Russian Pension System 1

Russia, in common with many other European countries has a growing pensions crisis. This has been caused in part by an ageing population. It will be exacerbated in future years by the birth rate which has undergone a sharp decline during the sometimes painful transitions of the last 15 years. In common with many other transition countries, Russia has decided that it needs a system of funded pensions.

Russia already has a voluntary third pillar which consists mainly of employer sponsored pension funds. However, often these funds are provided not for the benefit of employees, but are instead used as vehicles to self invest back into the employing company and act as poison pills in the event of a hostile take-over. There are also many fundamental regulatory problems with the sector which still need to be addressed. Russia can also learn from the experience of other countries in the region, that where a system is a purely voluntary, it is difficult to incentivise individuals to contribute and, in turn, accumulate substantial sums under management. Thus, Russia decided that it needed a second pillar.

A law on the investment of second pillar pension assets was signed by the President of Russia at the end of July 2002. The system created by the new law is based on the model of individual choice and owes its inspiration to the Swedish second pillar model. In particular, it provides that the Pension Fund of Russia will still collect in money from employers in favour of individuals but will then allocate such money in bulk to a number of asset managers in accordance with the decisions made by those individuals. This is planned to start from 2004. The crucial difference between this model and the model implemented in countries such as Hungary, Croatia and Poland (which followed the Chilean approach) is that the asset manager should not, at least in theory, know the identity of the contributing individuals. It will not hold individual member records and will not enrol individual members. All record keeping will be undertaken by the Pension Fund of Russia. The function which will have to be undertaken is pure asset management.

It is also important to note that, following lobbying by the non-state pension fund industry, an individual will be able to choose to have his/her account with a non-state pension fund (currently operating in the voluntary third pillar) instead of with an asset manager. This option will be available from 2005.

General principles of the tender process are set out in the law. The Pension Fund of Russia will perform an open tender in order to select asset managers to participate in the second pillar. There is no limit on the number of licences which may be awarded. Licences are awarded for a period of five years but may be extended. New entrants may apply each year. The asset manager must be established in Russia and possess the necessary professional experience in respect of investment/mutual funds and non-state pension funds. In particular, an asset manager must have a minimum level of assets under management, have a minimum level of capital and a certain number of clients. An asset manager must also demonstrate the professional qualifications of their employees and present a set of audited financial statements for the previous three years. The asset manager must not be a related party to a specialised depository or any of its related parties and the asset manager will have to draft, accept and approve (together with the Inspectorate) a code of professional ethics.

According to the original schedule, private asset managers should be able to start managing the second pillar pension reserves from 1 January 2004. To achieve this, the Government has had to promulgate a number of regulations dealing with the tender process, selection criteria and individual choice by 1 July 2003. So far, the Government has passed regulations on the procedure for conducting the tender and on the procedure for making a choice by individuals. Although these regulations have been enacted, they have little or no meaning at all without a key document, namely, selection criteria for private asset managers.

A story with the draft Governmental resolution on selection criteria for asset management might be a subject for a suspect story or a scientific research paper on how lobbying works in modern Russian realities. The original draft appeared early autumn last year setting rather high requirements for the minimum amount of assets under management and own assets of an asset management company. The draft limited the number of potential players to three – four well known names. Shortly after the draft was rewritten to allow almost all existing asset managers with more than 2 years of track record to participate in management of the second pillar pension reserves. Since the beginning of this year the Ministry of Economic Development as a primary responsible governmental body has been trying hard to accommodate conflicting interests of various lobbying groups into a document which would be nevertheless serve the purpose. Every second week there has been a story in newspapers about yet another final draft being prepared, reviewed, sent back for redrafting or revoked. It has become absolutely impossible to follow this Brownian motion. Recently, it has been reported that the draft has been agreed by all the interested parties and would be published in a couple of days required for the ink to dry on the original text. However, the very next day the draft has apparently been taken straight from the prime-minister’s desk for further redrafting.

It now seems that the final draft prepared by the Russian government raises the cap on the assets under management from R40 million to R100m and the cap on own capital from R30m to R50m. It has also been reported that licensing requirements for management companies have been softened, lifting a requirement to have a two year track record. However, regardless of what the text of the resolution would say, most of the commentators agree that the selection criteria will have to be published by the end of June to keep the pension reform going.

For further information please contact Leonid Zubarev at [email protected]