Portugal: Back on the right track
After lawmakers stabilised the public pension system, Portuguese private pension funds are poised to grow their participation in the country’s economic system
Regulation in summary
• The economic situation in the country is improving: GDP is forecast to accelerate over the next two years and unemployment to fall.
• The coalition government is focusing on reining in the budget deficit.
• Tying the public pension system to sustainable factors such as GDP and life expectancy seems to have secured the long-term viability of the system.
Portugal continues on the path of economic recovery. The GDP growth rate is forecast to accelerate slightly in 2016 (1.5%) and 2017 (1.7%) amid falling unemployment, according to the European Commission. The country’s financial system seems to have overcome the loss of confidence caused by the collapse of Banco Espirito Santo in July 2014.
Furthermore, the Commission waived a fine for breaching the EU’s fiscal rules by surpassing the 3% budget-deficit-to-GDP ratio. The country has additional time to rein in the deficit, which the coalition government is focusing on.
In this improving climate, the coalition between a centre-left socialist party and far-left political forces that formed a government in November 2015 has held up. This defied all expectations, as a fracture within the coalition government had been widely anticipated. The overall situation is in stark contrast with the dark times of the IMF and EU-sponsored €78bn bailout of 2011.
The bailout came with demands for wide-ranging reforms, including an overhaul of the pension system. The previous government cut benefits and raised the retirement age. As a result, the prospect of a default of the public pension system is much less likely than in neighbouring Spain.
By tying up public pension benefits with ‘sustainability factors’ such as GDP and life expectancy at retirement, the country’s lawmakers seem to have secured the long-term viability of the pension system.
In recent years, Portuguese pensioners with benefits higher than a certain threshold have also paid an ‘extraordinary sustainability contribution’ (Contribuição Extraordinária de Solidariedade). This temporary measure provided an additional safety buffer to the system, but it will be discontinued from 2017.
The reform was praised by the EU, says Nuno Silva, a consultant at Mercer in Lisbon. While the system is clearly not sustainable over the long term due to structural factors such as an ageing population and low job creation, the discussions on its future are now a matter of academic debate.
In terms of adequacy, the system still scores relatively well. Soon-to-retire baby boomers will enjoy relatively high benefits thanks to a replacement rate of about 60%. For younger generations, however, that figure is likely to be closer to 30-40%, which calls for the development of other sources of retirement income.
However, Silva believes there is an awareness that future public pension benefits will be low, and this will translate into growing interest for private pension savings. Private pensions, however, cover a small fraction of the population. At the end of 2015, total membership of second-pillar schemes was just over 318,000, or 5.9% of the working population.
The legislative and regulatory infrastructure for pension schemes, according to Silva, is robust. He says the pension fund industry enjoys a more liberal regulatory environment compared with other southern European countries.
“Over the years,” he says, “Portuguese pension schemes have diversified, both geographically and in terms of asset classes. They have awarded mandates to both local and international managers. At the moment, schemes are increasingly shifting from multi-asset mandates awarded to individual managers to specific managers for each asset class. This is to make sure the best managers are awarded for each asset class.”
A friendly environment for pensions means domestic and multinationals are setting up new pension schemes for Portuguese workers in large numbers. While companies have traditionally offered DB pension schemes, the number of DC schemes is growing significantly.
At the end of December 2015, Portuguese pension funds had total AUM of €18bn, or about 8.8% of GDP, according to the ASF (Autoridade de Supervisão de Seguros e Fundos de Pensões), the regulator. The figure is higher than the previous year, but the pace of growth is slowing.
There are 217 pension funds operating in the country, sponsored by different entities. The regulatory framework foresees that pension schemes, whether they are closed or open schemes, are managed by a Portuguese legal entity that acts as an administrator. There are 22 such entities, called Sociedade de Gestoras de Fundos de Pensões. This, says Silva, is perhaps the only limitation within the system. International asset managers can bid for mandates, but it must be a domestic company that administers Portuguese pension scheme assets.
According to the ASF, at the end of 2015, Portuguese pension funds allocated 28% of portfolios to sovereign fixed income, 17% to corporate bonds, 9% to equities, 14% to real estate, 11% to cash and the remaining 21% to other asset classes, including UCITS and non-UCITS funds.
Over the past year, the balance seems to have shifted away from equities toward traditional fixed income. At the same time, cash holdings have decreased, while the allocation to alternative assets has been stable.