sou · H0B353 · 2012-08-24 00:00:00 — A larger fund is better placed to negotiate fees, remuneration and prices with external fund managers and other financial partners. Studies indicate that improved governance affects returns positively. Attempts to quantify the positive effects indicate improve- ment of 1–2 percentage points annually, which is an assessment of appraisals made by individuals at different fund management organisations based on established principles for effective pension fund management governance. This alternative proposal, with a clearer objective, better governance and a larger and flexible asset management entity, offers good of living up to the prin- ciples that characterise effective governance and professional fund management. A returns increase of 1 per cent per year is not an unreasonable hypothesis for the alternative proposal as a whole. This would mean billion extra annually to the benefit of the pension system, based on capital of billion. The alternative proposal is based on the Inquirys main proposal, the difference being that in this proposal only administers and manages a single fund. The impact assessment conducted in Chapter 15 is also more or less valid for the alternative proposal. However, the duplication and triplication of some functions that the main proposal unavoidably leads to, due to the Inquiry terms of reference benchmark of at least three funds, will not arise. The savings potential of the alternative proposal will thus be greater than that of the main proposal while the costs of restructuring are assessed as being more or less equal. The consequences for the financial markets are assessed as being the same as in the Inquirys main proposal. Bilaga 3 Externa uppdrag och intervjuade personer 1.1Förteckning över externa uppdrag Financial Affairs Division; och , Internationell jämförelse och analys av buffertfonderna Advisors; professor , och Ashby Monk, Utvärdering och analys av strukturer och styrmodeller 1.2Förteckning av aktörer som på olika sätt bidragit till utredningen 1.2.1Internationella och svenska finansiella aktörer Utredningen har under arbetets gång träffat och samtalat med ett stort antal aktörer, banker, investmentbanker, kapitalförvaltare, konsulter etc. som på olika sätt har anknytning till AP-fonderna. Dessa möten har gett utredningen inblick och förståelse i nuvarande förhållanden och av hänsyn till de berörda avstår vi från att publi- cera uppgifter om dessa. Utredningens arbete har bedrivits nära AP-fonderna. De har för- tjänstfullt bidragit genom att ställa upp på flertalet möten och genom att bistå med olika typer av underlag till utredningen. Möten har hållits med samtliga fonders styrelseordförande, styrelsedamöter, ledande befattningshavare och personal. Nedan redovisas individer som på olika sätt bidragit till utredning- en genom möten eller andra kontakter. REVIEW OF THE SWEDISH is an international organisation made up of 34 Member coun- tries: , , , , , the , , , , , , , , , , , , , , , , the , , , , , the Slovak Republic, , , , , , the and the . The Commission of Communities takes part in the work of the . The mission of the is to promote policies that will improve the economic and social well-being of people around the world. The works by data collection, policy analysis and peer reviews, covering a broad range of topics – from edu- cation and health to environmental policies, to investment and taxation. Through its Insurance and , the has issued for Occupational Pension Regulation, guidelines on Governance and Pen- sion , as well as other recommenda- tions on pension issues approved by the 34 Member govern- ments. and work in the Financial Affairs Division of the OECDs Directorate for Financial and Enterprise Affairs. Though drawing on approved recommendations and other work supported by com- mittees, the views expressed herein are those of the authors and do not necessarily reflect those of the or the govern- ments of its Member countries. The authors are solely responsible for any errors. REVIEW OF THE SWEDISH NATIONAL PENSION 1.The has been requested by Inquiry to provide high-level guidance as to international experiences and good practices in relation to the Inquirys review of the First through (AP1 through AP4) and the (AP6). 2.The Inquiry has been tasked by the Swedish government to look at a number of both broader and specific issues such as the overall strategic investment objectives of the funds, whether the existing investment restrictions on the funds are appropriate, the level of efficiency of the current fund structure, board member require- ments, accounting and auditing of the funds and scope and timing of government evaluations. 3.This paper summarizes the OECDs proposals for the Inquiry´s consideration. The paper does not attempt to answer all of the questions posed by the Swedish government to the Inquiry, but rather presents an international perspective on some of the broader, key issues based on Member Country experiences and good practices. The comments made in this paper focus mainly on the general size and structure of the funds, the investment framework and the governance of the funds. 4.On a combined basis, the are large compared to public pension reserve funds in most other countries, although significantly larger funds exist in the , , Saudi Arabia and . The internal management of the AP funds appears to be strong with governance and risk management struc- tures in place (including experienced leadership and engaged board members) that appear to broadly follow guidelines. 5.Swedens four-fund structure is unique among global pension reserve funds. One of the most contentious issues to be examined by the Inquiry is whether the four-fund structure has been effec- tive. The original idea behind the design of the AP funds as four distinct and independently operated entities was to reduce the impact of the funds on the domestic market, diversify management risk, enhance performance through competition and to mitigate the risk of political interference (Björkmo and Lundbergh, 2010). Arguments against a multi-fund structure have tended to focus on the level of costs, potential for economies of scale from having a smaller number funds, consolidating expertise and the number of board members, as well as potentially stronger governance and greater resilience from outside influence from having one large fund rather than several smaller funds. 6.The has no strong view as to whether the current num- ber of funds or fewer funds is optimal and leaves this to the Inquiry and the Swedish government to establish. However, it should be noted that the other reserve funds around the world do not seem to encounter major difficulties operating on a centralized basis. In terms of operating costs, the AP funds 1 to 4 do appear to be in line with their international peers, even on a disaggregated basis, and low compared to the aggregated operating costs of traditional pension funds in countries. It is important to note that the risk of political interference of reserve funds is pervasive especially in times of economic distress. Having a multi-fund structure may work to increase the independence of the funds operations, yet on the other hand, the visibility of one large fund as opposed to sev- eral small funds may also serve to protect it from outside influence. The risk of political interference is, however, not necessarily tied to the number of funds. Finally, it is important to note that strong governance and oversight structures are powerful measures in miti- gating political risk, but cannot altogether eliminate it. 7.The over-arching investment mandate of the 1 to 4 encoded in Swedish law is to provide as high investment return as possible, while not taking undue risk. The funds must also be in a position to pay out benefits if requested by the . The actual interpretation of this mandate is left to each of the funds, and the resulting investment objectives are disparate and inconsistent. The lack of a distinct, specific and long- term investment objective that is consistent across the funds has meant that the funds performance has had no clear and objective target against which their performance could be measured. 8.A more powerful, consistent and specific investment mandate across the AP funds that is approved by Parliament would help make the evaluation of their performance more transparent and easier to establish. This investment objective could be expressed in terms of a targeted funding ratio, cash outflow schedule and a long- term real rate of return target and would serve to keep the funds answerable to the electorate on a more objective basis. Further- more, changes to the funds structure based on future reviews may be more readily motivated based on such an objective measure- ment, as could it help to protect the funds against undue political pressure. Our main suggestions for consideration by are summarised as follows: Establish an independent committee that is responsible for issues related to the AP funds: This independent committee should be answerable to Parliament (and could, for instance, potentially be a part of or an extension of the current parlia- mentary ). Its role would be to own issues related to the AP funds, such as establishing the over-arching investment objective, establishing performance measurement criteria, nominating board members. could also serve to promote public awareness of the role of the AP funds within the Swedish pension system. Establish one targeted and measurable long-term investment objective for all the AP funds: One clear and specific long- term investment objective should be set for all the AP funds against which their long-term performance can objectively be measured. This over-arching and long-term investment objec- tive should have Parliamentary approval. It should be clearly expressed and could directly take into account the expected timing and amounts of the cash in- and out-flows of the AP funds, the expected financial impact of demographic changes, the long-term funding target of the funds in relation to the pen- sion systems liabilities and the level of expected investment return versus the acceptable level of risk that the balancing mechanism would be triggered and pensioner benefits cut. Measure performance against this long-term investment objec- tive: Currently, the performance of the funds seem to be mainly measured in relation to each other and based on the level of their annual operating costs (which appear to be low if com- pared internationally). This appears largely to be due to the lack of a clear and specific investment objective that would apply consistently to all the AP funds. be measured directly against an over-arching and long-term investment objective, as described in the bullet point above. Implement the : As a general principle, the supports the implementation of the person rule. If the goal is to reduce risk, then this can be done specifi- cally in the over-arching investment objective described above and in the strict governance and oversight of the funds rather than via specific investment restrictions. Such restrictions could in fact lead to suboptimal portfolios and over-exposure to cer- tain types of assets. Furthermore, restrictive investment regula- tions leaves the AP funds with less room to adopt varying investment strategies, and thus takes away some of the potential benefits of competition and diversification from having four different funds. The implementation of a less restrictive invest- ment framework should furthermore be supported in each fund by a written investment policy describing primarily how each fund would intend to meet the over-arching investment objec- tive and their strategic asset allocation policies. Clarify the mandate of the and align the govern- ance and operation of the fund with that mandate: The man- date of the AP6 fund is to invest its assets in the Swedish ven- ture capital market, within the framework for what is in the best interest of the pension system. Unlisted assets and other alter- native investments can be an important investment class for pension funds. However, it is unclear to what extent such investments in and of themselves are in the best interest of the pension system. If AP6 is to be maintained, then its role and importance within the pension system should be clarified. As investment in unlisted assets takes expertise and specialisation, one potential option could be to embed the AP6 fund and its exposure to unlisted assets within the other AP funds. investments made by AP6 would then need to be motivated within the overall framework of the . Strengthen the selection process for the Governing Boards: The selection process of the governing boards of the AP funds currently appears to be ad hoc and not transparent. The supports implementing fit and proper criteria for board mem- bers, a balance of skills between members and a transparent and rigorous selection process. Furthermore, there appears to be no particularly compelling reason to limit mem- bers to Swedish citizens. Board Member candidates would need to follow a transparent nomination process, and meet pre- defined fit and proper criteria for the Board in aggregate. 10.The guidance and proposals made in this paper draw on previ- ous work done by the and are based on international good practices identified in this previous work. In recent years, the has analysed the governance and investment arrangements of public pension reserve funds around the world and monitored their investment performance in the OECDs annual Pension Markets in Focus newsletter. 11.The basis for the proposals made in this paper is the OECDs of Occupational Pension Regulation and the asso- ciated guidelines on sion Fund Governance. Particularly relevant to this review is the OECDs 2008 report Governance and Investment of Public Pen- sion in Selected Countries. Furthermore, the has done similar reviews for the pension reserve funds in and . 12.The supports the of reserves to prefund social security benefits as these funds allow governments to respond to the fiscal pressures from ageing populations (tax smoothing/improving debt position of the government) and inter- national diversification can provide (long-term) exposure to other countries experiencing less of a demographic decline. However, the also recognizes that such funds face some unique challenges as compared to traditional pension funds due to their size, their broader mandate and the sometimes difficult balance between political and economic considerations. 13.The pension reserve system in has a unique structure in that it is divided into four separate funds, known as AP1 through AP4. One quarter of the social security contributions made towards the state pension system are directed into each of these four funds. In turn, each of the four funds pays out one quarter of benefits due from the state pension system. In addition there is a separate AP6 fund which invests exclusively in private equity. The AP6 fund receives no contributions and pays no benefits. 14.The AP7 fund relates to the mandatory individual pension sav- ings accounts and is not subject to the current Inquiry. No further mention of AP7 will be made in this paper. 15.Based on our interviews, it is our understanding that the 1 through 4 have no formal obligations with respect to future pension payments, but can be called on by the Pensions Authority to make payments due. In effect, the funds act to an extent as a clearinghouse for cash flows in the state pension sys- tem, where on a monthly basis, one quarter of contributions into the state pension system are deposited into each of the funds and one quarter of payments due are paid out of each fund. excess of contributions in over payments out would remain in the funds and any shortfall would be a loss to the funds. 16.As of year-end 2010, the total assets in the 1 through 4plus 6 was billion which is equal to of the total liabilities of the state pension system (Pensionsmyndig- heten, 2010). the coming thirty years due to mainly demo- graphic changes, the payments to be made from the pension system are expected to significantly outsize the payments to be made into the system and by 2040, the size of the buffer funds AP1 to 4 and 6 is expected to have decreased to billion (, 2011). II.Structure, Size and Operating Costs of the Funds Multi-Fund Structure of the is unique in that it is the only country which utilizes a structure of multiple pension reserve funds. The multiple fund structure was originally set up for the following reasons (Björkmo and Lundbergh, 2010): To reduce market impact; To diversify management risks; To allow competition to reduce costs and improve performance; and, To reduce political interference. 18.Historical factors appear to have played a part in the creation of the multi-fund structure, as well. The single pension reserve fund that was the predecessor to the AP funds had several boards that were transformed into the boards of the AP funds 1 to 4 at their creation. Furthermore, the AP6 fund received its assets from a portion of the disbanded wage-earners funds (löntagarfonder) that existed in the 1980s and consisted mainly of pooled profits from Swedish corporations (Whyman, 2004 and Björkmo, 2009). 19.The question has been raised by the Inquiry as to whether the current structure of four AP funds plus the AP6 fund should be maintained? Obtaining economies of scale could argue for a smaller number of funds, whereas the risk of concentration of power and market impact could argue for several smaller and independently operated funds. Whether the multi-fund structure has achieved the four goals as listed above, and the relative importance of these four goals, will be left to and the Swedish government to establish. 20.From an international perspective, other reserve funds around the world have either not specifically identified the four goals listed above in relation to having a single fund versus several funds, or they have approached these challenges in different ways. The size of the in is large in absolute terms and as a percentage of GDP – with only the Saudi Arabian and Norwegian funds representing significantly higher percentages of GDP, with the Japanese and Korean funds being on a par. Source: Pension Markets in Focus, 2011. 22.The trend around the world is for pension funds (not just reserve funds) to get larger and indeed government and regulatory authorities have been finding ways to encourage this trend. For example in the pension funds have been working together to gain economies of scale, whilst in and the large funds (such as OMERS in and PGGM in the ) are now allowed to compete for external assign- ments. Centralizing is coming to the UK with the introduction of the () system, whilst in the licensing of trustees caused the number of superannu- ation funds to decline. It should also be noted that mandatory sys- tems in countries with less developed capital markets (such as in Latin American and Eastern Europe) operate with only a handful of large funds. 23.As a percentage of stock market capitalisation, the AP funds in combination represent a relatively large level of stock market capi- talisation which would highlight the importance of international diversification to their portfolios to reduce their potential domi- nance on the Swedish markets. The AP funds are, however, signifi- cantly smaller when compared to the relative size of some of the other reserve funds around the world (notably the Irish and the Asian pension reserve funds). Source: Global Pension Statistics and the World . Other public pension reserve funds have found different ways to reduce their potential market impact. For example, the Norwegian reserve fund has, for example, split its fund into a domestic and an international component in order to reduce market impact. Meanwhile, in the has invested exclusively in US Treasury obligations backed by the full faith and credit of the US government. Some critics, however, have questioned whether this funding from within the US government for US government obligations amounts to true additional security for pensioners (, 2011). The Level of Costs 25.In 2010, the received self-reported data on operating costs from AP 1, 3 and 4 as well as from pension reserve funds in some other countries. Based on the data received, the operating costs of the AP funds appear to be in the middle of the range com- pared to the operating costs of public pension reserve funds in other countries. 26.In 2010, the Swedish AP funds had lower total operating costs as a percent of total assets than the larger funds in the , and and a higher percentage of operating costs compared to some of the smaller funds. had the highest costs of the pension reserve funds that provided data to the for 2010. This may be to some extent explained by the small size of the pension reserve fund and hence less economies of scale. Also, the pension reserve fund invests relatively heavily in private equity and hedge funds which can be expensive (Pension Markets in Focus, 2011). 27.It is important to note, however, that comparing operating costs across countries can be difficult given different reporting methods and the variety of roles that funds play in various coun- tries. Therefore, the results of these charts can only be considered as a broad indicator of differences in cost across countries. Source: Pension Markets in Focus, 2011. The also keeps statistics on investment management costs. If the total investment management costs of traditional pen- sion funds over their aggregate assets across countries were com- pared to the investment management costs of the AP funds and other pension reserve funds, then the AP funds would be on the lower end of this comparison in 2010 (together with the majority of the pension reserve funds). The lower level of investment man- agement costs would make sense given the typically larger size of public pension reserve funds compared to traditional pension funds and associated economies of scale. It should be noted that occupational defined contri- bution pension system is lauded internationally for being a very low-cost system, so there may be areas where good practices from the occupational pension system could be shared. It is important to note that investment management cost data is often underreported due to difficulties in identifying fees in certain types of invest- ments. The data shown in Figure 3 has not been audited and should be viewed as a broad comparison only. Source: Global Pension Statistics. 29.In 2010, the costs associated with administration of the AP funds in total was million, divided roughly equally among them. Based on the 2009 review of the AP funds by the Swedish government, the level of administrative costs over the total fund assets has been roughly around ten basis points since 2005, whereas it was over twice that level the two years prior. 30.It should be noted that the 2010 administrative costs of the AP 6was approximately level with the administrative costs of the other AP funds in terms of SEK spent, despite its assets being roughly one-tenth the size of the other funds. This would place the AP 6 fund on the high end of operating costs as a percentage of total assets on an international basis. However the unlisted, direct nature of the investment of AP6 inevitably makes it more expensive to run. It should be noted that the pension reserve fund is small and invests more heavily in private equity and hedge funds compared to other funds and it also has relatively high operating costs. 31.The issue has been raised in the previous 2009 review and elsewhere whether the costs of the AP funds could be reduced if they were consolidated due to economies of scale.