International Forum on Pension Reform

June, 2007

(Re)designing regulatory framework for (Re)designing regulatory framework for pension reform and development ofpension reform and development of

financial markets: Estonian experiencefinancial markets: Estonian experience

Veiko Tali Ministry of Finance of Estonia

Impact of pension reform for development of financial markets

the earlier you will start with reform – the the earlier you will start with reform – the higher the impact - higher the impact - comparing with the relative level of development of financial markets

the bigger the potential financial volumes the bigger the potential financial volumes – the higher the impact - – the higher the impact - mandatory character and level of contributions

the smaller the country – the higher the the smaller the country – the higher the impact ? impact ?

Impact of pension reform for development of financial markets

the long term (30) impact is more the long term (30) impact is more important than short (5) and medium (10-important than short (5) and medium (10-15) term one 15) term one (adaptivity is crucial)

redesigning possibilities can be restricted redesigning possibilities can be restricted (eg. justified expectations of voluntary switchers)

Flexibility versus reliability ?

Reformed pension system

FIRST

publicly managed

compulsoryPAYG

ER-16 %

1999/2000

SECOND

privatelymanagedOptional/

compulsoryfunded

4(ER)+2 (EE)

2002

THIRD

privately managedvoluntaryfunded

1998

Preconditions for implementation of pension reform (II pillar)

Regulatory frameworkRegulatory framework

Supervisory capabilities Supervisory capabilities

Market infrastructure (registration, Market infrastructure (registration, central depository (1995), stock central depository (1995), stock exchanges (TSE in 1996)exchanges (TSE in 1996)

Level of market development (banks, Level of market development (banks, insurance)insurance)

Financial Supervisory Authority

Financial Supervisory Authority (2002)

Banking Inspectorate

(dep of BoE)

SecuritiesInspectorate

(dep of MoF)

InsuranceInspectorate

(dep of MoF)

DepositaryBanks

ManagementCompanies

Insurance companies

Reform of financial supervision - FSA

Integrated (at Bank of Estonia) Integrated (at Bank of Estonia)

Independent (special two-level Independent (special two-level management structure, 3/4 appointment) management structure, 3/4 appointment)

Financed by market participants Financed by market participants (budget ca 3 million euro) (budget ca 3 million euro)

Competent and capable (70 staff)Competent and capable (70 staff)

Impact of pension reform design

For development and structure of financial For development and structure of financial services services INDUSTRY INDUSTRY – – (higher level of competition, higher volumes, more diversified and viable financial sector)

For development of capital For development of capital MARKETS MARKETS (new instruments; more issue(r)s; deeper, more liquid and stable markets, domestic long-term investments, higher savings rate)

Impact for industry 1

Product design 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 Provider design asset managers vs. insurance companies vs. banks centralized or decentralized provision fully or partly specialized providers role of depositories (conflict of interests)

Impact for industry 2

Choice options Choice options product options (unified, restricted) switching conditions (full or partial switch or starting with new fund)

Fee structure Fee structure single or several fees (entry, exit) restrictions –ceilings disclosure requirements (incl expenses)

Capital requirements, marketing rules etc Capital requirements, marketing rules etc

General framework of II pillar

Employer

Employee

Tax BoardECSD

Accounts

FSA

LIC

Pension funds

DB

II phase

Guarantee fund

PFMC

I phase

Pension fund management company

Management company

Investment funds

Individual portfolios

Depositary bank

Pension funds(II+III pillar)

unit holders

Initial results for financial services industry

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

Financial sector framework

MINISTRY OFMINISTRY OF FINANCEFINANCE(DRAFTING LEGAL ACTS,

ISSUING SECONDARY LEGISLATION)

FINANCIAL SUPERVISIONFINANCIAL SUPERVISIONAUTHORITYAUTHORITY

(FINANCIAL SUPERVISION, ISSUING GUIDELINES)

BANK OFBANK OF ESTONIAESTONIA(ISSUING SECONDARY

LEGISLATION, MACRO-SUPERVISION)

• Investment firms (6)Investment firms (6)• Management Management companies (companies (99))• Investment fundsInvestment funds (24) (24) • Pension fundsPension funds (22) (22)

ASSET ASSET MANAGEMENT +MANAGEMENT +

• Insurance companies Insurance companies (1(144))• Branches (Branches (55))• Insurance brokers (Insurance brokers (2323))• Insurance agents (…)Insurance agents (…)

INSURANCEINSURANCE

• Credit institutions (7)Credit institutions (7)• Branches (Branches (88))

BANKINGBANKING

• Listed shares (1Listed shares (166))• Listed bonds (Listed bonds (44))

STOCK STOCK EXCHANGEEXCHANGE

I N D U S T R YI N D U S T R Y

Number of institutions inEstonian financial sector

2002 2003 2004 2005 2006Credit institutions 7 7 9 13 15

incl. foreign branches 1 1 3 6 8Management companies 7 7 7 7 9Investment funds 17 15 15 22 22Pension funds 19 21 22 20 22Investment firms 6 5 5 6 7

incl. foreign branches - - - - 1Insurance companies 13 13 13 15 19

incl. foreign branches - - - 3 5SE - - - - 1

Stock exchange issuers 14 18 18 25 21

Foreign ownership (end of 2006)

20%

40%

60%

80%

100%

% of sharecapital

% of total assets Listed sharesheld by non-

residents

All shares heldby non-residents

Banking Shares

* The biggest management companies of pension funds are subsidiaries of the foreign-owned banks

Financial market concentration(2006)

53%

Hansapank

27%

SEB

13%

Sampo ER

GO

LH

V

Investment Funds(by assets)

PensionFunds (by assets)

Banks(by loans to nonfinancial sec.)

Life insurance Companies(by gross premiums)

54% 22% 6%

Hansapank SEB

16%

Trigon

48% 30% 9%

Hansapank SEB

9%

Nordea Sampo

43%

Hansapank

25%

SEB

21%

Sampo

5%6%

ERGOSeesam

Estonian current account

-30

-25

-20

-15

-10

-5

0

5

10

15

1993 1995 1997 1999 2001 2003 2005 2007* 2009* 2011*

% GDP

Goods Services Income

Transfers Current account

Investments by sectors in Estonia

19,7

10,2

7,77,88,3

14,012,7

-5

0

5

10

15

20

25

2001 2002 2003 2004 2005 2006 2007* 2008* 2009* 2010* 2011*

% of GDP

-5

0

5

10

15

20

25

Private enterprises Public sector Financial sector

Households Total growth

Financial structure of Estonia (% of GDP)

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Debtsecurities

Insurance Assets ofinvestment

funds*

Stock marketcapitalisation*

Loans andleasings***

2003 2004 2005 2006

* Incl. pension funds' assets

** Stocks listed on Tallinn Stock Exchange

*** Loans and leasings to households and non-financial undertakings

Financial deepening (growth rates)

-40%

-30%

-20%

-10%

0%

10%

20%

30%

40%

50%

60%

70%

2004 2005 2006

GDP growthGrowth of debt securitiesGrowth of insurance premiumsGrowth of investment funds assetsGrowth of stock market capitalisationGrowth of loans and leasings

Profitability of financial institutions:(ROE in solo basis)

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

2003 2004 2005 2006

Credit institutions

Management companies

Investment firms

Payments by payment instruments

0%

20%

40%

60%

80%

100%31

.12.

97

31.0

5.98

31.1

0.98

31.0

3.99

31.0

8.99

31.0

1.00

30.0

6.00

30.1

1.00

30.0

4.01

30.0

9.01

28.0

2.02

31.0

7.02

31.1

2.02

31.0

5.03

31.1

0.03

31.0

3.04

31.0

8.04

01/3

1/05

06/3

0/05

11/3

0/05

04/3

0/06

09/3

0/06

02/2

8/07

Cash payments Card payments Direct debit

Mobile phone payments Standing order Paper based credit order

Telebank credit order Internet bank credit oders Other

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

Investment funds assets

0

5000

10000

15000

20000

25000

30000

1998 1999 2000 2001 2002 2003 2004 2005 20060,0%

2,0%

4,0%

6,0%

8,0%

10,0%

12,0%

14,0%

Assets M EEK % of GDP

Market share of investment funds

2002 2003 2004 2005

87%

14%

71%

14%

31%

44%

23%

46%

24%

27%

Debt funds

Equity funds

II pillar funds

III pillar funds

2001

94%

4,4 b EEK3,0 b EEK 7,2 b EEK 10,9 b EEK 18,1 b EEK

51%

19%

28%

2006

26,9 b EEK

Asset Management (% of GDP)

0%

1%

2%

3%

4%

5%

6%

7%

8%

9%

10%

Debt funds Equity funds Mandatorypension funds

Voluntarypension funds

Individualportfolios

2004 2005 2006

Total size of asset management in the end of 2006 – 2 781 mln EUR

Size of II pillar assets (mln EUR)

0

2 000

4 000

6 000

8 000

10 000

12 000

14 00020

04

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

2019

2020

2021

2022

2023

2024

2025

* 2007 – 2025: estimation

II pillar pension fund’s fees in practice

Management fee

Unit issue fee

1%

2%

3%

SE

B 00

SE

B 50

ER

GO

00

ER

GO

50

Han

sa K

1

Han

sa K

2

Han

sa K

3

Sam

po

00

Sam

po

25

Sam

po

50

LH

V D

V

LH

V M

A

LH

V K

V

LH

V T

S

LH

V U

T

Unit redemption fee

Management fees by fund type and country

Balanced Bond EquityAustria 0,7% 0,4% 1,1%Belgium 0,7% 0,4% 0,8%Czech Rep. 1,8% 1,1% 2,1%Denmark 1,1% 0,7% 1,2%Estonia 1,4% 0,9% 1,7%Finland 1,7% 0,6% 1,5%France 1,2% 0,9% 1,3%Germany 0,6% 0,5% 1,0%Greece 2,4% 1,6% 2,8%Hungary 1,9% 1,5% 2,0%Italy 1,5% 0,9% 1,6%Netherlands 0,6% 0,6% 0,8%Poland 2,9% 2,0% 2,9%Portugal 0,9% 0,8% 1,4%Slovakia 1,4% 0,9% 1,7%Spain 1,6% 0,7% 1,7%Sweden 1,1% 0,7% 1,2%UK 1,3% 1,0% 1,3%

Source: ZEW/OEE database. Data from Feri FMI Fund File, ZEW calculations; the data refer to the maximalfees included in the prospectus.

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)

III pillar assets

Pension funds

Pension insurance

0,5

1,5

2,0

1,0

2,5

Billion EEK

2002 2003 2004 200520012000

0,25%

0,75%

1 %

% GDP

0,50%

2006

Impact for markets

Investment rules 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)Switching rules, taxation etc. (long-termism)

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%

Main three types of pension funds

DDebt 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 fundsBalanced (mixed) pension funds, which can invest up to 25% of assets into equity.

Assets of II pillar pension funds

2002

0,17

2003

0,99

2004

2,48

2005

4,65

2

1

3

4

5

Billion EEK

50% debt - 50% equity

75% debt - 25% equity

100% debt

6

2006

7,43

1%

2%

3 %

% GDP

4 %

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

II pillar investment by asset type (2006)

Equities

Units of equity

funds

Units of other

investment

funds

Money market

instruments

Bonds

Bank accountsReal estate Other

41,1%

3,1% 14,8%

12,4%3%

24,5%

II pillar investment by asset type

0%

20%

40%

60%

80%

100%30

.06.

2004

30.0

9.20

04

31.1

2.20

04

31.0

3.20

05

30.0

6.20

05

30.0

9.20

05

31.1

2.20

05

31.0

3.20

06

30.0

6.20

06

30.0

9.20

06

31.1

2.20

06

31.0

3.20

07

Equities

Units of equity funds

Units of other investment funds

Money marketinstruments

Bonds

Bank accountsOther

II pillar investment by region (2006)

USA

EU-10 (except

Estonia)

RussiaOther

Estonia

EU-15

54,5%

9,8%

2,5%

19,1%

3,3%11%

II pillar investment by region

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%3

0.0

6.2

00

4

30

.09

.20

04

31

.12

.20

04

31

.03

.20

05

30

.06

.20

05

30

.09

.20

05

31

.12

.20

05

31

.03

.20

06

30

.06

.20

06

30

.09

.20

06

31

.12

.20

06

31

.03

.20

07

Other

Estonia

Russia

EU-10 (except Estonia)

EU-15

USA

Investments into Estonia (2006)

0

200

400

600

800

1000

1200

1400

1600

180030

.06.

200

4

30.0

9.20

04

31.1

2.20

04

31.0

3.20

05

30.0

6.20

05

30.0

9.20

05

31.1

2.20

05

31.0

3.20

06

30.0

6.20

06

30.0

9.20

06

31.1

2.20

06

31.0

3.20

07

5%

10%

15%

20%

25%Assets M EEK % of assets

Investments into Estonia (2006)

Equities and units of funds

34%

Money market

instruments

8%

Bonds

38%

Real estate2%

Bank accounts

17%

Other

1%

3/4 of investments into Estonia are in real economy 1/4 is actually invested outside of Estonia

Growth of Estonian GDP and TSE index

6 000

7 000

8 000

9 000

10 000

11 000

12 000

13 000

14 000

1.01.00 1.01.01 1.01.02 1.01.03 1.01.04 1.01.05 1.01.06 1.01.07

0

100

200

300

400

500

600

700

800

900

GDP (mln EUR)

Tallinn Stock Exchange index

Investments to Tallinn Stock Exchange (end of 2006)

Sweden20%

UK5%

Estonia52%

Latvia4%

USA3%

Other countries7%Finland

3%

Luxembourg6%

Tallinn Stock Exchange (2001 – 2006):incl. shares and bonds

* Incl. de-listing of Hansapank’s shares

0

500

1 000

1 500

2 000

2 500

3 000

3 500

4 000

4 500

5 000

2001 2002 2003 2004 2005* 2006

0

10 000

20 000

30 000

40 000

50 000

60 000

70 000Market capitalization (mln EUR)

Turnover (mln EUR)

No of transactions (on the right scale)

Nordic-Baltic Capital Markets Relative Size, End-2006

 

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%

Bond MarketsStock Markets

CountryOutstanding

Stock (mln €)% of GDP

Capitalization

(mln €)% of GDP

General government debt

70,9

7,6 6,4 5,7 6,2 4,7 4,4 5,3 5,3

70,469,269,470,472,874,274,975,1

5,0

0

20

40

60

80

1996 1997 1998 1999 2000 2001 2002 2003 2004

% of GDP

Euro area Estonia

69,4

4,5

70,8

4,0

2005 2006

Loans and leasings (% of GDP)

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

1999 2000 2001 2002 2003 2004 2005 2006

Households Debt/GDP

Non-financial corporations Debt/GDP

Annual interest rates of loans granted to individuals

0,0%

5,0%

10,0%

15,0%

20,0%

25,0%

30,0%30

.04.

97

31.0

8.97

31.1

2.97

30.0

4.98

31.0

8.98

31.1

2.98

30.0

4.99

31.0

8.99

31.1

2.99

30.0

4.00

31.0

8.00

31.1

2.00

30.0

4.01

31.0

8.01

31.1

2.01

30.0

4.02

31.0

8.02

31.1

2.02

30.0

4.03

31.0

8.03

31.1

2.03

30.0

4.04

31.0

8.04

31.1

2.04

30.0

4.05

31.0

8.05

31.1

2.05

30.0

4.06

31.0

8.06

31.1

2.06

30.0

4.07

Consumer credits EEK Consumer credits EUR Housing loans EEK Housing loans EUR

Financial deepening (growth rates)

-40%

-30%

-20%

-10%

0%

10%

20%

30%

40%

50%

60%

70%

2004 2005 2006

GDP growthGrowth of debt securitiesGrowth of insurance premiumsGrowth of investment funds assetsGrowth of stock market capitalisationGrowth of loans and leasings

Savings in Estonia

%GDP

0

10

20

30

40

50

2000 2001 2002 2003 2004 2005 2006 2007* 2008* 2009* 2010* 2011*

Domestic privatesavings

Domestic public savings

Foreign savings

Investment return of II pillar PF’s

Debt instr PF

3% 3,5%

Mixed PF’s

6,6%9,3%

Equity PF’s

11%

15,5%

5%

15%

20%

10%

From beginning

Last 12 months

Investment return of II pillar PF’s

2002 2003 2004 2005

100

150

120

130

110

140

EPI 100

EPI 75

EPI 50

EPI

2006

160

Initial conclusions for capital market development

Overregulated – too strict quantitive Overregulated – too strict quantitive investement restrictions – negative real investement restrictions – negative real rate of returns of debt pension funds.rate of returns of debt pension funds.

Lack of long-term views in investment Lack of long-term views in investment strategies (short-termism) strategies (short-termism)

Moderate level of impact to domestic Moderate level of impact to domestic capital market (no corporate and capital market (no corporate and mortgage bond market boom, no new mortgage bond market boom, no new long-term instruments) long-term instruments)

Redesigning regulatory framework

Removing investment restrictionsRemoving investment restrictions- real estate and real estate funds up to 40% - venture capital funds up to 50%(+20%)- ? increasing 50% equity ceiling (70% or 100% for equity funds) for III pillar funds already 100% - ? allowing 10 % equity for most conservative fund (10 %, 40%, 70% instead of 0,25,50)

Making fee structure more transparent Making fee structure more transparent

removal of entry fee removal of exit fee if 5 years before retirement regressive ceilings for management fee

Payment phase (annuities etc) Payment phase (annuities etc)

Contacts

www.pensionikeskus.ee

veiko.tali@fin.ee