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International Forum on Pension Reform June, 2007

Explore the Estonian pension reform's impact on financial markets, regulatory frameworks, and industry structures. Understand the preconditions, implementation measures, and industry transformations influenced by the reform.

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International Forum on Pension Reform June, 2007

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  1. International Forum on Pension ReformJune, 2007 (Re)designing regulatory framework for pension reform and development of financial markets: Estonian experience Veiko Tali Ministry of Finance of Estonia

  2. Impact of pension reform for development of financial markets • the earlier you will start with reform – the higher the impact - comparing with the relative level of development of financial markets • the bigger the potential financial volumes – the higher the impact - mandatory character and level of contributions • the smaller the country – the higher the impact ?

  3. Impact of pension reform for development of financial markets • the long term (30) impact is more important than short (5) and medium (10-15) term one (adaptivity is crucial) • redesigning possibilities can be restricted (eg. justified expectations of voluntary switchers) Flexibility versus reliability ?

  4. Reformed pension system FIRST publicly managed compulsory PAYG ER-16 % 1999/2000 SECOND privately managed Optional/ compulsory funded 4(ER)+2 (EE) 2002 THIRD privately managed voluntary funded 1998

  5. Preconditions for implementation of pension reform (II pillar) • Regulatory framework • Supervisory capabilities • Market infrastructure (registration, central depository (1995), stock exchanges (TSE in 1996) • Level of market development (banks, insurance)

  6. Banking Inspectorate (dep of BoE) Securities Inspectorate (dep of MoF) Insurance Inspectorate (dep of MoF) Depositary Banks Management Companies Insurance companies Financial Supervisory Authority Financial Supervisory Authority (2002)

  7. Reform of financial supervision - FSA • Integrated (at Bank of Estonia) • Independent (special two-level management structure, 3/4 appointment) • Financed by market participants (budget ca 3 million euro) • Competent and capable (70 staff)

  8. Impact of pension reform design • For development and structure of financial services INDUSTRY – (higher level of competition, higher volumes, more diversified and viable financial sector) • For development of capital MARKETS (new instruments; more issue(r)s; deeper, more liquid and stable markets, domestic long-term investments, higher savings rate)

  9. Impact for industry 1 • Product design • pension fund structure • parallel products or not (II vs III pillar) • differentiation of accumulation and decumulation stages • annuity vs. programmed withdrawal Provider design • asset managers vs. insurance companies vs. banks • centralized or decentralized provision • fully or partly specialized providers • role of depositories (conflict of interests)

  10. Impact for industry 2 • Choice options • product options (unified, restricted) • switching conditions (full or partial switch or starting with new fund) • Fee structure • single or several fees (entry, exit) • restrictions –ceilings • disclosure requirements (incl expenses) Capital requirements, marketing rules etc

  11. General framework of II pillar FSA Employee LIC Guarantee fund Employer II phase ECSD Pension funds I phase Tax Board PFMC DB Accounts

  12. Depositary bank Pension funds (II+III pillar) Investment funds Individual portfolios unit holders Pension fund management company Management company

  13. Initial results for financial services industry • Real boom of asset management and investement funds (incl. PF-s) industry • More diversified financial services sector – but clearly dominated by banking sector • Increased competition (new providers) but (still) highly concentrated, lack of competition in pension fund management (fees unchanged) • Export of financial services (Competence center – FC?)

  14. Investment firms (6) • Management • companies (9) • Investment funds (24) • Pension funds (22) • Credit institutions (7) • Branches (8) • Listed shares (16) • Listed bonds (4) ASSET MANAGEMENT + BANKING STOCK EXCHANGE Financial sector framework FINANCIAL SUPERVISION AUTHORITY (FINANCIAL SUPERVISION, ISSUING GUIDELINES) MINISTRY OFFINANCE (DRAFTING LEGAL ACTS, ISSUING SECONDARY LEGISLATION) BANK OFESTONIA (ISSUING SECONDARY LEGISLATION, MACRO-SUPERVISION) I N D U S T R Y • Insurance companies • (14) • Branches (5) • Insurance brokers (23) • Insurance agents (…) INSURANCE

  15. Number of institutions in Estonian financial sector

  16. 100% 80% 60% 40% 20% % of share % of total assets Listed shares All shares held capital held by non- by non-residents residents Banking Shares * The biggest management companies of pension funds are subsidiaries of the foreign-owned banks Foreign ownership (end of 2006)

  17. ERGO LHV Hansapank SEB Sampo Pension Funds (by assets) 53% 27% 13% Hansapank SEB Trigon Investment Funds (by assets) 54% 22% 16% 6% Hansapank SEB Nordea Sampo 48% 30% 9% 9% Banks (by loans to nonfinancial sec.) Hansapank SEB Sampo ERGO Seesam Life insurance Companies (by gross premiums) 43% 25% 21% 5% 6% Financial market concentration(2006)

  18. % GDP 15 10 5 0 -5 -10 -15 -20 -25 -30 1993 1995 1997 1999 2001 2003 2005 2007* 2009* 2011* Income Goods Services Transfers Current account Estonian current account

  19. % of GDP 25 25 19,7 20 20 14,0 12,7 15 15 10,2 8,3 7,8 10 7,7 10 5 5 0 0 -5 2001 2002 2003 2004 2005 2006 2007* 2008* 2009* 2010* 2011* -5 Financial sector Private enterprises Public sector Households Total growth Investments by sectors in Estonia

  20. 100% 2003 2004 2005 2006 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Debt Insurance Assets of Stock market Loans and securities investment capitalisation* leasings*** funds* * Incl. pension funds' assets ** Stocks listed on Tallinn Stock Exchange *** Loans and leasings to households and non-financial undertakings Financial structure of Estonia (% of GDP)

  21. Financial deepening (growth rates) 70% 60% 50% 40% 30% 20% 10% 0% 2004 2005 2006 -10% GDP growth -20% Growth of debt securities Growth of insurance premiums -30% Growth of investment funds assets Growth of stock market capitalisation Growth of loans and leasings -40%

  22. 50% Credit institutions 45% Management companies 40% Investment firms 35% 30% 25% 20% 15% 10% 5% 0% 2003 2004 2005 2006 Profitability of financial institutions: (ROE in solo basis)

  23. Payments by payment instruments

  24. Investment funds sector • Total investment funds • 46 funds (18 equity, 15+7 pension, 6 debt) • 9 fund management companies • assets: 30,2 billion EEK (2 billion EUR,14% of GDP) in march 2007 • II Pillar pension funds • 15 mandatory pension funds • 5 pension fund management companies • assets: 9 billion EEK (0,6 billion EUR, 4% of GDP) in may 2007 • ca 530 000 investors

  25. Assets M EEK % of GDP 30000 14,0% 12,0% 25000 10,0% 20000 8,0% 15000 6,0% 10000 4,0% 5000 2,0% 0 0,0% 1998 1999 2000 2001 2002 2003 2004 2005 2006 Investment funds assets

  26. 3,0 b EEK 4,4 b EEK 7,2 b EEK 10,9 b EEK 18,1 b EEK 26,9 b EEK 94% 87% 71% 44% 24% 19% 51% 46% Debt funds Equity funds II pillar funds 31% III pillar funds 14% 28% 27% 23% 14% 2001 2002 2003 2004 2005 2006 Market share of investment funds

  27. 10% 2004 2005 2006 9% 8% 7% 6% 5% 4% 3% 2% 1% 0% Debt funds Equity funds Mandatory Voluntary Individual pension funds pension funds portfolios Total size of asset management in the end of 2006 – 2 781 mln EUR Asset Management (% of GDP)

  28. Size of II pillar assets (mln EUR) * 2007 – 2025: estimation

  29. 3% 2% 1% SEB 00 SEB 50 LHV DV LHV MA LHV KV LHV TS LHV UT ERGO 00 ERGO 50 Sampo 00 Sampo 25 Sampo 50 Hansa K1 Hansa K3 Hansa K2 II pillar pension fund’s fees in practice Management fee Unit issue fee Unit redemption fee

  30. Balanced Bond Equity 0,7% 0,4% 1,1% Austria 0,7% 0,4% 0,8% Belgium 1,8% 1,1% 2,1% Czech Rep. 1,1% 0,7% 1,2% Denmark 1,4% 0,9% 1,7% Estonia 1,7% 0,6% 1,5% Finland 1,2% 0,9% 1,3% France 0,6% 0,5% 1,0% Germany 2,4% 1,6% 2,8% Greece 1,9% 1,5% 2,0% Hungary 1,5% 0,9% 1,6% Italy 0,6% 0,6% 0,8% Netherlands 2,9% 2,0% 2,9% Poland 0,9% 0,8% 1,4% Portugal 1,4% 0,9% 1,7% Slovakia 1,6% 0,7% 1,7% Spain 1,1% 0,7% 1,2% Sweden 1,3% 1,0% 1,3% UK Management fees by fund type and country Source: ZEW/OEE database. Data from Feri FMI Fund File, ZEW calculations; the data refer to the maximal fees included in the prospectus.

  31. III pillar in practise • PENSION FUNDS: • 7 pension funds • 31 984 members (5% of employed) • 866 million EEK (0,4% of GDP) • average nominal investment return • around 20% (yearly basis, from beginning) • PENSION INSURANCE: • 5 life insurance companies • 81 463 contracts (13% of employed) • 1651 million EEK (0,78% of GDP)

  32. Billion EEK Pension funds % GDP 2,5 Pension insurance 1 % 2,0 0,75% 1,5 0,50% 1,0 0,25% 0,5 2000 2001 2002 2003 2004 2005 2006 III pillar assets

  33. Impact for markets • Investment rules • Quantitative vs. prudent man rule • Diversification rules • Instrument based restrictions (equity, non-listed, non UCITS funds, real estate etc) • Country based restrictions (home, EEA, third countries) • Self-investment restrictions (same group) Switching rules, taxation etc. (long-termism)

  34. Investment restrictions – main asset class rules • into equity (incl. equity funds) – up to 50% • into non-listed securities – up to 10% • into bank deposits – up to 35% • into money market instruments – up to 35% • into non-UCITS funds – up to 30% • into real estate – up to 10%

  35. Main three types of pension funds • Debt pension funds – all assets must be invested into debt instruments. Each pension fund manager must have at least one this type of fund under management. • Equity pension funds – up to 50% of assets can be invested into equity. • Balanced (mixed) pension funds, which can invest up to 25% of assets into equity.

  36. 7,43 % GDP Billion EEK 6 50% debt - 50% equity 4 % 75% debt - 25% equity 100% debt 5 4,65 3 % 4 3 2,48 2% 2 1% 0,99 1 0,17 2002 2003 2004 2005 2006 Assets of II pillar pension funds

  37. Investment rules – country based investment restrictions • no restrictions for EEA or OECD investments • securities issued by third country issuer – up to 30% • securities traded only in third country – up to 20% • currency matching rule – not less than 70% in EUR or EEK

  38. Real estate Other Equities Bank accounts 3,1% 14,8% Units of equity funds 24,5% 41,1% Bonds 12,4% 3% Units of other Money market investment instruments funds II pillar investment by asset type (2006)

  39. 100% 80% 60% Money market instruments Units of other investment funds 40% 20% 0% 30.06.2005 30.09.2004 31.03.2005 30.06.2006 31.12.2006 30.06.2004 31.12.2004 30.09.2005 31.12.2005 31.03.2006 30.09.2006 31.03.2007 Equities Units of equity funds Bonds Bank accounts Other II pillar investment by asset type

  40. USA EU-15 2,5% 54,5% Estonia 19,1% 11% 3,3% 9,8% Other Russia EU-10 (except Estonia) II pillar investment by region (2006)

  41. 100% 90% 80% 70% Other EU-10 (except Estonia) Estonia 60% Russia 50% 40% EU-15 30% USA 20% 10% 0% 30.06.2004 31.12.2004 30.09.2005 31.12.2005 31.03.2006 30.06.2006 30.09.2006 31.12.2006 30.09.2004 31.03.2005 30.06.2005 31.03.2007 II pillar investment by region

  42. % of assets Assets M EEK 1800 25% 1600 20% 1400 1200 15% 1000 800 10% 600 400 5% 200 0 30.06.2004 30.09.2004 31.12.2004 31.03.2005 30.06.2005 30.09.2005 31.12.2005 31.03.2006 30.06.2006 30.09.2006 31.12.2006 31.03.2007 Investments into Estonia (2006)

  43. Other Bank accounts Equities and units of funds 17% 1% 2% 34% Real estate 38% 8% Money market Bonds instruments Investments into Estonia (2006) • 3/4 of investments into Estonia are in real economy • 1/4 is actually invested outside of Estonia

  44. Growth of Estonian GDP and TSE index

  45. Investments to Tallinn Stock Exchange (end of 2006)

  46. Tallinn Stock Exchange (2001 – 2006): incl. shares and bonds * Incl. de-listing of Hansapank’s shares

  47. Nordic-Baltic Capital Markets Relative Size, End-2006 Stock Markets Bond Markets Capitalization Outstanding % of GDP Country % of GDP (mln €) Stock (mln €) Denmark 181 606 83% 413 202 188% Iceland 27 375 219% 13 371 107% Sweden 467 072 152% 207 631 68% Norway 232 556 87% 117 71 44% Finland 234 691 140% 55 864 33% Estonia 4 521 35% 392 3% Lithuania 7 724 33% 1 170 5% Latvia 2 039 13% 649 4%

  48. General government debt % of GDP 80 74,9 74,2 75,1 72,8 70,9 69,4 70,4 70,8 70,4 69,4 69,2 60 40 20 7,6 5,7 6,4 6,2 5,3 4,5 4,7 5,3 5,0 4,0 4,4 0 2000 2003 2005 1998 1999 1996 1997 2004 2006 2002 2001 Euro area Estonia

  49. 100% Households Debt/GDP 90% Non-financial corporations Debt/GDP 80% 70% 60% 50% 40% 30% 20% 10% 0% 1999 2000 2001 2002 2003 2004 2005 2006 Loans and leasings (% of GDP)

  50. Annual interest rates of loans granted to individuals

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