Andrew Sheen travels to Belgium and discovers this country of predominately small pension funds is labouring with the implementation of OFP reforms and harbouring dreams of becoming Europe's cross-border pension hub
Key to understanding the Belgian pensions industry is an appreciation of its size, which underpins virtually every aspect of the way the country's funds and investors view the market.
Oliver Lafont, managing director and CEO of Fortis Investments, Belgium, commented on the size of the market: "There are very few large pension funds in Belgium, with even the big ones being small compared to the Netherlands. Everything is relative. We're in a small market with a lot of small pension funds."
Figures widely discussed with Global Pensions showed there to be 253 pension funds in Belgium, the overwhelming majority of which (163, or 64.4%) had assets under management (AuM) of less than €25m (US$37m). Medium-sized funds, with an AuM of €25 to €125m, made up 68 (or 26.9%) of the total, while there were only 22 'large funds', with assets of €125m or more, making up a mere 8.7% of the total. The total size of the market was approximately €40bn.
This lack of size therefore poses a number of problems for funds, not least in the realms of corporate governance, investment management and asset allocation. Henk Becquaert, member of the Banking, Finance and Insurance Commission's (CBFA) Executive Committee and former adviser to the Belgian minister of social affairs and pensions, commented: "There's a division between small to medium and big pension funds."
On the whole, 'stability' and 'conservatism' seem to be the watchwords for Belgian funds, with investment portfolios that were directly attributable to the size and competencies of the market.
According to Thierry Laloux, retirement business leader with Mercer in Belgium, asset allocations among funds had been "pretty stable" with "no major shifts" throughout the past decade.
Fortis' Lafont agreed: "For about ten years now we've seen an average equity weight in portfolios between 40% and 50% - there's no big change. When the markets are good, you see a kind of market drift and the average is a bit higher, then you have a bad year and the average is a bit lower. Allocations are conservative - not in the sense of defensive, but in the sense that it doesn't change. It's stable."
At the end of 2007, figures show allocations were split about 48% in equities, 38% in bonds or other fixed interest assets, and 9% in property, with the remainder in various other asset classes.
Patrick Marien, an account director at Aon, said: "The interesting thing is that real estate has become more popular. In 2000, it was 4%, while in 2007 it was 9%." Property investments aside, one of the more marked differences between Belgium and its larger European neighbours is the relative lack of alternative assets in portfolios, with little or no investment in hedge funds or other such vehicles.
Olivier de DeckÂï¿½re, assistant manager of ING's pension funds, commented: "Pension funds are not the kind of investors that will take the lead with new investments. They try to get some alpha through more exotic investments, but it's still quite a small part of the overall portfolio."
Lafont explained that one of the main reasons the Belgian market had shied away from hedge funds and other alternatives was because of the technical abilities of pension funds to engage with managers and monitor investments.
He said: "If the market is less technical, the evolution will be slower. Diversification toward alternatives is blocked by the fact portfolios are small and alternative strategies are technically more complicated to assess . The point is, is it worth dedicating the resources to something complex if you know that you will only invest, say €3m? To put it simply, if you convert the added value into euros, you wonder if it's really worth doing so."
The result is that only a small portion of Belgian pension funds do have exposure to alternative investments.
Peter Bastiaens, partner and consulting actuary at Lane Clark & Peacock Belgium, agreed: "Belgian pension funds invest very conservatively. You won't find many special vehicles. It's size related. And in general, I think Belgians are more prudent." Becquaert agreed: "The small and medium pension funds don't invest in alternatives because they want to avoid investing in things they don't understand."
But to concentrate on the pension funds alone is to tell only half the story. The Belgian market is split between funds (be it DB or DC) and insurance company-based pension products.
With only around 250 pension funds in the country and a bias towards small and mid-sized enterprises, the majority of companies use these products as a way to give their employees access to a pension scheme without the burdens of running a dedicated pension fund.
Aon's Marien explained the rationale behind this: "The group insurance [sector is] much bigger. It's a matter of volume. A pension fund has to be a separate entity, and if you are only a small or medium enterprise with less than 200 people, or even sometimes less than ten people, the group insurance scheme is the more obvious solution."
Closely allied to this is the use of SICAVs (Société d'investissement à capital variable), or open-ended collective investment funds.
Marien said overwhelmingly, smaller funds opted to invest through SICAVs: "Below €25m, you'd see that they're invested for maybe more than 90% through SICAVs. But also the bigger funds use them."
Much has been made of Belgium's attempts to attract pan-European or cross-border pension plans. The OFP law (see page 24) was in many respects a transposition of the European IORPs directive, providing Belgian funds with a flexible framework for domestic and international pension funds. It put the country in competition with Ireland, Luxembourg and the Netherlands, which have all implemented IORPs, as potential domiciles for cross-border systems.
Thierry Laloux, retirement business leader, Mercer, summed up the mood of the industry: "Our position is that pan-European pensions are the way to go. It's a vision, a goal for the long term."
One of the reasons the industry so readily embraced the concept of cross-border schemes was, as Olivier de Deckère, assistant manager of ING's pension funds explained, the existing knowledge base of international standards: "With many US companies in Belgium, we have used FAS accounting standards for about 15 years now, so we have the knowledge of international accounting and expertise in a pension fund situation."
Progress in attracting multinational companies to set up cross-border pension schemes has been slow, with no deals announced so far. Despite this, everyone seemed optimistic some schemes would come in the near future, although as Philip Neyt, president of the Belgian Association of Pension Institutions (ABIP-BVPI) commented, "It will never be a big bang."
Peter Bastiaens, partner and consulting actuary at Lane Clark & Peacock Belgium, agreed: "Everybody has high expectations. But companies don't change just because the legislation changes."
Henk Becquaert, who was instrumental in the process of setting up the framework and is acknowledged as one of the most important figures in the Belgian pan-European pension efforts, gave his opinion.
"I think we have a legal, tax and prudential framework which is attractive for pan-European pension funds. I can confirm there has been a lot of interest and I believe that in coming months we'll see more and more pan-European pension funds establishing themselves in Belgium," he said.
The business case for cross-border schemes has been well made. Consolidating and harmonising pension schemes into a single location allows sponsoring companies to benefit from greater economies of scale, reducing costs and risk. But getting employees to agree may prove harder, as Thierry Verkest, pensions consultant, Hewitt Associates, pointed out.
"Employee representatives don't want to see their pension fund move to another country. But if, as an industry, we can communicate and show the added value that would bring, then it would be a win/win situation."
As Bastiaens argued: "Global employers are looking more at economies of scale. If you can do things on a European scale, you have the economies of scale, which you don't have now."
Neyt said it made little sense for a multinational corporation present in many European countries to have separate pension arrangements in each territory: "It's not about having one pension plan, but consolidating the execution of the plan and the knowledge. You have knowledge and expertise, you can share that knowledge. It doesn't make sense to have all these separate bodies."
Verkest said he could see another possible formation of cross-border schemes, whereby culturally and geographically close nations would 'clump' together as a halfway step between individual country schemes and full pan-European plans. "I can imagine clusters forming. The Benelux countries could join together, the UK and Ireland, the Germanic countries, Eastern Europe. Not the big pan-European structures, but groups. Maybe the Benelux countries could test it out that way." It could be possible to set up a cross-border 'lite' system by bringing a lot of the processes under one roof, as Laloux explained.
"To get there, you need to do a number of things such as an audit, having a central pensions policy, and you'd need to have a view on the way you manage pensions. As you do all that, you'd probably get 70% to 80% of the benefits [of a cross-border vehicle] through centralising and harmonising the arrangements under the existing framework. The vehicle would be just the final thing you put on top - the single structure to finalise things - but you can achieve a lot already through harmonising and structuring."
From an economic standpoint, Belgium seems to have survived the first waves of the credit crunch and global downturn relatively unscathed, but as the year has worn on, some cracks have appeared.
Data from actuaries Lane Clark & Peacock (LCP) showed inflation had jumped dramatically within the space of a year. Whereas in June 2007, inflation rates were steady at around 1.4%, two months later they had spiked to 5.91%. Placed in the context of interest rates, which had remained fairly stable around 4% (short term) and 4.8% to 4.9% (long term), this has posed a significant problem.
Peter Bastiaens, partner and consulting actuary at LCP, commented: "In Belgium, salaries are linked to inflation [when it rises above 2%]. Currently inflation in Belgium is 5.9%, with the European average at 4.1%, and this has a serious impact on everything."
Thierry Laloux, retirement business leader, Mercer, agreed: "Inflation is certainly a big question."
Bastiaens continued, adding IFRS funding levels would "go down drastically". "You'll see it when we do valuations again at the end of the year. It will all depend on what the bond rates do between now and the end of the year. If bonds go down a lot, it will be dramatic for some companies," Bastiaens said.
Moreover, the BEL20 has underperformed due to the weight of the financial sector. Olivier de DeckÂï¿½re, assistant manager, ING pension funds, noted: "The BEL20 is very sensitive to financial crises because something like 20% to 30% of the market is made up of financial institutions."
Laloux said research carried out by Mercer showed how poor 2008 returns would be. Over the first quarter, funds delivered a return of -8.6% and very preliminary reports suggested a Q2 result in the region of -2.6% leading to a -10.5% performance for the first half of 2008. In the absence of any significant improvement, funds could end up with a possible year-end final negative result of 10% to 15%.
He commented: "On one side you have the minimum prudential funding requirements increasing by 15%, and on the other side you see your assets going down by minus 10% to 15%. That creates a gap of 25% or 30%, which is not what companies want to hear in the current economic climate."
The possibility of moving into a protracted low-return environment, a fear raised by several people, would also pose significant problems for pension schemes.
Philip Neyt, president of the Belgian Association of Pension Institutions (ABIP-BVPI) commented: "Since the beginning of the year, most Belgian pension funds are down 10% or 15%. Risk control is very important in these times."
Laloux said the Belgian system did not have "a tradition of full funding or nearly full funding".
He continued: "Many Belgian funds aim to cover just above the minimum funding requirements and not much more. So with these new conditions, that will cause troubles."
The large insurance-product sector has also been affected. Dimitri de Marneffe, senior manager and consulting actuary, LCP, said bond yields would increase and, as most insurers were invested in bonds as a low-risk way to match liabilities, this could be advantageous.
"Over the long term, [the sub-prime crisis] may have a positive impact on profit sharing. In the short term, we do expect lower profit sharing though."
However, de Deckère offered some hope to pension funds looking to invest: "Everything is cheap. It's not a correction; the economic value of assets is higher than the market value right now, so it can be very positive for pension funds which have the cash."
The OFP reforms
The single largest change to the Belgian pension system in a generation was the adoption of the European IORP (Institution for Occupational Retirement Provision) directive on cross-border pensions.
Previously, Belgian pension funds were regulated by the same legislation as other non-profit organisations, such as charities, as an ASBL (Association sans but lucratif) but were brought under the pension-specific Organisation for Financing Pensions, or OFP law, on 1 January 2007, although existing pension funds have until 2012 to fully transition to the new framework.
The key changes brought about by the OFP were to alter discount rates used by funds, create a more prudential operating environment, enhance minimum funding requirements and reform taxation on fund assets and investments, with the aim of opening up the Belgian market to cross-border pension schemes.
Oliver Lafont, managing director and CEO of Fortis Investments Belgium, commented: "The OFP was made to attract international schemes. At the same time as Belgium was setting up the OFP framework, Luxemburg and Ireland, for instance, were finetuning their own schemes. It's very difficult to compare because there are a lot of different elements. But Belgium has a very nice proposal."
Probably the single most immediate effect of the implementation of the OFP law was the scrapping of the previously accepted 6% discount rate used by all pension funds when calculating liabilities and its replacement with 'prudential principles'.
Peter Bastiaens, partner and consulting actuary at Lane Clark & Peacock Belgium, explained: "The way you calculate minimum funding requirements has been changed. Every fund or every plan had its own rules about setting up minimum funding requirements, whereas before it was a fixed 6% discount rate. You must guarantee a minimum return on employee and employer contributions. It has a significant impact on the risk that an employer is running on the pension plan."
Olivier de DeckÂï¿½re, assistant manager of ING's pension funds, added: "The new law says that now the board of the pension fund has to build up a way to value their provisions. Only the board knows the risk of their own fund. It's the responsibility of the board to build up a technical appendix where it lays out the risk and calculates provision for risk and so on."
Key to the prudential principles is the idea that while a fund has almost free reign to pick and chose its own discount rates and decide the way it wants to calculate provisions, it has to be able to justify such choices to the Regulator, which in turn requires greater reporting and governance mechanisms.
According to Henk Becquaert, member of the Banking, Finance and Insurance Commission's (CBFA) Executive Committee and former adviser to the Belgian minister of social affairs and pensions: "It's quite a big change for the pension funds. The quantitative rules have now been changed to a qualitative law. It's flexible but prudent."
Lafont said: "It is becoming very complex for them to manage a pension fund, in the sense that many funds are not seen as the highest priority for the company." The lack of independent trustees in Belgian funds means that responsibility for running the scheme often falls to personnel within the company.
Lafont continued: "Especially for smaller pension schemes, the company has multiple objectives on the corporate side and they have very few resources to dedicate to the pension side, so only deal with that when they have the time."
Another aspect of Belgian pension law is a minimal guaranteed return over interest of 3.25%, as Marien explained: "The legal minimum guarantee of 3.25% on employer contributions in DC plans is already integrated in most insurance-based plans."
But De Deckère pointed out the idea of only providing a minimum: "Everyone knows that if we only give a 3.25% return over the career, it will not lead to a sufficient pension, so we have to create alpha."
The OFP law has, however, also stipulated 'prudential reserves', which has caused pension funding requirements to increase dramatically.
Laloux explained: "The implementation of prudential reserves will boost minimum funding requirements by about 15%."
Dimitri de Marneffe, senior manager and consulting actuary, LCP, continued, pointing out that again, "because Belgian schemes are small, the new framework puts a great burden on them and it's not so easy to operate at the level of professionalism that's now required".
De Deckère agreed: "Governance is a big issue for the future. While the new law gives more flexibility on how we value provisions, with that comes responsibility - funds can be flexible but they have to be responsible."
Fortis' Lafont said he felt this was a key weakness in the Belgian system, as the market was becoming increasingly complex, yet the resources on the client side were often lacking, simply because the pension funds didn't have the adequate size or scale to dedicate to the running of the scheme.
"I think that's really a weakness," he said, "because the pension environment is becoming complex and the resources on the client side are not always there." Bastiaens agreed: "Regulation requires much more professionalism. Compliance is a hot issue."
Thierry Verkest, a pensions consultant with Hewitt Associates, also voiced his concerns: "My impression is that we need to be careful with this and not go too far. We have lots of small and mid-sized pension funds, but not too many big ones."
He added: "It's a small market and a lot of the work is outsourced, but now funds need their own control procedures and so on. But if they outsource most of the work, why do they need to do that? Sometimes I think they're going too far. Will it make the smaller funds move to group insurance products?"
More than the reforms on technical aspects of governance, however, the OFP law overturned disadvantageous elements of the tax regime.
De Marneffe said the OFP offered "enormous tax advantages" to funds. "Before, when funds operated as an 'ASBL', there was a tax of 0.17% on the general assets which has been removed for OFP pension funds. Also, all the pension funds which were invested in mutual funds - because there was no tax on dividends and capital gains - are exempt from the taxes under the OFP," he explained.
Laloux said it was probably too early to say firmly whether or not the OFP law would encourage funds to invest directly in the equities markets rather than through mutual funds: "It's too early to conclude whether there's been a really large outflow from mutual funds. SICAVs give the benefits of diversification, especially for small or mid-sized pension funds, compared to other European funds. Many of them view SICAVs as a good way to spread risk, and so that will probably stay, irrespective of the tax elements."
Becquaert noted: "I don't think smaller funds are ready to invest, but I think we will see the bigger funds moving that way."
Marien agreed: "The level of investment through SICAVs has remained fairly steady. It's not going down."
Socially responsible investing (SRI) has been slower to break into the mainstream in Belgium than it has in much of the rest of the pensions industry. But it is interesting to note that the reaction was one more of indifference than opposition.
Thierry Laloux, retirement business leader, Mercer, commented: "We don't see it as a target. Pension funds tend to stick to 'classic' asset classes."
Peter Bastiaens, partner and consulting actuary at Lane Clark & Peacock, said the economic climate made it difficult to think about matters such as ESG, which could be viewed as a 'nice to have' rather than an integral part of an investment strategy: "People think about sustainable investments when things are going well, but when things are not going well, they forget about it. It will come over time."
He added that he didn't feel the size of funds was a factor in the lack of traction ESG had gained in the Belgian market, but Aon's Marien highlighted the role of SICAVs as an investment vehicle.
Patrick Marien, an account director at AON Consulting, said: "It's not something that people say they don't want to do, as there are a lot of pension funds investing through SICAVs, it depends on the way the SICAV itself invests."
One possible future driver of ESG investments was felt to be the requirement to disclose social responsibility in a pension fund's annual report. Although, as Oliver Lafont, managing director and CEO of Fortis Investments Belgium, said, it is not obligatory to have "the stamp of a fund dedicated to SRI investing", fund's do need to explain how their investments are (or, moreover, could be interpreted to be) socially responsible. Pension funds sponsored by public entities are definitely the most ESG-oriented ones, mainly by political influence.
Not all were convinced, as Lafont continued: "It's a very free text - it can be very broad in terms of explanation. If you're not a 'green' fund or just generalist in the way you invest, you can pass the text by writing that the portfolio management takes into account some general ESG aspects, while there is no specific ESG policy in your portfolio.
"It's not an obligation; it's part of the reporting you have to do, but is just a first level commitment and does not ensure strict ESG observance in the actual portfolio." But Olivier de DeckÂï¿½re, assistant manager of ING's pension funds, was more optimistic: "If you look at the reports this year, I think you'd be disappointed, but in the near future, people will feel that as they must write about it, they will think they must do something about it. The issues pensions funds are facing now are more about compliance, governance and provisions. Social investment might be fine-tuning that can't [be done] now, but [it] will come on the agenda."
Some early adopters of SRI though were public bodies throughout the Brussels region, which were required by a local bylaw to have at least 10% of their assets invested according to an ESG or SRI approach.
As Lafont put it: "It's like the old saying, you're either pregnant or you're not, but you're not 'a little bit' pregnant. You take an option or you don't. I don't think it is complex and I don't think it is related to size. Some funds do SRI investing for x% of their portfolio as a kind of "compromise", a strategy I find difficult to understand, unless they consider the environmental and sustainable assets as a trend/bet they want to play, with pure financial considerations."
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