Russian evolution

The new Russian pension system,
based on the Swedish funded system,
was launched on 1 January
2002 when the new pension legislation
was enacted. Originally, males born
before 1952 and females born before
1956, did not get the right to participate
in the funded pension pillar. For
everyone else, employers began to
transfer 2% of pay to the funded pension
pillar at the state pension fund of
Russia (PFR).
In 2002 more than 33bn rubles
(€1bn) was contributed. ‘Vnesheconombank’
1 was designated to serve
as the State Asset Manager (SAM) for
the PFR’s reserves. These reserves
were temporarily invested in Russian
government securities denominated
in rubles and hard currencies.
In 2003 the funded pillar was
strengthened with new operational
mechanisms. For the first time ever the
PFR assigned personal data to the individual
pension accounts of citizens in its
record keeping system.2 Each eligible
citizen received his first ‘letter of happiness’
– an envelope containing the
information about the size of his personal
pension account. In order to cope
with this size mailing, the PFR purchased
a powerful printing facility and
negotiated special arrangements with
the Russian postal service, and despite
some technical problems the progress
of reform was not interrupted.
The same year private asset managers
joined the system. In the summer of
2003 the first competition among private
asset managers took place, and 55
companies were selected to manage the
funded pillar’s pension reserves. In the
fourth quarter, the government conducted
the first ‘pension elections’ during
which eligible Russian citizens
could file a petition to transfer their
pension savings from the SAM to one of
the 55 private asset managers. The savings
of people who did not make a
choice (the so-called ‘silent’ citizens)
automatically remained under the
SAM’s management. Private asset
managers embarked on their own
advertising campaigns, while the government
provided little or no help in
promoting the reform and explaining
its meaning to the population. As a
result only 2% of eligible citizens
(slightly more than 700,000) transferred
to the private system. By the end
of 2003 the PFR’s funded portfolio
already had more than 100bn rubles.
Investing this money yielded two positive
results almost immediately: a very
high investment return and a sizable
contribution to lowering the country’s
public foreign debt.3 The high return
was possible because much of the
money was invested in Russian
Eurobonds, which at that time traded at
an enormous discount. Very soon, however,
Russia’s economy improved dramatically
through positive trends on
international energy and commodity
markets, which in turn raised the price of
the Eurobonds. So, the ‘pure financial
result’4 on contributions of 2002-03
was approximately 40%. In other words,
the total invested amount increased by
1.4 times during this period.
Aperiod of disappointments and
pessimism came in 2004. The
beginning of the year is marked
by a massive government/administrative
reform and many of the ‘ideologists’
of the pension reform changed
At the same time the accelerating tax
reform lowered the unified social tax,
which provides funding for the PFR
(mainly for the pay-as-you-go part of
the system). As a result supporters of a
more conservative pensions reform
path prevailed. Decisions were made
to, firstly, exclude everyone born after
1967 from the funded pillar of the
pension system, and, secondly, to
cancel the originally planned increase
in contributions to 6% of the paycheck.
All this provoked a wave of criticism
and pessimism.
At the beginning of the second quarter
of 2004, the money of those people
who had chosen private asset managers
was transferred to these companies,
and the private investment had began.
The list of investment assets allowed
for private asset managers is broader
than that of the SAM – in addition to
government securities they can invest
in stock and corporate bonds. Unfortunately,
during the first nine months
the market performed poorly causing
bad investment results across the
board, on average below inflation.
The results ranged from 10% to -6%
depending on the portfolio and professionalism
of a particular asset manager.
Opponents of allowing private asset
managers access to the pension savings
became very vocal in the media. As a
consequence, 2004’s ‘pension elections’
failed. The number of eligible
citizens who for the first time selected
a private asset manager dwindled by
almost 50% compared to 2003 (only
375,000). The only positive development
in 2004 was that non-state/private
pension funds (NPFs) joined the
funded pillar. Now, eligible citizens
could chose among 55 private asset
managers and more than 80 funds.
By the end of 2004, the funded pillar
already had 200bn rubles; out of this
amount only 3bn rubles were managed
by private companies. At that time parent
companies (particularly banks) of
some private asset managers and NPFs
decided to put the pensions side of
their business on hold.
However, 2005 brought positive
news. The initiative in executing the
pension reform moved to the ministry
of finance and the Federal Service for
Financial Markets of Russia
(FSFM),5that are run by fairly progressive
teams of young pro-market
officials. Also, private asset managers
demonstrated a dramatic improvement
in their investment results (see
table 1).
The results of 2005’s ‘pension elections’
are markedly better: this time
about 750,000 new petitions were
filed. This is twice the number of the
previous year and higher than the number
of the first ever pension elections of
2003. Today, the total number of citizens
whose funded pension savings are
managed by the private sector companies
is about 1.5m.6
It is important to understand, however,
that most of these transfers
occurred because a number of large
employers strongly encouraged their
workers to make a choice. Naturally,
corporate and regional funds are leading
the pack in terms of the number of
attracted votes. Among private asset
managers the best election results
belong to companies that are owned by
large investment groups and banks.
At the start of 2006, Russia’s
funded pillar included 55 private
asset managers and 99 NPFs. In
order to join the system they have to
meet a number of official criteria. Private
asset managers also have to go competition.
The current 55 companies were
selected in 2003 and received the
right to sign five-year agreements
with the PFR. In 2004 and 2005 there
were no new asset managers willing to
join the system, and therefore the
competitions did not take place. And
NPF’s joining procedure is easier. If a
fund meets the required criteria, all it
has to do is to file a request with the
FSFM. In this category there are many
willing entrants and their number is
constantly growing.
There is one principal difference in
the way pension savings are accounted
for during transfer to private asset managers
and to NPFs. When a citizen
chooses a private asset manager, his
savings are transferred there anonymously,
ie, the company receives a
lump sum transfer from the PFR not
knowing whose savings constitute this
lump sum. In contrast, when a citizen
chooses a non-state pension fund, he
does not only have to file a petition, but
also sign an agreement with a particular
fund regarding the transfer and
management of his pension savings.
Any eligible citizen can make a new
choice (or change their previous
choice) once a year during a threemonth
Below is a summary of the 2005 pension
elections results: 730,000 new
petitions were filed, of which 600,000
people chose to transfer their pension
savings to private pension funds
(NPFs) and 130,000 to private asset
managers. The highest number of
votes went to large corporate pension
funds: roughly 160,000 people chose
NPF Blagosostoyaniye (affiliated with
transportation giant JSC Russian Railways),
100,000 chose NPF Lukoil-
Garant (affiliated with oil company
Lukoil), 50,000 chose NPF Elektroenergetiki
(affiliated with RAO
UES of Russia). Among asset managers,
Rosbank’s subsidiary (affiliated
with Vladimir Potanin’s Interros holding)
is expected to have the best result
– about 40,000 votes.
As instructed by citizens’ petitions
the PFR transfers their savings to the
selected private asset managers or
NPFs, which then do the investment.
Notice that NPFs do not invest these
reserves directly, but through agreements
with private asset managers. In
other words, the savings attracted from
individual citizens by NPFs also end up
under the management of private asset
managers. Many asset managers
understood this situation and now prefer
to spend their advertising budgets
on targeting particular funds instead of
individual citizens. The market of
managing the funded pension pillar
reserves remains extremely attractive
due to its high growth potential.
Today the funded pillar incorporates
about 54.6m accounts of insured citizens7
(although 40-year-olds have
only three years worth of savings:
2002-2004). It has almost 300bn
rubles and is forecast to reach 1.8trn
rubles by 2012, with annual contributions
of about 400bn rubles – in seven
years the funded pillar is expected to
grow six-fold in terms of absolute
monetary value.
Now the funded pillar equals 1.7% of
the GDP. Even if the goal of doubling
the GDP within 10 years is achieved, by
2012 the funded pillar will constitute
7.5%. Will the government be able to
use such a powerful investment
resource effectively, ensure high
investment results and security without
distorting the financial markets?
This remains to be seen.
Do not forget that today private
asset managers and pension funds
have only about 6bn rubles of the
funded pillar reserves under their
management. The rest is in the hands
of the state asset management company,
Vnesheconombank, which
invests mainly in ruble-denominated
government securities. Now, however,
the federal budget has practically
no need for and is well balanced without
borrowed funds.
The forecast growth rate of the
funded pillar reserves is considerably
higher than the planned growth rate of
the Russian national debt, therefore the
market of government securities will
soon be too small to accommodate the
savings of all ‘silent’ citizens. Besides,
investment returns on government
securities have dropped dramatically.
Thus, if the list of assets allowed for the
investment of silent citizens’ savings is
not broadened today, investors will face
dire consequences tomorrow.
In order to liberalise this market the
Russian government is planning to
amend the law on investment of
pension reserves. It is proposed to
broaden the list of assets permitted for
the investment of pension reserves and
eliminate the monopoly of Vnesheconombank,
which is currently the
only asset management company
investing the money of silent citizens.
One promising investment asset is
mortgage-backed securities. However,
due to flawed legislation this type of
securities has not yet developed in Russia.
It is also proposed to invest pension
reserves in various infrastructure development
projects through bonds issued
by development banks. – in this respect
Russia is paying close attention to the
experience of Kazakhstan.
A discussion is under way about the
possibility of investing the silent
citizens’ pension savings into Russian
and foreign corporate bonds and
stocks. Legally, private asset managers
(unlike Vnesheconombank) are
already allowed to invest in foreign
assets, but the government has temporarily
limited their ability to do so in
practice. It is hard to promote the idea
of investing in foreign assets due to the
demagogy of certain politicians who
oppose “financing foreign economies
with Russian money”. But there is a
more balanced and constructive view
of this matter among state financial
Investing everything in the Russian
market alone is, of course, limited by
fears of an asset bubble and monopolisation
of the market by the pension
reserves. As a consequence, some
experts suggest allowing private asset
managers to manage the silent citizens’
savings.8 How to achieve it technically
speaking remains a question – most
likely special competitions will be conducted
to select managers for certain
mandates (amounts of money with
specified investment criteria). Some
argue that these mandates should
relate to various market segments (eg,
only stock, only bonds, etc.); others
insist that each mandate should be
diversified into several groups of assets.
Supposedly there will be no limit to
the number of asset managers that can
compete for the money of silent citizens.
At the same time, there will be
strict requirements regarding an asset
manager’s portfolio size and experience
of working in the market of pension
The government also wants to boost
the citizens’ interest toward pension
savings. A bill on voluntary funded pension
pillar has been drafted. Its authors
believe that it will be important for
those who are currently excluded from
the mandatory funded pillar. According
to this bill, citizens will be offered to
contribute 4% of their salary into this
voluntary system while the state will
provide a matching contribution.
Today, it is fair to conclude that the
Russian pension system is not stagnating,
and that its funded pillar is developing
and growing. In future issues of
IPE, we will discuss the development
of Russia’s private pension funds in
terms of voluntary savings, and also the
growth of the asset management
industry where investment portfolios
and professionalism are reaching new
Alexander Kupriyanov and Vadim
Loginov, FundsHub.Ru
1A large state-owned financial institution/bank.
2The breakdown of new pension contributions by
individual accounts for a particular calendar year
always takes place in the first quarter of the next
year after employers report all personalised data to
the PFR. For example, the contributions made during
2002 were broken down by individual accounts
only in the beginning of 2003.
3Through investing this money in government securities
a significant part of foreign public debt was
converted into domestic debt.
4A term created by the government to designate
return on investment of all contributions made in
2002 and 2003 as if they were made as a lump sum
and not as regular installments over time.
5Formerly known as the Federal Commission for
Securities Market.
6Adjusted for the number of petitions filed to switch
among private asset managers, among NPFs, or
between private asset managers and NPFs.
7The pension system is officially called ‘the system of
pension insurance’.
8The idea is that involving multiple asset managers
will (a) disperse investment decision-making among
many different players and (b) ensure investment of
pension savings into a broader group of assets
(including securities issued by 2nd and 3rd tier companies).

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