The decision by Poland’s European Union negotiating team earlier this year to accept the EU standards for the free flow of capital as they apply to second pillar pension funds is likely to lead to a dramatic shift in pension funds’ investment patterns.
Currently Poland’s open pension funds (OFEs) are allowed to invest no more than 5% of their assets under management in other OECD countries. This has shackled the development of the country’s reformed pension system. The architects of the new system, notably Professor Marek Gora, have consistently urged the government to remove this limit.
The new EU agreement means that OFEs can to invest 20% or 30% of their assets under management in other EU markets. This is likely to lead to major changes in investment patterns.
James Kernan, financial sector regulatory consultant and member of the international pensions reform board at PricewaterhouseCoopers in Warsaw, says: “Adopting the EU standard will help promote the Polish financial markets in the medium to long term. Polish capital markets will face additional competition. Pension monies will no longer be captive.
“Second, the financial sector human resources talent pool will benefit. More Polish asset managers will gain valuable experience working in larger markets – and they will be able to do this from Poland. Such experience will help asset managers better meet the expectations that future pensioners have for a sufficient retirement.”
The size of the potential exodus of pension monies is substantial. The OFEs are currently the biggest players on the Polish bourse and play a key role in the capitalisation of the Warsaw Stock Exchange (WSE). Pension funds have already invested over PLN 6bn (E1.6bn) on the WSE. Their contribution to the capitalisation is over 5%.
However, the WSE is relatively illiquid, with only one-third of capitalisation free floating. The OFEs have taken an increasingly large share (13%) of the free-float. The OFEs’ capital is also highly concentrated, with all but 5% of assets invested in some 70 stocks in a universe of 230 companies. This is not surprising in a market where 20 companies account for 80% of the capitalisation.
Kernan says that the dominance of OFEs will have a disruptive effect upon the domestic market, unless they are provided with an opportunity to invest in foreign markets. “Market positions will become increasingly difficult to liquidate. A financial instrument that cannot be liquidated is essentially worthless.”
Pension funds are also worried that the pool of investment is running dry. Krzysztof Lutostantski, president of the Pension Funds’ Chamber of Commerce, which represents the OFEs’ interests, has warned that the WSE will become too ‘tight’ for pension funds this year. Credit Suisse First Boston (CSFB) estimate that OFEs will buy shares worth between PLN3.5bn and PLN5bn on the WSE in 2002, increasing their share of the free float on the exchange from 13% to 20%.
The OFEs’ dominance of WSE is driven by the system by which OFEs receive contributions from the Social Insurance Company (ZUS). This year, the funds expect to receive PLN 11.5 bn of current contributions from ZUS. In March, the pension funds received PLN940m ($228m). These large intermittent inflows of money can dramatically boost WSE indexes, in particular the large cap WIG 20 index.
The Polish government believes that the future of the Polish capital market depends on the investment of assets collected by the OFEs. The future of the capital market is a basic element of the government’s economic strategy, which was announced in January under the slogan ‘Enterprise-Growth-Jobs.’
The government sees OFEs as the engine of this growth. It is estimated that, even without foreign investment, OFE assets are likely to grow from PLN21.6bn today to between PLN180bn and PLN230bn by 2010.
The easing of the 5% restriction could encourage a flow of this OFE money from the WSE out into foreign stock exchanges. Some estimates put the potential outflow at between PLN1.5 bn and PLN3bn.
This outflow is likely to be accelerated by the recent tie-up between the WSE and Euronext, which allows WSE members and brokerages, and their clients, to place buy and sell orders on the Warsaw bourse and Euronext. This means that pension funds will gain access to nearly 2,000 companies listed on Euronext.
If pension funds are to be persuaded to keep their money on the WSE, Kernan says, there will need to be further efficiency reforms, better corporate governance, lower transaction costs, and new products.
Pension fund members will benefit from improved levels of corporate governance, he says. The PricewaterhouseCoopers’ Opacity Study, which shows the cost of capital in 35 countries based in part on corporate governance and transparency, ranks Poland in the bottom third. Investors and borrowers – including Polish pensioners – are paying a premium for investing solely in Poland. The EU agreement is likely to change this.

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