: Full reform on the cards

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Iceland is set for a broad revision of its 20-year-old pension laws

Key points

  • The main pension fund act of 1997 is to be thoroughly revised
  • Issues include competition, homogeneity of investment cohorts and management relationship
  • The FSA is focused on accounting for corporate bond investments
  • Pension funds are implementing their own ESG policies following a 2017 regulatory change

Iceland’s pensions sector is gearing up for a comprehensive update to the two-decade-old body of law governing pension funds. 

The country’s pension funds have weathered a period that has brought much change, both in their economic environment and to their asset bases since Act No. 129/1997 on the mandatory insurance of pension rights and activities of pension funds came into effect in July 1998. 

Preliminary discussions took place before the summer and the Ministry of Finance and Economic Affairs, which is getting ready to revise the framework, said work on the new law will be comprehensive and take time to complete.

The revision aims to investigate several issues relating to pension funds. Finance and economy minister Bjarni Benediktsson has highlighted questions such as the homogeneity of investment groups, management relationships and competition problems.

Other questions Benediktsson has mentioned include potential problems associated with the large proportion of Icelandic pension fund assets held in listed equities and bonds, which has an effect on bond liquidity as well as share prices.

The growth of pensions assets in Iceland has been so strong that pension savings amounted to ISK4.43trn (€31bn), or almost 160% of the country’s estimated gross domestic product (GDP), at the end of 2018, according to Iceland’s Financial Supervisory Authority (FSA). Based on preliminary figures from the OECD, the authority says that only Denmark and the Netherlands have a higher ratio of 199% and 171%, respectively, at the end of 2018. 

Foreign investment accelerates in 2018

Icelandic pension funds made significant headway last year in reaching their targets for foreign investment. Having spent almost a decade under post-crisis capital controls, when they were unable to add to allocations of non-Icelandic investments, the funds are now in a catch-up process.

The foreign assets of pension funds and custodians of private pension savings amounted to over ISK1.2trn (€8.7bn) at the end of 2018, the Icelandic Financial Supervisory Authority (FSA) reported in June, with foreign assets of pension funds having increased by 15%, or ISK160bn since 2017. New investment in foreign currencies amounted to ISK128bn, the agency said.

“An increase in foreign investment is in line with the investment policies of pension funds,” it added. 

At the end of 2018, pension funds’ foreign assets amounted to 28% of their total assets, although the funds had a weighted foreign assets target for 2019 of 31% of total assets, according to the FSA.

However, it noted that there were large fluctuations in foreign financial markets in 2018. “Following increases in the first half of 2018, markets declined at the end of the year and both world indices of bonds (-1.2%) and equities (-8.7%) yielded negative returns.”

But the weakening of the Icelandic krona during the year offset a weaker yield on foreign markets, the FSA added, saying the domestic currency had depreciated by 6.4% in 2018

The problems associated with the dominance of the funds within the domestic economy have been exacerbated over the past decade. This is partly because of the relative youth of the population compared with other developed countries. In addition, because capital controls introduced after the 2007 economic collapse meant that for many years pension funds were forced to invest new contributions into domestic rather than foreign investments. 

Concerns that the heavy ownership by pension funds of Icelandic companies could harm competition between the businesses – since within some sectors, pension funds hold large stakes in competing companies – continue to be aired and could influence the formation of the new pensions legislation.

The interaction between social security and pension funds is also forming part of the debate. A permanent solution is said to be needed to resolve the interplay between the two systems regarding disability pension payments.

iceland

In 2018 and 2019, Icelandic pension funds have been working on implementing the changes to the investment regulation of July 2017. Broadly, the changes involve requirements of the pension funds’ investment policy statements as well as their investment limits. They also include a change of emphasis towards fiduciary duty and the prudent-person rule and away from simple prescriptive limits.

There was also a demand that the funds devise ethical standards for their investments. This was followed by the publication of an explanatory statement from the regulator saying that it would be up to each pension fund to decide on further details.

In its report for the year ending 30 April 2019, the FSA said that during its pension fund monitoring it had given special consideration to the areas of pension insurance risk, market risk, operational risk, credit and consolidation risk, as well as the governance of the funds. 

“Concerns that the heavy ownership by pension funds of Icelandic companies could harm competition between the businesses and could influence the new pensions legislation continue to be aired”

At the end of June 2018, the funds produced their own risk assessments for the first time, which were reviewed by the regulator.

Projects undertaken by the authority during the year included examinations of asset management and company pension funds, and how the provision of mortgage-backed loans was handled. This included to fund members on the one hand and to legal entities on the other. 

Supervisory focus has also landed on corporate bonds, with some discussion about how pension funds account for them in different ways – at fair value in some cases and at book value in others.

Noting that this difference in classification might affect the funds’ returns, the FSA says it has started to examine best practice. The authority says it will decide on whether to change the rules when its conclusions are available.

Work was carried out by the FSA’s staff in the reporting period on the supervision of the work of actuaries and the demands made on parties seeking the authority’s approval for actuarial roles. It said in the report that efforts had also been made to identify where the Icelandic pension market and its supervision were in relation to the OECD Core Principles of Private Pension Regulation, and that this work was likely to be completed by mid-2019.

Overall the FSA said it had increased its level of analysis of the data submitted by pension funds, as well as on promoting information disclosure.

In February it began publishing quarterly information on the investment of pension funds and other custodians on its website.

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