Download PENSION FUNDS IN UKRAINE AND THEIR INVESTMENT OPPORTUNITIES

PENSION FUNDS IN UKRAINE
AND THEIR
INVESTMENT OPPORTUNITIES
SERGEY VARFOLOMYEYEV
Consultant on Investment Issues
USAID/PADCO Ukraine Pension Reform Implementation Project
Prepared for the Roundtable
“New Investment Challenges in Pension Insurance”
Sofia, Bulgaria
15 April 2004
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ECONOMIC OVERVIEW
(2003)
• GDP: ~ US$ 50 billion, ~ US$ 1050 per capita; real growth –
9.3%, over 2000-2003 – 32.3%
• Industrial output grew by 15.8% (main drivers: construction,
manufacturing - >20%, machine-building - 36%)
• CPI inflation: 8.2%
• Budget deficit: 0.2% of GDP
• Public debt: US$ 14.6 billion (~ 29.5% of GDP), of which
US$ 10.7 billion – external, US$ 3.9 billion – internal
• “Risk-free” rates: 3-6 month - ~ 9%, 2-year government bond
yield – 11.5% (at auction); but – can’t be called “benchmarks”
• Impressive growth of individuals’ bank deposits: 68.2%
(67.9% in 2001, 71% in 2002), total amount as of 1/01/2004
exceeds US$ 6 billion (>12% of GDP)
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FUNDED PILLARS’ STATUS
• The Law On Mandatory State Pension Insurance (1st & 2nd pillars) and
the Law On Non-State Pension Provision (voluntary 3rd pillar) were
passed in June 2003 and became effective on 1/01/2004
• 2nd pillar: Singapore model (administration – by Pension Fund of
Ukraine, but asset management, custodianship, audit – selected by public
tender); most likely contributions will start on 1/01/2007 (a lot of
preconditions should be met) and will be 7% of wages; separate Law on
mandatory occupational pensions must be developed and passed till 2005
– employers of individuals working under labor categories I and II will
make mandatory contributions to 3rd pillar funds
• 3rd pillar: only funded DC schemes, return guarantees are prohibited;
still no Non-State Pension Fund (NPF) created; Financial Services
Commission and Securities Commission actively develop necessary rules
and regulations but the most are still absent (asset valuation & unit
pricing, personified & financial accounting, fees & costs, disclosure,
some other); law on EET model with 15% level of tax-free contributions
not passed yet (now tax preferences for life insurers only)
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INVESTMENT LIMITS
Asset category
Government securities
Bank deposits & CDs
Municipal bonds
Corporate bonds (incl. banks')
Equity shares
Mortgage securities
Real estate
Bank metals
Foreign investments
Limits per issuer:
general
banks
Ukrainian government bonds
foreign government bonds
Limit type
NPFs
2nd pillar
max
max
max
max
max
max
max
max
max
50%
40%
20%
40%
40%
40%
10%
10%
20%
50%
50%
10%
20%
40%
40%
max
max
5%
10%
-
5% (10%)
10%
max
10%
And no prudent-man-type or other prudential investment regulations in the Laws
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PROHIBITED INVESTMENTS
• Securities not listed at registered stock exchanges or OTC
trading systems (for NPFs – except for government
securities municipal securities and securities guaranteed by
third parties)
• Securities issued by collective investment institutions (CII),
but for NPFs – Securities Commission may lift this ban
• Bills of exchange, promissory notes
• Derivative securities (even for hedging purposes – despite
allowing significant foreign investments)
• Securities issued by affiliated entities (administrator, asset
manager, custodian, auditor, investment consultant, etc.);
but self-investment is allowed for corporate NPFs – 5%
(10% during first 5 years)
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THIRD PILLAR FUNDS:
TYPES & GOVERNANCE STRUCTURE
• Types of NPFs: 1) open PFs; 2) corporate PFs (founders - employer
or a group of employers, participants - individuals who have/had an employment
relationship with contributing employers); 3) professional PFs (founders association of employers or individuals incl. trade union associations, participants individuals related on the basis of professional activities)
• Governing body: board of the pension fund (fund board) - at
least 5 persons elected for 3 years by the assembly of the
founders of the NPF (no representation of participants)
• All key services – administration, asset management,
custodianship – are contracted out by fund board (but sole founder
of a corporate PF can make a decision on self-administering the fund)
• Contributors conclude pension contracts with administrator
• Administrator & asset manager can be combined in 1 entity and
may have the same founders as their NPF(s)
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PENSION FUNDS & ASSET MANAGERS:
THEORETICAL DEVISION OF RESPOSIBILITIES
• Pension fund responsibilities:
- analysis of participants’ needs (age, income, wealth distribution, etc.)
- choice of fund structure (single fund or several sub-funds, number of
mandates per fund/sub-fund – but the Law is vague about possibility of sub-funds)
- choice of risk profile(s) (strategic asset allocation, benchmarks,
management style (active/passive), etc.)
- selection & monitoring of asset managers
According to the Law, investment policy declaration shall be developed &
approved by fund board. If it lacks professionals in the area of investments, the
board must involve investment consultants into development of the declaration.
• Asset managers’ responsibilities:
- tactical asset allocation
- security selection and other specific issues
- selection of traders
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ASSET MANAGEMENT IN UKRAINE
• There were a lot of “trusts” in Ukraine in the first half of the
1990-s, and significant number of them just robbed people
• Professional asset management slowly began to develop after
the Law on CII was passed in Mar-2001
• Majority of created investment funds are closed venture capital
funds; 1st & only relatively actively marketed fund – Synergy
(managed by KINTO) – was created in spring-2003
• Investment fund industry growth is hindered by undeveloped
capital markets and still existing lack of people’s trust
• 40 licensed asset management companies, 5 of which have
already obtained license for pension fund asset management –
rapidly growing interest to pension business
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UKRAINIAN PENSION FUNDS:
WHERE TO INVEST?
 Internal government bonds
 External government bonds
 Corporate bonds
 Municipal bonds
 Equities
 Other domestic investments
 Foreign investments
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INTERNAL GOVERNMENT BONDS
• Marketable internal government debt amounts to ~ 4%
of GDP and the most of this are short-term and/or
poorly structured instruments
• Secondary trading – almost absent, primary market –
non-market, uncompetitive mechanisms, MinFin wants
to introduce min legal limits for PFs, CII, insurers
• Must be the most liquid, efficient, transparent financial
market in almost any country
• Ukrainian government declares (in some official policy documents)
its importance but in practice do little to develop it,
borrowing mainly on international bond market
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EXTERNAL GOVERNMENT BONDS
• Jun, Sep 2003 – very successful issue of US$ 1 billion
10-year global bonds (7.65%), Feb-Mar 2004 - US$ 600
million 7-year global bonds (6.875%)
• Market capitalization exceeds US$ 3.5 billion
• The only relatively highly liquid securities market of
Ukrainian issuers
• Bid-ask price spread: ~ 20-50 bps
• It’s unclear how much accessible this market will be for
residents, incl. PFs – current regulations are incomplete
and create some obstacles for such investments
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CORPORATE BONDS
• Most dynamically developing debt market segment
• Since 2001 grew from almost zero to ~ US$ 200 million
• Main investors and players are Ukrainian banks
• Several large and some medium-sized banks are actively
developing their underwriting businesses
• Secondary market – illiquid, primary market –
insufficiently competitive
• Market players hope for near coming of PFs, CII, etc.
• Government is introducing national credit rating system
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MUNICIPAL BONDS
• After famous default by City of Odessa in May-Jun 1998
and debt crisis of Aug-1998 the market was dead
• Legal & regulatory framework was renewed during
2001-2003
• Jul-Aug 2003 – US$ 150 million 5-year fiduciary
external bond issue by the City of Kiev (8.75%)
• Nov-Dec 2003 – Kiev issues UAH 150 million (~ US$ 28 mil.)
domestic bonds, but only UAH 100 million were placed
• Market is developing: UAH 20 million internal bonds of
the City of Donetsk are almost ready for issuance,
several other transactions – in the pipeline
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EQUITIES
• The market is recovering from the 1998 crisis: 50%
growth in 2002, 65% - in 2003 (KP-Dragon index)
• But market size and liquidity are still very low: relatively
tradable “free float” is ~ US$ 2 billion (~ 4% of GDP)
• Most analysts agree that Ukrainian companies are heavily
undervalued, so the market cap has the potential to surge
• Privatization – major potential driver of market growth
and liquidity improvement
• Coming PFs may also contribute to market development,
but hardly it will be in the near future (PFs’ equity
exposure probably will be no more than 5-10%)
14
OTHER DOMESTIC INVESTMENTS
• Real estate –Laws on state registration of property rights in real
estate & on relevant State registry are still not passed; but returns
are very attractive now (rent income ~ 20% and prices are rising)
• Mortgage securities – Government pays very big attention to
mortgage market development and the market is growing, but
laws & regs needed to start up securitization process are still very
incomplete
• Bank deposits – most likely that during first years of NPFs’
operation 40% limit utilization will be very high, but it should fall
gradually as domestic capital markets will develop; ideally –
should be used only for liquidity management purposes
• Bank metals – treated like foreign currencies; investments may
be only in the form of current/deposit metal accounts with
Ukrainian banks; gold price – excellent diversifier (optimal share
~ 6-9.5% - estimates of the World Gold Council)
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FOREIGN INVESTMENTS
• Securities Commission must set minimum acceptable
credit rating level of foreign countries’ external debt
(PFs will be able to invest in bonds and shares of
issuers from countries with such rating level or higher)
• National Bank must develop and approve until Jul2003 regulation on simplified procedure for
investments of PFs & life insurers into foreign
securities; but it seems that NBU is not going to do it
• The most likely is that foreign securities will be
difficult to access for PFs in the near future
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CONCLUDING REMARKS
• Ukrainian pension fund industry is just incipient
• Great interest among potential market players, but …
significant risks exist that the process may be stalled
(tax treatment, managers’ integrity, politics, etc.)
• Keen need for development of domestic localcurrency capital markets, and first of all – government
bond market (don’t exaggerate crowding-out effect)
• Need to eliminate limit on government securities or, at
least, raise it from current 50% to 70-80%
• NBU should create appropriate regulatory framework
for investments in Ukrainian sovereign international
bonds and for foreign investments
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Thank you for your attention!
ADDITIONAL INFORMATION
 www.pension.kiev.ua
 [email protected]
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