Despite being one of the most favoured nations for EU assimilation the Czech Republic continues to be inward-looking when it comes to investment reform and pensions. It is indeed a measure of the failure of many other countries in central and eastern Europe to create capital markets that the Republic continues to receive enthusiastic reports from the Brussels assessors.
Just two months ago what many thought was a straight forward, and much needed pension reform hit the rocks. The minority Social Democrat government, which holds onto power thanks to its coalition with a right wing party, failed to push through part of its pension plan. At the moment the 15 voluntary pension funds operate as joint stock companies, showing their clients assets in their own books. The draft legislation aimed to create separate companies and introduce the concept of mutual funds. “Unsurprisingly, given the current economic climate, the bill failed to make it through parliament,” says Petr Zaluda, chief executive officer of Winterthur Penzijni Fond in Prague. “Even so most of us in the industry believe this would be a good thing and a big step forward.”
Jiri Kral at the Ministry of Labour and Social Affairs was also disappointed that the bill was rejected. “We had prepared a substantial amount of legislation, but were unable to progress it through a fractured parliament,” he said. “We were keen to create a new social insurance agency and create the climate for mutual funds to develop, but all the proposed reforms were turned down.”
Critics suggest that the government tried to push through too many items in an unwieldy bill, and point out that some of the reforms were unlikely to appeal to either the left or right wing opposition, or indeed the Social Democrats own coalition partner. Successive governments have seen the state pension first pillar as inviolable, and unlike other neighbouring countries have shied away from any kind of third pillar provision. Instead they have relied on open pension funds sponsored by the banks and private insurance policies. The current administration continues to ignore the potential of a third pillar, relying instead on voluntary funds rather than a privately managed mandatory sector.
The recent bill included some provision for occupational pensions and also was meant to deal with the mandatory aspect of the second pillar, but everything fell together. “The government did try to deal with the second pillar issue, attempting to make it easier for smaller companies to establish funds. The opposition, not unreasonably, pointed out that we have had provision for these funds since 1994 and tax incentives since 2000. They questioned whether any new legislation was necessary,” explains Zaluda. “One of the main concerns of the government is the stability of the economy, and the ability of small companies to efficiently administer schemes. There is a fear that it is simply not safe for workers to place their savings in such funds. In reality this is a political football, and it is hard to see any agreement being reached. The key to it may be the trades unions who have been actively promoting the idea of reform.”
This may explain why Kral and his ministry are eyeing a different social model from that followed by other eastern European states. “We are very keen to create something along the lines of the Swedish model,” he said. This would suggest the introduction of industry wide schemes, but again the question is whether consensus will be achieved.

Meanwhile, Zaluda believes the system is stalling. “We expected a growth in assets by now, but we have not really seen any great increase. At the same time the market situation makes it very difficult for us. Equity holdings remain around the 5% mark, although we are allowed up to 25%. The volatility and lack of liquidity of the Prague exchange also creates its own problems. Consequently we rely on the money markets and fixed income investments.” He believes that the election next autumn may mean a government less reliant on trying to please all political parties. “We remain on track to join the EU in 2004-5 and I anticipate some tinkering with the investment rules and the establishment of new-style pension funds.” Observers of the Czech political scene know, however, that we have been here before. Only six months ago it seemed the reforms would be passed and legislation be in place by the end of the year. Now it seems the government will have to begin again.
The story of asset growth in the country is a difficult one to gauge. Despite Zaluda’s disappointing assessment of the growth of pension assets, there are some brighter spots. “It is often difficult to assess the pension fund asset position, because of the limited access we have,” says Tomas Strnad of Citicorp Investment Company. “As we are not part of an organisation administering a pension fund, we can only gauge things by the amount of pension fund assets we actually manage. This is relatively small since most management is in-house. I would agree, however, that the funds have not been banging on our door asking us to select products for them, and so I suspect that growth has not been what either they or the government hoped for. There area number of reasons for this, one being the confusion over what the government intends to do. The other is the lack of genuine incentives which one would expect to see, both for employers and employees, if the government is serious about developing this market.”
On the corporate and institutional side, however, things are very different. “We are seeing massive interest in specialised products from those clients,” says Strnad. “I see two main reasons for this, which are in stark contrast to those which I described for the pension funds. First of all there is the general economic climate. We are enjoying some growth, and many companies have much more surplus cash than they have had in the past. We have also seen falling interest rates, and directors realise that they must look for new products, rather than rely on the traditional banking ones. We are detecting an important shift also in the way companies look to invest, they are more aware of the possibilities than ever before.”
Strnad says corporate clients are more sophisticated than ever and consequently more demanding. “Nowadays they expect tailor-made solutions, and are more knowledgeable than even a few years ago. The banks and financial institutions have played their part here, by educating their clients, especially on issues such as risk management. At one time clients were just happy to beat bank term deposit returns, but now they demand much more.”
Ironically one reason for this increased sophistication is the rationalisation of the banking industry in the republic. “The banks have laid-off thousands of executives over the past five years, and many of them have found jobs in companies acting as company secretaries or treasurers and finance officers,” says Strnad.
Despite the demand for special products, Strnad believes there is enormous long-term value in domestic equities. “The closer we get to EU membership, the more interesting the market will become, as accession will bring its own rewards. We expect many of the local companies to benefit, bringing the much needed liquidity to the market,” he says.
“At the moment the number of stocks is limited, and there are no big privatisation deals on the horizon. This makes it especially difficult for the pension funds in particular. At the moment they cannot invest in foreign equities. It is little wonder then that they limit their exposure to around 5% of assets. Anything greater and the risk becomes ever larger. For countries in the Euro-zone, which are able to designate the whole zone as their ‘domestic’ market the risk is spread much more thinly. It is obvious that membership of the EMU will mean that the government will have to liberalise investment criteria, and that can only be to everyone’s benefit.”

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