sou · H0B353 · 2012-08-24 00:00:00 — Further- more, should the Swedish government decide that specific financ- ing for the domestic private equity and venture capital market is a priority to be maintained, then there may be an argument for doing this independently and without any ties to the state pension system whatsoever. 72.In terms of the governance of these funds, the notes that the main feature of public pension reserve funds is that their ultimate beneficiaries do not have legal or beneficial ownership over the funds assets – leaving them potentially exposed to state influence (particular as may lack oversight body/clear objec- tives/peer comparisons). 73.The Guidelines on Governance7 also apply to reserve funds – but they need additional safeguards to promote better protection from political manipulation – in partic- ular special care over the appointment of the board (which usually contains government representatives). It should be noted that proper governance can mitigate the risk of political interference – though public pension reserve funds and pension funds can remain exposed to such interference especially in times of economic dis- tress. 74.The AP funds appear to have highly experienced management teams in place, including at the CIO and level. The internal running of the funds is not seen as an issue by the based on our high-level review. Remuneration does not appear to be exces- sive and is subject to government guidelines. The prestige of the positions and salaries that are broadly competitive with the indus- 7 See The guidelines cover issues such as the governing board, the role of accountants and actuaries, reporting and disclosure. try appear to make it possible for the AP funds to recruit high quality staff. 75.Overall, the AP funds generally appear to follow gov- ernance recommendations, such as the requirement for independ- ent audit and oversight. The risk-management systems of the funds appear to be well organized (for example with a Chief Risk Office reporting directly to the Board8). 76.The selection process for the governing board, however, could be made more transparent and rigorous, as discussed below. Autonomy of the Governing Body 77.As the guidelines point out, the governing body of the pension fund is the key body in governance terms. The governing body is the central strategic decision-making organ of a reserve fund. Its main function is approving the investment policy for the fund, and specifically, the strategic asset allocation. The governing body also monitors the executive and operational staff of the fund and is responsible for fulfilling the funds mission and complying with regulations. Given the critical importance of the governing body, it is understandable that efforts at insulating reserve funds from political risk have focused on this. The role of the governing body is even more important for public pension funds and espe- cially for reserve funds as they are usually the single players in the sector and hence they cannot readily be compared against their national peers, as is often done with private pension funds (though one can, however, compare reserve funds across countries, as is done in this paper). A strong, qualified board of directors, as far removed as possible from political influence, is therefore an essen- tial feature of a well-governed reserve fund. 78.The finds that a segregated and independent governing body that is established expressly for overseeing a pension reserve fund is preferable as a protection against political interference, especially if a government ministry is responsible for administering the pension systems benefits. In practice, however, the governing body of a reserve fund may also be a government ministry or the board of the social security institution. 8 This is one recommendation made in the Good Practices for Risk- management Systems 79.Furthermore, ideally reserve funds should be served operation- ally by an autonomous management entity, dedicated exclusively to the administration and investment of the reserve fund assets. 80.Sweden, along with , , and follow this approach preferred by the . 81.The approach taken by a number of countries to management and governance is described below. Source: Yermo, 2008, Governance and Investment of in Selected Membership and Selection of the Governing Body 82.As the ultimate authority with responsibility for the manage- ment of the reserve fund, the composition and functioning of the governing body are the first and main determinant of the funds performance. An experienced, well-functioning board will ensure that proper monitoring, incentive and control mechanisms are put into place to achieve the funds objectives. 83.The governance guidelines note that the membership of the governing body of a pension fund should be subject to mini- mum suitability (or non-suitability) standards in order to ensure a high level of integrity, competence, expertise and professionalism in the governance of the pension fund. Furthermore, the governing body should collectively have the necessary skills and knowledge to oversee all the functions performed by a pension fund, and to monitor those delegates and advisors to who such functions have been delegated. While it may not be necessary for all board members to be experts in finance, the board must collectively possess the necessary skills to carry out is oversight function effectively. 84.Special care needs to be taken with the selection and appoint- ment of the board of reserve funds, given the potential for political interference and the appointment of directors to serve largely as representatives of specific stakeholders9. The role of independent directors appears to be even more needed than in private pension funds. 85.The size of the board is also important. Though it should reflect the nature and scope of the organization, if too large, effi- cient decision making can be impeded. Board members should be appointed following a transparent selection and nomination pro- cess. While the government often appoints directors to represent non-government interests, it is likely that the influence that the government has on their nomination process seriously limits the ability of the appointed directors to independently execute their functions. One way to reduce the direct influence of government in the appointment of directors and reduce the scope for cronyism is to establish a nominating (selected by the government) who in turn nominate the directors of the reserve fund following a transparent recruitment process. This appoint- ment structure is followed by the Canadian and reserve funds. 86.Termination are also important to avoid the capricious dismissal of members of the governing body by government. 9 Social security institutions usually have tripartite representation in their governing body (governments, employers and employees). Source: Financial Market Trends 2008. 87.Overall, the governance structure of the appears to be strong and to follow recommendations. Sound govern- ance and risk-management structures appear to be in place, for example, with established codes of conduct, risk management committees, the chief executive officer and the chief risk officer reporting to the governing boards, internal and external audits, and regular reporting and disclosure. 88.That said, greater clarity could be given in terms of reporting lines to government. The pension reform that originally established the AP funds was the result of a compromise between the five main Swedish political parties, and any further major reforms would need to be driven by the parliamentary . 89.It is not entirely transparent which authority has ultimate responsibility for the pension system – given that the State Pension Authority (which administers benefits) is under , where as the AP funds are under the and the parliamentary drives major reform. Furthermore, communication of the role and the importance of the AP funds in the Swedish pension system with the Swedish public seems to be quite limited. Greater public aware- ness as to the role of the AP funds may help build the publics confidence in the system. One idea that could be explored would be the of an independent committee answerable to Parliament (potentially as a part of or an extension of the existing ) that would be responsible for issues surrounding the AP funds such as objective setting, performance measurement, board member nominations and communication with the public. 90.In their previous report on public pension reserve systems (Yermo 2008), the notes that one potential drawback of this segregated governance model practiced in is that investment management is separated from the actuarial and pay- ments functions of the social security system. This separation may be impacting the AP funds and partly explain the lack of clarity in their goals and objectives (see previous discussion). 91.The board members of the AP funds are appointed by the gov- ernment – which is standard practice for public pension reserve funds around the world. However, aside from the employer and employee nominated trustees, it is not clear how the board mem- bers are selected (indeed the process could be described as some- what ad hoc). 92.International good practice suggests that the independence of the AP Boards could be made more secure if an independent nomi- nation committee (as discussed in the previous section) were responsible for selecting the Board members. This would allow for a more transparent and independent process. The nominations would be approved by Parliament rather than the government, again to ensure greater independence and stability, with the boards reporting to Parliament on an annual basis. 93.The Boards of the AP funds in currently consist of nine representatives, including four elected following proposals from organisations representing employers and employees (two nomi- nations each). The Chair and Vice Chair are from these four nomi- nations. This is not out of line with the size of the Boards of reserve funds in other countries (which range from seven in and to twenty in ). In addition, several of the other Boards (such as in ) include representatives of employers and employees – which is not unreasonable provided that they have the appropriate skills and are approved by an inde- pendent nominating committee. Indeed these representatives (if appropriately selected) can bring a welcome broad perspective to the boards, representing Swedish society as a whole. Current law requires board members to have Swedish nationality. 94.The has not made a detailed review of the skill level of the AP funds board members, although it does appear as if the board members are, on balance, quite engaged and dedicated. In the interviews made with stakeholders, feedback was received that a handful of board members have strong investment experience, but on an overall basis, the level of investment experience on the boards could be augmented, which would give the boards greater capacity and credibility when discussing with and assessing the executives running the fund. 95.Based on our high-level review, there does appear to be some scope to strengthening the nominations process for the governing boards of the , in particular to make the process more transparent and rigorous, following pre-defined selection criteria. 96.The selection criteria for the governing board members does not appear to be well-defined. The would propose that overall requirements for experience and skills be defined on a col- lective basis for each fund and disclosed. Each individual board member would not need to meet all of the skills and experience required, but should complement the other board members, and as a whole, each board should meet the fit-and-proper criteria on a collective basis.10 97.A template for the necessary skills for any board to have could be outlined by the independent nominating committee which proposes candidates, which would also help with the transparency of the selection process. The timeline and process for selection, as well as the reasons for which a board member can be removed from their position should also be clarified (for transparency and to further ensure independence from political interference). 98.In addition, given that there are four reserve funds, the number of suitable directors which have to be recruited is larger. Consoli- dating the funds together would allow for the appointment of one high level and highly experienced Board. It is currently not allowed to recruit foreign nationals as Members. This is not gen- erally forbidden for the reserve funds in other countries. However, in order to attract the best possible candidates, this restriction should be lifted. This would seem more practical in than in some other countries given that language barriers are generally less of an issue. Members of the AP funds are remunerated according to government policies, where as they serve on a volun- tary basis in some countries – such as in . Given the prestige of such appointments, remuneration is unlikely to be the driving factor for candidates to sit on the AP Boards and therefore does not appear to be a major issue. 10 This is consistent with the Guidelines for Governance 99.In summary, the proposes that a consistent, clear and measurable objective with a long-term horizon be implemented for all the AP funds. This objective should be approved by the Swedish parliament and regularly reviewed. It could be expressed in terms of the expected timing and size of the pension systems cash-flows, the long-term funding target of the AP funds in relation to the pension systems liabilities and the acceptable risk/return trade-off. The performance of the AP funds should be measured primarily against this long-term objective. 100.The investment regulations for the funds should be based on the person principle, with oversight by an independent supervisory authority. 101.The Inquiry should also consider the position of the AP6 fund and clarify its mandate in relation to the best interests of the bene- ficiaries of the pension system. The Inquiry may wish to further consider whether the current venture capital mandate be maintained and, if so, how to make its investment decisions transparent. If providing funding to the domestic venture capital market remains a political priority, consideration could be made as to whether the AP 6 fund should be separated completely from the pension system. 102.The extent to which the decision-making powers of the AP funds are independent from the government should be confirmed. clear reporting lines could also be established within the gov- ernment, potentially with an independent committee answerable to Parliament as the owner of issues relating to the AP funds such as nominating board members, setting the overall objective of the funds, establishing performance measurement criteria and com- municating the role of the funds to the Swedish public. 103.To help ensure independence, the board members of the Funds should be nominated by this independent committee, and the nominees should be confirmed by Parliament. The nomination process should be transparent and criteria for the skills and know- ledge required collectively by the governing boards should be established. Furthermore, the requirement for Swedish citizenship of members of the governing boards could be lifted. Björkmo, M. (2009), Fyra dyra fonder? Om effektiv förvaltning och styrning av AP-fonderna, Rapport till expertgruppen för studier i offentlig ekonomi 2009:4. Björkmo, M., Lundbergh, S. (2010), Restructuring AP Funds for Scale and Global Impact, Jour- nal of , Volume 3, Issue 1 Spring 2010. (2011), : The Lent or Spent Dilemma, Commentary, , NJ. (2011), Annual Report 2011, , . Dyck, A. and Pomorski, L. (2011), Is Bigger Better? Size and Per- formance in , agement, . , W. and F. (2011), Reform on Govern- ance and Management: The 1998 Reform of Pen- sion Fund, Working Papers on Finance, Insurance and Private Pensions, No. (2011), Kommittédirektiv 2011:84: Översyn av AP-fondernas regelverk, Beslut vid regeringssammanträde , . , (2008), Governance and Investment of in Selected Countries, Financial Market Trends No. 94 Volume 2008/1, , . (2009a), , , . (2009b), Recommendation on of Occupational Pension Regulation, , . (2009c), agement, , . /IOPS (2011a), /IOPS Good Practices for Pension (2011b), Pensions at a Glance 2011: in Countries, , (2011c), Pension Markets in Focus, Issue No. 8 2011, , . (2010), Report: Annual Report of the 2010, . (2009), Riktlinjer för anställningsvillkor för ledande befattningshavare i AP-fonderna, , F. and J. Yermo (2010), Options to Improve the Govern- ance and Investment of 's , Working Papers on Finance, Insurance and Pri- vate Pensions, No. (1995), Proposition 1995/96:171 En sjätte m.m., ok_id=GJ03171&rm=1995/96&bet=171 (2009), Skrivelse (2009/10:130) Redovisning av AP-fondernas verksamhet , . riksdag (2000), Lag (2000:192) om allmänna pensionsfon- der (AP-fonder), 2000: 192, changed through SFS 2011:1074. riksdag (2000), Lag (2000:193) om , 2000: 193, changed through SFS 2007:709. Whyman, P. (2004), An Analysis of in : Distinguishing Myth from Reality, Economic and Industrial Democracy 2004 25: 411, : 10.1177/0143831X04044833, , , . Yermo, J. (2008), Governance and Investment of in Selected Countries, Working Papers on Insurance and Private Pensions, No. The Governance of Reserve Schemes: Implications for the Swedish AP () and Ashby H B Monk In this report, we set-out the principles and policies associated with the management of pension reserve funds, noting their close rela- tionships with Anglo-American pension funds. This leads to a brief overview of our research programme, and the new realities driving institutional innovation in the sector. We outline the findings from our evaluation of the Swedish AP funds, and we report on common concerns about the evident shortcomings in the current AP fund system. The report closes with a series of recommendations for the redesign of the system. Pension funds and pension reserve schemes are significant institu- tions in many countries, offering participants, sponsors, and gov- ernments the opportunity to pre-fund and manage accumulated assets on behalf of current and future beneficiaries. These funds and schemes often underwrite a significant portion of beneficiaries expected or promised future retirement incomes, supplementing government benefits and guarantees. As such, the effective regula- tion, governance and management of these funds have become cru- cial lynchpins for the social welfare of present and future genera- tions of retirees (and taxpayers). There is an extensive academic literature on the design and governance of pension funds, much of which is focused upon the Anglo-American experience of work- place pensions (see 2000). Pension reserve schemes have received less attention even as their importance grows (and Monk 2011). Pension reserve schemes are often used by governments to par- tially fund retirement commitments. Government sponsors utilise entities modelled on the pension fund institution as vehicles for managing and investing earmarked assets on behalf of current and future citizens. In this , pension reserve schemes mimic and match the attributes of Anglo-American pen- sion funds, taking advantage of widely-accepted institutional arrangements and, where possible, the principles and practices associated with best practice investment management (and Urwin 2008a). Nonetheless, the form and functions of a pension reserve fund can differ from a traditional pension fund in that it may not have explicit liabilities but be subject to constraints or rules on its investment activities. Accordingly, pension reserve schemes come with their own challenges and considerations in attaining best practice governance and management. In some countries, pension reserve schemes run parallel to existing supplementary pension plans (as in ). In a small number of countries, public and private supplementary pension plans have been offered the option of being incorporated into gov- ernment-sponsored public utilities (as in ) (2012). In the Swedish case, five separate AP funds were established to manage and invest a portion of the assets of the national pension system. The existence of these funds is owed to legislation passed in 2001, following public debate about the need for a sustainable national model of retirement saving for Swedish citizens. This model was recognised around the world as an innovative solution to the problems associated with realising an adequate retirement income given an ageing population, competing claims on govern- ment expenditure, and the pressures faced by small countries due to economic globalisation. As buffer funds, these organisations act like large pension funds and provide partial insurance against the year-to-year and long-term liabilities of the Swedish pension system. As part of the inquiry, we were asked to provide advice and commentary on the following four issues: the principles and policies of pension reserve fund governance; the common governance shortfalls amongst pension reserve funds and how these shortfalls can be remedied in a generic sense; the costs and benefits of good governance, including reference to the experience of other similar institutions including pension funds, and; a gap analysis of the Swedish system as it pertains to the best practice frameworks developed by and Urwin (2008a, 2008b, 2010), and and Monk (2011). To make an informed assessment of the Swedish AP system, we undertook an extensive review of the existing academic and indus- try literature on the topic. Recent government reports on the sys- tem were collected and assessed. Interviews were undertaken with a wide variety of stakeholders in the system, including past govern- ment ministers, government officials, and social partners. Site visits took place with each AP fund, involving discussions with the rele- vant CEOs, CIOs, and other employees. As part of the consulta- tion process, we had the privilege of talking to each AP chairper- son. Consultation also took place with informed of the Swedish AP system. As well, two presentations were made to the panel. Assessment of the structure and performance of the Swedish AP system was undertaken in the light of our research programme on the governance and management of pension reserve schemes, pension funds, endowments, and sovereign wealth funds. This rese- arch has its origins in a 2006 report and his colleagues produced for on the governance of UK pension funds and the decision-making competence of UK pension fund boards. This report focused upon the size, composition, skills and expertise of these institutions, given the UK governments commitment to maintaining boards of management that combine expertise with stakeholder representa- tion (see et al. 2006, 2007). Crucial findings from this research included recognition that many pension fund trustees are subject to common behavioural biases. It was also found that domain-specific skills and relevant expertise can make a positive difference to board decision-making. Likewise, it was found that effective governance and management of pension institutions are important in fostering the various skills needed to sustain these institutions. This research was then extended in and Urwin (2008a, 2008b), which focused upon the principles of best practice, the role of leadership, and the pro- cedures whereby decisions are taken in these institutions both at the board level and in the funds themselves. We identified a clear relationship between the resources expended on effective govern- ance and the performance of these types of institutions as reflected in risk budgets and the nature and scope of investment.