No business in the world is possible unless one condition is met: that both clients and shareholders perceive it as being useful to them. Should one of the two partners fail to see the benefit is enough to start questioning its future.
Bloomberg announced that the treason charge against supermarkets by president Erdogan for their prices on vegetables (as inflation spiked) had the shelves emptied. Retailers refused to take the risk of selling them. This is a lesson that we see repeated on a number of years and in a number of places, and yet no one is learning from it.
Any excessive measure to control the prices of goods or services will end in having them disappear from the shelves as the client – shareholder balance is disrupted.
Please find below excerpts from my interview with Sorin Paslaru, editor in chief at the Ziarului financiar newspaper [Financial Newspaper]
Sorin Paslaru: What will happen with the private pension market in the new legal setting? The emergency ordinance was passed at the end of last year and requests private pension funds to bring in more capital to reach 10% of the amount of contributions.
Radu Craciun: The ordinance features three major provisions for the private pensions system. The first relates to giving Pillar 2 (mandatory private pensions) participants the possibility to transfer to Pillar 1 (public pension system). Please note that this covers only future contributions and that the money already paid into Pillar 2 will remain there. I want to underline the fact that it will not be possible to take out that money as cash.
SP: As of when?
RC: It is not clear. As a matter of fact, the ordinance requires implementation rules which have yet to be in place and for that reason, there are currently many questions with no answers.
The second provision refers to a sharp decrease in the commissions that pension fund administrators can apply. Certainly good news for the participants, on the face of it, but let me make one comment. Any company, regardless of where it carries out its business in the world, can only be successful if there is a win – win situation for both clients and shareholders. Whether it is the clients who lose out on their business relationship with the company, or the shareholders, the company cannot survive. Alas, the substantial drop in commissions badly hurts precisely that balance.
We apply two commissions: one on contributions and the other on assets. The commission on contributions drops five times. Initially it was up to 2.5%, but now it falls to up 1% of which 0.5% is paid to the National Pension House. So we are left with 0.5%, not taking into account the taxes due to the ASF [Financial Supervison Authority]. The commission on assets, under the ordinance, will be capped based on the investment performance in relation to inflation.
This latter basically seems like a reasonable approach, but I would add that its making sense depends on the time horizon that we look at. Financial markets are volatile, with years where investment performance is below the inflation rate. The point is to have a medium and long-term performance that exceeds inflation. As it stands, based on information in the press, the intention is to monitor performance over the short term, which doesn`t add up in my opinion.
Let me give you an example. At the end of November, the 2-year investment performance of most Pillar 2 funds was above the inflation rate. The emergency ordinance was passed in December, the stock market collapsed and, all of the sudden the investment performance slipped below inflation. And that had nothing to do with our investment skills.
(…)
SP: And if it is below inflation …
RC: …the commission hits the lowest level. Before it was a maximum 0.6% per year, and now it drops to a maximum annual value of 0.24% if performance is below inflation. And then there are other thresholds for when we exceed inflation.
SP: And the top percentage?
RC: The highest reaches 0.84% per year if we are more than 4 percentage points above the inflation rate.
SP: Higher than the initial commission …
RC: Four percentage points above inflation is easier said than done …
SP: Won`t they balance each other out? One year can be worse, as it is now when you apply 0.24%, and on some other years, when markets rebound, you may collect 0.8%.
RC: A company does not want this volatility when it puts together the budget, because income predictability is crucial. If I am uncertain of the size of my future revenues, then my investment plans will be extremely conservative. This is why the association advocated before the ASF that a 10-year time horizon, but no less than five, should be considered when performing the analysis. A 5-year span to help judge how well a pension fund performs seems very reasonable to me.
SP: So until now, out of RON 100 paid, RON 97.5 used to be invested and now it`s 99. That is an extra RON 1.5 for each contribution.
RC: This is why I said that on the face of it this is a good thing. On the face of it because participants need as well pension funds to exist. This is why we must have a win-win partnership. If only one side wins and the other loses, the business model is not sustainable.
Unfortunately, this is not the end of it. On the one hand we see plummeting pension funds revenues, and on the other a third provision which is like an atomic bomb on the system: the capital requirement. The minimum capital that a pension fund will have to have is 10% of contributions paid to the fund they manage. At first glance, the understanding is that they refer to historical contributions, but I think that there is room for interpretation as to whether the law-maker may have had the annual amount of contributions in mind.
If they meant historical contributions, however, it means that private pension funds need to bring in nearly 800 million extra money. An unprecedented situation, I think, in the post-revolutionary Romania.
SP: Compared to what?
RC: The increase would be 11 fold. (…) On average. There are funds which need to bring in 20 or 22 times more capital on top of what`s already here
SP: What is the current minimum capital? EUR 4 million…
RC: That`s correct, and 1.5 million for Pillar 3.
(…)
SP: A bank has a minimum required capital of EUR 10 million…
RC: I agree, but with a word of caution. Clients` banking assets are on the bank`s balance sheet. In a pension fund, the fund is kept off the administrator`s balance sheet. I fail to understand the financial justification of this capital requirement. Do not forget that administrators also set provisions aside to guarantee their obligations, which is still tied up capital as they come from profits. So the question is: if I set up provisions, why do I have to shore up the capital? If they hadn`t been in place, the provisions could have been distributed as dividends to shareholders.
(…)
Why do we need such a dramatic rise in capital given the circumstances, is beyond me. Especially when the impact on administrators` business models is so dramatic that I am convinced that many are pondering whether to keep doing business in Romania or not.
People in the business world are familiar with an indicator called Return on Equity. And we are in a situation where the „return” is collapsing due to commissions, but the „equity”, the fraction denominator increases several times. Under these circumstances, our estimates based on historical data and publicly available information, put the industry`s return on equity at maybe around 5%.
SP: How much is it now?
RC: This is different for each pension fund.
SP: On average?
RC: I think that it is around 30%.
SP: Considerable…
RC: Considerable, but please note that the initial investments have yet to be recouped. A 5% return on equity is equal to a government bond yield. So the logical question is: if you had RON 100, would you put it into a business that carries risks with a 5% return or a government bond that would pay the same? This is rhetorical but it shows the question that ultimately faces our shareholders and fund administrators.
SP: What have been the reactions so far from BCR Pensii shareholders or from other fund administrators?
RC: I think that it is still early days to talk about a decision, but it will be a very hard decion to take as many administrators have not recovered their initial investments, 10 or 11 years on.
SP: BCR Pensii is in a better position. It has a capital of RON 88 million, and it should bring in another RON 181 million.
RC: True, but if we look at the return on equity indicator, our position is just as bad.
SP: And are shareholders willing to contribute an extra EUR 40 million?
RC: I cannot answer that, especially that the decision lies with the shareholders, not with us. Everything will depend on the strategy each administrator is going to have. The deadline for paying half of the capital contribution is June.
SP: That money should be brought and kept in Romania, is that right?
RC: Yes, it is tied up here, in government bonds or bank deposits.
(…)
SP: Maybe the Romanian government thought along the lines of: If you want to manage EUR 1 Bn, you should put in EUR 100 million. Is that much? Contribute a tenth of the amount that you manage …
RC: I have already heard the whole „is it much, is it little” idea when we talked about commissions…. Let`s use a benchmark when we say it, and the indicator taken by shareholders is return on equity. And they say, „What`s the point of doing business at a rate of 5 or 6%. I`m better off putting it in government bonds and take no chances.” This is how „much” and „little” are being looked at. In the scenario where commissions remained the same, business would have looked different. But as you cause the commissions to plummet while raising capital requirements many times over, the whole story takes a completely different turn.
SP: What should we expect by June?
RC: What I believe should happen and not in June, because shareholders will not wait until June for their decision, is to first establish whether reporting for calculating the capital is done based on annual contributions or contributions over the past 11 years. If capital includes contributions in the previous year, then I believe that our plight may not be so dire, although even in this case we should each do our homework. But if we talk about historical contributions then the situation will be overwhelming.
SP: What will happen?
RC: I think we can imagine a scenario where one or more administrators may think it is not worth it. But decisions of course, are individual, up to each administrator. The one million dollar question that they will be asking will be: Should I take the risk and wait out the entire madness? Will it last one year, two or will it ever end?
(…)
SP: Is it likely to see Pillar 2 shut down completely in the aftermath of this provision?
RC: I cannot answer that. What I can say is that right now there is legislation for when an administrator wants out, and we`ve seen that happen in the past. There is a special administrator assigned who temporarily takes over the assets of the exiting fund, and manages them before they are distributed to the remaining administrators on the market. If the market is left with no pension fund to whom to allocate the assets….I do not have an answer to that. There is no piece of legislation for such an extreme case.
SP: So we see uncertainty in a very serious situation. It`s EUR 10 Bn, a good part of Romanian wealth, isn`t it?
RC: The only savings plan for retirement for 50% of them.
SP: As good or bad as it is. EUR 1,000 – 1,500 for each on average.
RC: Averages may be deceiving. There are many who stopped after a few contributions. But if we take the contributions on an average wage paid monthly for 11 years, then the accrued amounts are more in the range of RON 12,000.
(…)
SP: What implications do you see for the capital market?
RC: What chances would all the IPOs would have had, had it not been for the private pension funds? The largest institutional investor in Romania will come out weakened by the circumstances and, as a result, a significant source of funding for Romanian companies will be gone.
(for the full interview in ROmanian click here)
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