Spain is due another round of pension reform and the government is doing its best to smother debate. They’ve got good reason to. The economics are simple, the sums don’t add up. “When is someone in the parliament at Moncloa going to admit they can’t pay state pensions?,” wonders David Burns, head of Schroder Investment Management in Spain. “It’s not exactly an election winner.” Burns and his fellow asset managers have long given up waiting for the government to break into the pension problem. They don’t need to now the mutual fund market is keeping them happy. Still, you can sense their frustration. Spanish pensions is a potentially rich market completely failing to materialise.
Only 600,000 people are members of occupational pension schemes in Spain and only 5% of companies offer pensions. Company schemes have E22.4bn under management. The main reason for that is lower paid workers who retire at 65 can get a public pension of 92% of final salary. At the moment the system generates a surplus. Much of that is channelled into a reserve fund which has now reached E9bn. But the social security system is projected to go into deficit around 2015. And by 2050, according to estimates from the Centre for Strategic and International Studies (CSIS) Spain’s public pension spending then will be 25% of GDP. The reserve fund doesn’t amount to much in terms of the potential deficits; E9bn is two months’ worth of current payments. There are less hysterical projections than the CSIS’s around, but the message is clear. This is not no time to avoid action.
Pension reform in Spain is built around the Pact of Toledo, an agreement that was first established in 1995. A revised version of the pact was signed at the beginning of October by the Pact of Toledo commission, a cross party parliamentary body, which takes soundings from business, unions, and other interest groups. The new edition extends the agreement for another five years and adds a further seven recommendations to the 15 contained in the original document.
“They will be debated by the parties from 2004 onwards to decide the best way to fulfil the objectives of the Pact of Toledo, essentially, to preserve our pensions system,” says David Carrasco, director of business development at BBVA Pensions.
It’s all pretty vague, and deliberately so. There’s a general election coming up next year, which makes real debate practically impossible.
There are however changes in prospect at the micro level. This year’s financial law set out in principle new requirements for pension fund investment and for communication between managers and the fund members. Those principles need to be elaborated in detail in a further ruling known as a reglamiento. That document is currently circulating in draft form.
Although the politics of the situation are complex and controversial, the economics are very simply: in order to meet its future pension liabilities, the Spanish government will either need to reduce benefits or increase social security contributions substantially.
“It’s clear what’s needed,” says the director of one Spanish pension fund manager. “There needs to be more proportionality between contributions and benefits in the public system.” This assessment shouldn’t be a source for genuine ideological division, even if the eventual course of action may be.
But the political parties aren’t likely to face up to it. And the banks see it as a political issue which can only do them harm. They are all right of course. Whoever does speak up is likely to be punished by the public. Whether that means voting for another party or moving to another bank, whoever breaks the deadlock stands to lose. But everyone else, politically and commercially, would benefit if the process was moved forward by a bit of straight talking.
“I believe there will be movement towards private provision of pensions,” comments that same pension fund manager, “but it won’t be a dramatic step forward. Small steps are less controversial.”
If you look beyond the immediate and considerable obstacles facing Spanish pensions, there is tremendous growth potential. It’s worth repeating: only 5% of employers have company pension plans. There is a big market waiting to develop given the right environment.
Part of the problem is that Spanish companies are already footing the bill for one of the more generous social security systems. They are reluctant to set up pension funds as well.
“The government could offer further tax breaks to sponsors,” says Constantino Gomez, an investment consultant with Mercer in Madrid. “But pension plans are still an additional labour cost.”
The first stage in creating that right environment will be reducing social security contributions. At present, employers contribute 31% of salary while employees add another 6.4%. What’s more, the system is in surplus, and, perhaps worst of all, some of those surplus funds are being channelled into projects such as job creation schemes which as seen as essentially political (the Pact of Toledo recommends separate funding for so-called political schemes).
The government has introduced measures to make pension plans more flexible for SMEs. They’ve streamlined the administrative process and changed the regulations governing the control committees. Now the company and employees can have equal representation, whereas previously they required a majority of workers. “This makes employers more willing to set up schemes,” says Angel Martinez-Aldama, general manager of Inverco, the Spanish association for pension asset management.
Cutting employer contributions is a necessary but insufficient condition for stimulating corporate plans. It will also require pressure from employees to force business to set up plans. At present organised labour is more likely to press for increased salaries than other benefits because pay is still low in many parts of the Spanish economy, while pension benefits, of course, are extremely generous.
The unions therefore won’t press for company pension plans unless they see that public pensions are in danger, which brings us back to the same problem: to send out those signals would be political suicide for any government.
Of course, there’s no reason why the shortfall has to be met by the private sector. “There are a few different measures that could help,” says Gomez. Despite its centre right government, Spain retains many socialist instincts, a flair for bureaucracy and a mistrust of the private sector being principle among them.
Unlike in France, where the Fonds de Reserves de Retraite, has been getting asset managers excited, the Spanish reserve fund is not a likely source of business. Outsourcing its management to capitalists would provoke immediate condemnation from the broad range of parties who reached consensus on its creation. So ultimately the political solution may well involve an increase in contributions one way or another to partially offset the unavoidable cut in state benefits.
The industry isn’t optimistic that the growth in occupational schemes is going to materialise any time soon. The externalisation process, which was all but completed at the end of last year brought in some E18bn, divided equally between insurers and pension plans. But that is likely to prove a one-off boost to assets.
“Once the transition period is over we don’t expect the second pillar to increase as much as over the last few years,” says Aldama. “We expect to see pillar three plans driving growth.” Aldama estimates pillar two will grow at around E1.5bn a year and pillar three at twice that.
Individual plans are an easier sell for foreign managers who are already selling retail products. “If you’ve already got your fund distribution capability in place then you can effectively double up,” says Burns. But there’s still a problem with individual plans. Participants already outnumber those in occupational schemes by a factor of ten, but they’ve generated only marginally more assets.
“The personal plans are voluntary,” points out Gomez. “How much more pressure can you exert on individuals? They already get an enormous tax break on contributions.” The way to exert more pressure of course, would be to mount a major publicity campaign. And that would mean admitting there’s a problem. “The big development has to be in pillar two,” says Gomez.
The broader problem for asset managers is not just the slow pace of reforms, but the margins available for what is out there. “Winning pension money in Spain is dependent on the level of pain you can tolerate,” says Burns.
The problem, says Burns, is that the banks that dominate the pensions market view the pensions business within the context of their overall relationship with corporate clients. They might run their payroll, do car loans and handle capital markets. “Within the overall scheme of things, the pensions business doesn’t add up to much, so they tend to throw it in as a bit of a sweetener and that means pretty racy margins,” Burns complains. “At the fee levels available, I just don’t think it’s worth it.”
“Asset management has so far been like a commodity,” explains Mariano Colmenar, Spanish banking analyst with Credit Suisse First Boston. One manager’s performance is seen as much the same as any other’s. “Pension funds need to recognise that high quality management can produce superior returns and therefore it is worth paying for,” says Gomez.
Pension assets might be a source of continual frustration for asset managers. But they can afford to be philosophical about it while the retail business is doing as well as it is currently.
The total volume of assets under management in domestic funds is climbing again (by nearly 9% in the first half of 2003) after seeing a steady decline since the beginning of 2000. Those figures exclude the sale of Luxembourg SICAVs, the preferred vehicle for most foreign managers. SICAV sales were given an extra boost this year when a tax benefit included in the new financial law was extended to cover foreign registered funds (after intensive lobbying by the foreign managers).
Schroders has had a record year with E600m of new business, almost all of it in fixed income. The ‘Converging Europe Fund’ has been a particular hit. “The man in the street can relate to that story,” says Burns. “They’ve been through the same process themselves only recently.”
JPMorgan Fleming Asset Management has capitalised on the prospects of a broad economic recovery with a move back into equity funds. “At the beginning of the year, there was still an air of uncertainty in the markets. Investors were low on confidence and reluctant to move into equities,” said Javier Dorado, head of JPMF Spain and Portugal. “But as the months past, statistics started to indicate timid shifts out of money market funds towards equity funds as the media began to talk about the possibility of a global recovery. The industry as a whole, and JPMorgan Fleming in particular, has benefited from this trend.”
For the mainstream domestic players this year has been all about guaranteed funds – and the share of the upside they have been offering has rocketed from 50% to 100% in less than a year as high street banks compete for market share.
Guaranteed funds are structured products. The bulk of the fund is invested in government bonds to deliver the principle at maturity. The rest of the fund is then used for options to deliver the upside on the underlying securities, typically a combination of funds or indices. So guaranteed funds are marketed for a limited period and then closed.
SCH has been the major winner in this area. It has launched a series of funds throughout the year which have each taken in between E1.5 and E2bn. The range had brought in E5.6bn by the beginning of September, and still counting.
So despite the pension problems, fund managers are happy in Spain at the moment. And they look set to remain so. “Asset management fees should pick up,” says Colmenar, “primarily because of the interest rate environment. For the average saver, it’s just not worth having your money in a bank account.”
The current pie is around E200bn. That includes mutual funds, individual pension plans, and life insurance. There is generally considered to be the same again in unmanaged accounts. “There is all this cash in bank deposits and under the bedclothes which one can safely assume will one day find its way into the savings market,” says Burns. “Add to this an organic increase in savings overall and it’s safe to say that managed assets will double over the next five years.”

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