Bulgaria’s first privately managed pension funds were established in 1994. But no special law regulated their activities until 1999. Unlike other countries, which did not allow foreign investment during the initial stages of their private pension systems, the Bulgarian legislature looked at this issue in 1999 when the special second and third pillar laws were adopted.
Foreign investment restrictions state that:
q A pension company may not invest more than 10% of third-pillar pension fund assets abroad in government bonds, municipal bonds and securities tradable in regulated stock markets.
q A pension company may not invest more than 5% of second-pillar pension fund assets abroad in government bonds and municipal bonds and not more than 5% of second-pillar pension fund assets in securities tradable at regulated stock markets.
Though the limits on foreign investment reflect restrictions applied in other countries, when one bears in mind the permanent shortage of new investment in the Bulgarian economy, such legislation should be viewed as something of a breakthrough given the prevailing domestic view on pension fund investment.
Official data on the investment allocations of third pillar pension funds may help to answer the ‘obstacle-versus-excuse’ argument. As at 30 June 2000, Bulgarian third-pillar pension fund assets are invested as follow: government bonds 57%; deposits 27.5%; municipal bonds 9.5%; real estate 4%; securities tradable at regulated stock markets 1%; other 1%.
From 30 June 2000 to 31 March 2001, although investments in government bonds decreased by 16.95%, they still account for more than half of the portfolio. Bank deposits increased by 9.92% and municipal bonds doubled, as did real estate. Investment in securities tradable at regulated stock markets is not significant. There are no investments abroad.
It is obvious that the lack of diversification of the investment portfolio with regard to investments abroad is in fact a continuation of a total lack of portfolio diversification.
One reason for this might be a general inertia in investment thinking effected by the legal requirement introduced in 1994, which made it compulsory for third-pillar pension institutions to invest 85% of their contribution receipts each month in government bonds. The minimum maintained throughout the fiscal year had to be at least 40%. From 1998, when tax amendments were introduced, until 1999 when the special third-pillar law was adopted, there were no investment restrictions at all. By virtue of the third-pillar legislation adopted in July 1999 and second-pillar legislation adopted in December 1999, a detailed set of investment rules were prescribed. The requirement to invest in government bonds is now less severe: at least 50% in securities issued or guaranteed by the government, and/or bank deposits and mortgage bonds issued by banks (currently mortgage bonds issued by banks apply to third-pillar funds only). In practice, the “and/or” clause makes it possible not to invest in government bonds at all. However, the majority of private pension fund assets are still in domestic government bonds.
It is clear that foreign investment is restrained by the requirement that investment abroad should be made following the law established by the minister of finance in accordance with the governor of the Bulgarian National Bank. However, the required law has not yet been established.
Characteristic of this international reluctance on the part of Bulgarian pension companies is the fact that, amidst the stream of opinions, suggestions and demands put to the respective government bodies and institutions for the past three years, the actual question of speeding up the process of establishing the necessary law for pension fund investment abroad has not been decisively put forward.
In view of Bulgaria’s desire for EU membership, the presence of a legal possibility for pension fund investment abroad would not be enough. A real move towards the abolition of quantitative restrictions and the introduction of qualitative ones is necessary.
The attitude of Bulgarian legislation towards the investment of private pension fund assets abroad should be placed in the context of a certain foresight in Bulgarian law which requires that pension fund assets “are managed with the care of a diligent trader complying with the principles of safety, liquidity, profitability and diversification”. It could be asserted that if regulatory stringency and precaution are traditional, Bulgarian legislators not only followed this tradition, but laid the foundations of principles that exist in countries with highly developed private retirement provision markets.
There are other issues that fuel the obstacle/excuse debate over the foreign investment of Bulgarian private pension funds. Some believe that existing restrictions for private pension fund investment abroad may be overcome effectively by investing in Bulgarian depositary receipts (BDRs). They blame pension companies for not making use of this option. However, their opponents point to the legal uncertainty about what type of investment BDRs are: domestic or foreign.
BDRs are investment instruments which were recently introduced into the Bulgarian financial market and are tradable certificates of ownership over securities issued abroad. Issued by Bulgarian financial institutions, BDRs possess all the elements of ownership over the basic assets issued abroad. All the deals with BDRs are carried out on the Bulgarian stock exchange.
BDRs are considered to be a manageable and inexpensive means of purchasing foreign securities. The primary and secondary trading is done on a local level in local currency.
Of course, there are drawbacks and risks associated with investment in BDRs. The investment in securities of foreign companies itself brings forward a certain investment risk. Excluding the risk associated with exchange rate fluctuations, the risk in BDR investment might not be larger than the one taken by investments in native issues.
Statements by lawyers of the State Insurance Supervisory Agency (SISA) and by representatives of the National Social Security Institute (NSSI) at a round table on 9 March 2001 in Sofia, were clear that BDRs are not Bulgarian securities and are therefore under the same foreign investment restrictions. The argument is that BDRs are certificates of ownership over securities issued abroad and therefore represent investment of pension assets abroad.
Lawyers of some investment intermediaries took an opposing view, stating that since the BDR issuer is a Bulgarian financial institution, BDRs should be treated as Bulgarian securities and therefore the limits on foreign investment should not apply to them
Legal problems require legal solutions. However, it is important to point out that those pension companies present at the round table demonstrated absolute indifference to BDRs. Keeping in mind their extremely active participation in public debates on all the legal issues related to the activities of pension companies over the past seven years, lack of interest in this investment instrument is certainly not due only to inadequate legal regulation.
Despite the different interpretation of the restrictions on foreign investment of Bulgarian pension fund assets, these restrictions appear not to be the decisive reason for the lack of international orientation of the pension companies licensed to establish and managed second and third pillar pension funds in the country.
One explanation might be the annual average investment income of 7.08% which pension companies allocated to their clients’ individual retirement accounts for 2000 under the current non-diversified and domestically biased portfolio. It exceeds the annual average interest rate on bank deposits at 4.24% for 2000. The annual average central interest rate for 2000 was 3.85%. New investment instruments including foreign investment are always welcome if they offer better investment opportunities.
As has been seen, there are particular legal obstacles for the foreign investment of Bulgarian private pension funds. Pension companies are playing in a lonely domestic market. Yet this seems not just to be excused by inadequate foreign investment regulation. Ultimately, the pension companies seem to feel satisfied with their domestic investments.
Nikolai Slanchev is chief retirement scheme analyst at Allianz Bulgaria Pension Company in Sofia

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