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IPE special report May 2018

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Iceland: Glimmers of hope

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After seven years of capital and currency controls, restrictions on pension funds investing outside the country are beginning to be relaxed

Regulation in summary

• Icelandic pension funds have been given ISK10bn (€679m) to invest in foreign currency by the end of 2015.
• Allocation is to be split among pension funds based on size and net inflow.
• Central bank is to review ISK10bn figure in 2016 based on performance of overall Icelandic economy.
• Pension funds continue to support the local economy with investment in manufacturing.

After years of waiting, Icelandic pension funds enjoyed some reprieve in 2015 as the government and central bank began to relax capital controls placed on the krona seven years earlier. The decision to restrict the free flow of the island’s currency has had a negative impact on pension funds but, despite only being a tiny glimmer, investors can see signs of hope.

Industry observers, however, should not expect any radical change in asset allocation or for a wall of money to flow to external assets. The relaxing of the rules, which was always expected to be slow, is exactly that. Íslandsbanki, the central bank, said it would allow pension funds to allocate ISK10bn (€679m) in the first year, divided among schemes based on their size.

Until the end of 2015 pension funds and providers of personal pensions are exempt from the Foreign Exchange Act banning investments in financial instruments denominated in a foreign currency. The central bank said the division of the ISK10bn will be decided based 70% on the size of the fund and 30% on the fund’s net inflows. At the end of 2015 the central bank will assess the strength of the economy before allowing further extensions.

The central bank’s slow start barely covers the net inflow of assets into the Icelandic pension fund industry. It does not allow any absolute increase in exposure to foreign currency assets, it merely maintains the current proportion. The proposed amount is close to one-quarter of net inflows into the pension funds, making it just enough to keep the share of foreign assets at the current level of around 22%. The annual review of the country’s economic performance makes for a potentially slow process. 

Icelandic retirement assets (€ ’000s)*

Defending its decision, the central bank said allowing some investment would benefit the Icelandic economy by allowing pension funds to spread their risk. It would also allow funds to begin building up foreign exposure once controls were fully lifted – reducing the risk of instability.

The controls were originally brought in to stop foreign owners of Icelandic assets from triggering a run on the króna by pulling out of the collapsing economy. But they also forced Iceland-based investors to support the local economy with investments that were not always to their liking.

Now pension funds can start to consider how to diversify their assets. According to the Icelandic Pension Fund Association, about one-fifth of the assets are held outside the country – the ideal allocation would be closer to 50%.

Iceland Country facts

If the system laid out by the central bank is successful, the quota for pension funds should increase. Relaxation of the rules is testament to the current strength of the economy, and with the tourism and fishing industries growing, this could fuel further positive sentiment.

What remains to be seen is the reaction of other stakeholders. The failed Icelandic banks have international creditors waiting to reclaim their assets. 

Measures are now being implemented to ensure a gradual flow of the króna back to these investors, with tax penalties for those moving too quickly.

In the meantime, Icelandic pension funds continue to support the economy. Last year’s returns were lifted by significant exposure to the growing Icelandic stock market and by private equity returns. This year funds have continued their support, along with support for the recovering economy.

For example, in June it was announced that Icelandic pension funds are to partially finance a $300m (€266m) silicon metal plant in the country’s north, in partnership with Germany’s development bank, KfW.

The domestic pension sector was previously expected to contribute more than one-quarter of the $300m in financing. A statement from Íslandsbanki has confirmed that the funds will now contribute $80m through Bakkastakkur, a joint venture between more than 10 funds and the bank.

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