1
CENTER FOR GLOBAL DEVELOPMENT
PUTTING PENSION FUNDS TO WORK IN LATIN AMERICA:
PROPOSALS FOR NEW FINANCIAL INSTRUMENTS TO HELP
DEEPENING FINANCIAL MARKETS
FEATURING
THE LATIN AMERICA SHADOW FINANCIAL
REGULATORY COMMITTEE (LASFRC)
Thursday, July 14, 2005
10:00 a.m. - 11:30 a.m.
Brookings Institution
1775 Massachusetts Avenue, N.W.
Falk Auditorium
Washington, D.C.
[TRANSCRIPT PREPARED FROM A TAPE RECORDING]
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PARTICIPANTS:
Roque Fernandez
Former Minister of Finance, Argentina
Pablo Guidotti
Former Vice Minister of Finance, Argentina
Ricardo Hausmann
Professor of Economics, Harvard University
Former Chief Economist, Inter-American
Development Bank
Former Minister of Planning, Venezuela
Ruth de Krivoy
Former President, Central Bank of Venezuela
Liliana Rojas-Suarez
President, LASFRC
Senior Fellow, Center for Global Development
Former Chief Economist, Latin America,
Deutsche Bank
Roberto Zahler
Former President, Central Bank of Chile
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P R O C E E D I N G S
MS. ROJAS-SUAREZ: Good morning. Thank you very
much for coming today. As you know, we are the Latin American Shadow
Financial Regulatory Committee. I will spend just a couple of minutes to
introduce ourselves.
First of all, I will start by giving you all our Web page
because all the statements that we write are posted there. So it is
www.claaf.org.---CLAAF. What does CLAAF have to do with the Shadow
Financial Regulatory Committee? It's because in Spanish it's [SPANISH
PHRASE.]
This is a group of independent economists that in the past
have had high-level positions either in the government or in the private
sector, but now are completely independent, and its mission is to shadow
the regulators both in Latin America and multilateral organizations that
define or advise governments into financial policies that are going to be
affecting the future of Latin America.
We've been functioning for about four years now, something
like that, and this is our 13th statement. That's why I gave you the
reference to the Web page so that you can take a look at what are the
issues we've been dealing with.
The members with me right here--I don't know if you have
gotten--if you have, I think--a list of the--yes, you do, okay. So in
addition of the people present here, the committee also has Angel Guria
[ph], who was with us until yesterday, but he had to go back to Mexico, as
you know. Now, he--well, he used to be the former of Mexico, but now
he's one of the top candidates for the position of the Secretary General of
the OECD. So he went back. Of course, if he takes that position, he
cannot become part of the committee. He will become a non-active
member.
Then we also have Ernesto Talbi [ph], who is the director of
the think tank in Uruguay called Ceres [ph]; Miguel Mansera [ph], who is
the former president of the Central Bank of Mexico.
We have two Brazilians: Mr. Contador [ph] and Mr. Pedro
Carballo de Melo [ph]. Pedro was here, too, and he is a director at the
Security Exchange Commission in Brazil. And representing Central
America we have Mr. Guillermo Chapman [ph], who is the former
Minister of Finance of Panama.
Okay. Now that you know who we are and what our mandate
is, why don't we focus on the statement that I hope you have in your
hands? You're all aware, and the reason why you have come is because
I'm sure you know about Latin America being a leader of reform in the
pension fund systems among developing countries.
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These reforms started in '81, in Chile, and since then
progressively have been adding more and more countries and now there
are ten countries in the region. What we have found as a fact is that the
assets held by these pension funds are increasing continuously and at a
rapid pace. On average, they are 10 percent now of GDP in most
countries, but we forecast that--not only us, a number of studies--by 2015,
this ratio is going to reach 30 percent of GDP.
The interesting statistic is that that is basically the same ratio
of financial intermediation done by banks. So by 2015, if banks don't
expand more, which they're recently not doing, you're going to have a
financial intermediary that basically is comparable with the size of the
banking system.
Now, when the pension fund was--the reform of the pension
fund system took place, a large priority, as it should have been--it's very
understandable--was to ensure safety, transparency and integrity. And for
that, there was a number of regulatory conditions that largely limited the
set of financial assets where the pension funds could invest.
Pension funds were and are allowed to invest in government
paper, in bank deposits. But when you ask whether they an invest in
equities or bonds, there is a restriction and the restriction is that they
have to be listed--the companies have be listed in the stock exchange.
They have to be public offerings of the instruments that are being offered
by these companies.
Now, there is a number of problems that I know you would
like to hear from us about the pension fund systems, and let me just tell
you what we are not going to talk about. For example, pension funds have
a significant problem in terms of the coverage. A large amount of the
population is still not covered, and we are not going to talk about that.
We are not also going to talk about the high concentration of
the pension fund industry and the fiscal cost and long-term sustainability
of the reform. And the reason why we are not focusing on these particular
issues is because we have identified one that we believe actions can be
taken in the near future and represent at the same time a major problem.
And for one statement, one issue is sufficient.
The problem is that we have identified an increasing gap
between the supply of pension fund savings and the capacity of the
markets to supply instruments meeting the regulatory requirements. In
other words, the pension funds are accumulating a lot of resources, and
besides government bonds and bank deposits, there are very little places
to invest. Okay? And we believe that this gap is growing.
This morning, we had an interview with some representatives
from the press and somebody was asking us, well, how does this compare
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with the United States? And the answer is that the problem is exactly the
opposite as in Latin America.
In the United States, you have a huge capital market and a
little part of the savings not being part of the private pension system
scheme, and that little part can easily integrate into the already existing
capital markets. In Latin America, you have a private pension fund that is
increasing, increasing, increasing, and no capital markets. Okay?
So what if, having identified this problem, we ask ourselves
what is the problem? Why are we concerned about that? Well, we think
that the major danger is that the pension reform is not going to deliver its
full potential in terms of growth and investment; that it is a waste. That's
our concern.
Why is this happening? Well, we believe that, of course, a
very important reason is that there has been little growth in the region,
right? If there is no growth in the region, well, this reflects a depressed
demand for investment.
However, the regulatory framework also plays a very
important role in preventing the closing of the gap between the supply and
demand from funds. We think that the existing corporate structure in
Latin America is very different from that in industrial countries, while at
the same time the regulatory framework is just mimicking the industrial
country framework.
How does the corporate structure differ in Latin America
from that in industrial countries? Well, very simple. In most Latin
American countries, the large majority of firms are small, closed, familyowned. And if you ask them, they do not want to open. They do not want
to go into being public offerings, for many reasons.
And as we discussed yesterday, you cannot rule out the fact
that the region is not a safe region and many firms would not feel
comfortable in giving information--the small firms, in giving information
about their particular situation because of fear of even criminal attacks.
Now, you could tell us, well, yes, that will evolve. You
know, as growth proceeds, companies will be willing--they will not have
enough resources on ? and banks will not have enough capacity to lend
and they will open up. Maybe, but the truth of the matter is that we don't
see that in the foreseeable future, but we see the gap growing now.
So when you face that, the question is what to do. And we
believe that a combination of new instruments and change in regulation
can make the trick while we converge toward a more developed system.
Let me give you just one idea of one kind of instrument and
the kind of regulatory changes that you will need to have. As I was
telling you, most companies are small and medium-size enterprises,
because remember the large corporations actually can finance themselves
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abroad. They don't even need the domestic capital markets. We're talking
the ones that are potential sources for additional growth in the countries.
How do they finance themselves besides their own savings?
Well, they go to the banks, for good reasons. A bank can assess the
quality of this small client, and we believe that that is what is going to
continue happening, that the bank is going to be the major source of
external finance for the majority of enterprises in the region. Okay?
But what can we do? These bank loans could be repackaged
and sold as a package, mainly little loans sold as a big pooling of loans to
a fiduciary. Okay? This has one effect. First, the loans are out of the
banking system, freeing resources for more loans to the small and
medium-size enterprises that we think are going to go nowhere else.
Okay?
So we are accepting the fact that at least in the short and
medium term, medium and small enterprises go to banks and nowhere
else. Okay? So we're trying to free more resources for the banks. Okay,
now these package of loans have been moved to a fiduciary, but this
fiduciary now can issue liabilities that can be now purchased by somebody
else. And we assume, or we propose that among those that can purchase
these new instruments are the pension funds.
What are the instruments? How does the instrument now
become a source attractive to the pension fund? Well, because even
though there is 1,100 loans in this big package, I basically will strip the
instruments into different categories of risk.
So we say, okay, you want to be safe? All right, so one
tranche of this category will be very safe with little return. If you want to
take more risk, then you even buy equity. So this is financial
engineering. That's all it is. It's financial engineering.
You are not forcing anybody to buy the instrument. The idea
is that the pension funds who right now in most countries are holding only
government bonds and deposits might find attractive to getting to an
instrument that by pooling risk and choosing the category of risk they are
willing to take--they are willing to take--will allow for the mobilization
of resources from the banks to the capital market and allow for the
creation of instruments available for the pension funds to absorb.
To give you one example, the document presents five, but I
don't want to get into each of these, but we can discuss all of them with
my colleagues here. More than that, we think that regulations restricting
the investment of pension funds abroad are too binding. Too restrictive is
the word, too restrictive.
If you want to allow pension funds to diversify for both
return and safety, you need to let them invest abroad. How much? We
don't have a consensus among the group, and we don't think we should
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have a consensus among the group for reasons that I will explain in a
second.
But clearly the change in regulations imply more flexibility
to the investment of the pension funds. We should allow pension funds,
with the proper procedure for disclosure, information. Not necessarily we
should require the firms to go into public offerings. If we require that,
there's not going to be financing to firms domestically.
Now, I told you that we don't have consensus about how much
to open, and we don't have consensus on many things. Why? And we're
not trying to get consensus. Why? Because what we are doing through
this statement--and we believe it is the role of the committee--is to
identify a problem, put ideas for thoughts, for consideration of people like
you and people in the region, and then let the countries design the
processes.
You know, when the pension reform was implemented, in
most countries this was a case of crisis, right? I mean, there was no other
way to go. But I'm not talking about crisis now. I'm anticipating that in
the future this gap is unsustainable.
We have time, but in the time is not us, is not a group of 12
people who can or should provide the solutions for the country. Instead,
we think it's a question of opening up a process in which the different
members and participants have a word and take a place in the
decisionmaking.
We actually have a name for a committee that we would
suggest should be formed and it's called the Financial Market
Development Commission. But we believe--and you will find that in
section 4 of the report, but we believe that that is country-specific; that
the amount of risk that a given system is able to take or willing and
capable to take is not something that we should say; that the countries
should decide that themselves.
Okay, let me stop right here and ask my colleagues to add or
expand on what I haven't said or what they would like to emphasize a
little bit more, and then we open for discussion.
MR.
: I want to talk about a little bit or complement
the view that Liliana has just exposed. In a certain sense, it is a problem,
but at the same time it's an opportunity, okay. In a certain sense, we
think that we are at a stage in the evolution of institutions starting from
the initial situation in which many of these pension reforms were adopted,
in which essentially it was already a revolution to actually allow
individuals to have individual capitalization accounts, okay.
So part of the response of congress, politicians, regulators
was actually to protect a lot the future pensioners by putting a lot of
capital market restrictions. And also this was based on the fact that the
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view was that the major source of finance was still the banks, okay, so
that eventually the banks, which typically have a more short-term credit,
would be the initiators of a process that then would cascade into other
forms of finance into a private sector.
And, you know, after 10 years, 15 years in some countries of
this reform, what we find now today is that funds have increased so fast,
but the cascading has not actually functioned. First of all, banking
systems have remained small mainly because of vulnerabilities,
uncertainties, macroeconomic crisis in many cases. And essentially they
have remained very short-term-oriented.
And on the other hand, we many times say that there is--we
don't find a demand for credit in Latin America. Well, maybe we don't
find demand for short-term credit, but there is certainly a lot of need for
long-term investment, okay. And the fact is that when you arrive to these
other forms of finance to the private sector, suddenly we find that
regulations impose restrictions that really are not fully consistent with the
type of preferred finance that the private sector would need in Latin
America.
A second issue is that up to now, in a certain sense it has
been very easy for pension fund managers to have the largest portion of
their returns essentially coming from interest on government bonds, which
essentially reflected high-risk premia, okay.
And in this you have essentially two cases, cases such as
Argentina in which, in fact, risk materialized, and we have seen massive
intervention of the government forcing more bonds into pension funds,
okay. So in a certain sense, now we realize that that was not really maybe
the best way to get high returns for pensioners.
On the other hand, we have some other countries in which, in
fact, the macro economy has evolved favorably and interest rates on
government bonds are falling, okay. So in a certain sense, when you look
into the future, it's not clear that the same high returns, easy high returns
on government debt are going to be the engine in pension funds.
So maybe it's the time in which we can actually try to
convince different stakeholders in society that maybe there is a way to use
pension funds more productively for long-term investment projects in the
private sector.
And it's very important to realize that the process that we sort
of put forward which seems like, you know, building a commission, seems
like a bureaucratic thing, in fact, reflects that these are not necessarily
simple regulatory changes, okay. In most countries, this requires changes
in legislation, okay, so it requires the intervention of congress.
It requires, you know, making sure that these changes,
although they expand the type of instruments and go beyond simply
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publicly traded securities, also do not place excessive risk on pension
funds. So, you know, one has to convince workers and future pensioners
that the reform actually can add value, okay. And this is why we think
that the process aspect is really a crucial point.
Finally, I think that it's always necessary to recognize that
there is sort of a tradeoff between how much we see this as an opportunity
to promote growth and investment versus clearly the fiscal transition costs
that are very high especially for countries that, you know, maybe initiate
the reforms now or that have initiated the reforms recently.
I mean, I think that, you know, our view is that maybe the
'90s view when some of the reforms were undertaken was a little bit naive
in the sense that people thought simply, well, this is a reform that
eventually improves intertemporal solvency of governments. So capital
markets should be very willing to understand that we are simply
translating bonded debt and substituting for unregistered pension
obligations.
And in many cases, one can even argue that the bonded debt-that that switch actually reduced total obligations, so it would be fiscally
good, okay. But, you know, then we have found that sudden stops are a
major part of life for emerging market finance, and liquidity
considerations are important.
And so the fiscal transition costs are an essential component
that has to be addressed both by governments in terms of understanding
what is their actual effective capability of responding with fiscal policy,
and also we think multilaterals should actually consider seriously the
implications on financing and borrowing requirements that reforms of
long-term value and long-term span have on government finances.
MS. ROJAS-SUAREZ: You want to add
? ?
Anybody
else? No, okay. Why don't we open to questions and from that we build
up? We found out it's easier that way.
MS.
: [Inaudible.]
MS. ROJAS-SUAREZ: Use the microphone right there. You
could use it so we can hear you.
MS.
: I work with the Inter-American Development
Bank and this is an area--this issue of investment liberalization is an issue
that we have been tackling for some time in most of the countries that
have undertaken the structural reforms.
The problem that we have encountered is that governments
are using this mechanism as a way to finance themselves and cover their
fiscal deficit. So while we could propose--we have been proposing this
now for some years. I think it's going to take something in addition to
this to get governments to implement fiscal discipline, as well as
liberalize the investment criteria.
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MS.
: I guess one of the innovations that this
approach brings to the table is that we are identifying mechanisms
whereby specific stakeholders in the economy, such as infrastructure
development, agriculture, small and medium companies, and so forth,
have a tool whereby they could tap a source of long-term funding.
They have until now been out of the discussion in terms of
pension funds because it seemed to be irrelevant. Pension funds involved
pensioners and government and banks, and banks in two ways, providing
the instrument for pension fund investment, deposits, and often owning
and managing the pension fund industry, as such.
By opening the discussion and bringing instruments that
allow for a wider sector of society to benefit from the long-term funds
that are managed through pension funds, we're bringing new social
stakeholders into the picture. And this financial sector development
committee in each country could be a way to catalyze the process, because
if you there get together government, legislators, the business community,
the banks, the pension fund managers, et cetera, there is a forum to
discuss these issues and to promote the kind of legislative changes that
are needed to balance the need for pensioners to have a safe and profitable
instrument to ensure their pensions in old age and for the economy to
develop the financing instruments that are needed to promote growth and,
in turn, improve investment. So perhaps this is an approach that might
help open the window to solutions to your problem.
MR.
: Let me say just a little bit.
MS. ROJAS-SUAREZ: Before that, just a question of order.
Yes, thank you. A hand--would you mind going, if people go kind of-MS.
: Thank you. I think it's a very interesting
proposition, as well. My-MS. ROJAS-SUAREZ: Can you identify yourself, please?
MS.
: My name is Anita Campion [ph] from
Kemonics [ph] International. I'm actually curious because the first
proposal you were talking about with having the banks sell their
portfolios and then being able to just have the liquidity to be able to go
ahead and expand their portfolios further sounds wonderful.
My concern is that many Latin American countries don't do-the banks don't do a very good job in lending especially to small
enterprises, but even some to the medium enterprises. And I think that
banks see them as a very different risk than the portfolio they probably
lend to, primarily the larger enterprises, or they know those families very
well, et cetera.
So what else would you see would be necessary? To me, it
seems like there would be more needed in working with those banks on
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being able to expand their portfolios in ways that they haven't had to in
the past.
MR.
: Well, let me mix the two questions. The first
question was, you know, the problem is that governments have very large
deficits and they're using the pension funds to fund themselves. That is
sort of like a different problem from the one we are identifying.
Typically, the legislation puts a cap on how much government
that the pension funds can buy. In fact, many countries are up to their cap
and they cannot buy anything more. So there's more money than actually
can flow into the government.
But the worst thing that can happen now, for example, is for
the government to start running a surplus. That may be good for the
macro economy, but if the government were to run a surplus, then the
pension funds will really be without anything to buy. So in some sense,
the problem is one of insufficient instruments for the pension funds to
buy, not one of crowding out by fiscal authorities.
Now, we propose several instruments in the document. The
one that Liliana mentioned is the collateralized loan obligation. So the
idea is that, you know, an obligation, a bond is something that has to have
a certain maturity. It has to have two ratings. It has to be traded on an
exchange. It has to have liquidity. It has to have, you know, a circular
offering. It has to have disclosure standards, and so on.
All of this generates very large fixed costs which can only be
justified if you are going to issue, say, $10, $20, $50, $100 million in a
bond. That's never going to be done by a small and medium enterprise.
So if you restrict pension funds to buy these traded instruments, you are
restricting them to buy stuff issued by very large corporations.
And if you look at corporate bonds in Latin America, they are
issued by utilities. That's it, and the banks, and that's it. So essentially
what we are saying is you can extend the reach of financing by taking a
bunch of loans which don't have to be traded, don't have the same
disclosure standards, don't have the same maturity standards, and so on,
and you create--you tranche it so that you can generate as many different
categories of risk as the market wants, and then you sell them as
obligations.
So that is the concept behind this initiative. It's something
that exists in the U.S. It's something that might or might not work out in
Latin America, but we will never know until we adjust the legislation to
let it happen, okay.
Now, banks--but that's not the only instrument we have. You
know, we have--there is collateralized, you know, mortgage-backed
securities. Mortgage-backed securities are being developed in Colombia.
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They have worked better in some countries than in others, but it requires a
concerted effort.
There are legal changes in different aspects of things, in the
way market participants originate the mortgages, and so on. And that
requires a certain coordination for these markets to take place, and that's
why we think that we need a process whereby this coordination can
happen, if it's regulatory changes, if it's legal changes, if it's market
participants to agree to do things in some way. And that's why we would
like to open some kind of policy process.
In some ways, this policy process occurs more successfully in
better-functioning political systems than in others. You could say that
Chile is a place where this process more or less takes place, and there's
been very active reform and transformation of the legislation to
accompany the development of a capital market.
In countries that have less trust, less confidence in the
political system, this may become more problematic. People may not trust
the pension fund administrators. They may not trust the market
participants. They may not trust this or that, or they may not trust the
politicians who would like to get a hand on the pot to finance some
cockamamie social idea. So they would like to tie their own hands so that
they are not forced to do things they don't want to do, and so on.
So that's why this policy process has to be designed in a way
that is compatible and consistent with the public interest. And that's why
we have some ideas on how to make it transparent and accountable so that
it's not diverted to other reasons.
MR.
: I would like to make two comments. One is that
probably the bulk of possibilities of issuing these sorts of securitized
bonds is from the loans from the banks. There, I think that in certain
countries you may find the problem in terms of banks maybe not willing
to do that, for different reasons, and I think that's not a minor comment.
So the point I would like to stress is that in our statement we
do a more general sort of approach regarding securitization which is not
only from bank loans, but also from different sorts of activities. It could
be department store receivables and it could be some, I would say, nontraditional sorts of activities.
There are some experiences in the region, in Chile and in
Colombia and in other countries--at least I know in Chile and Colombia-where you have been able to securitize the sort of, I would say, very nontypical sort of receivables. And I think that is something which could
also--is included in our statement.
And the other point I would like to mention that perhaps
something which is very crucial here is that when you think in terms of
CLOs especially, or CMOs, which are two of the five instruments that we
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mention in our report, clearly these types of instruments would require a
change in legislation or regulation regarding investment by pension funds
in Latin America in the sense that the tranche which pension funds would
buy from these sorts of assets would be extremely difficult to trade in a
sort of public offering in a stock exchange. Therefore, we would need
some sort of change in regulations, which is not a minor component of our
proposal.
Thank you.
MS. DE KRIVOY: I would like to add a comment to address
the question posed with respect to bank lending to small and medium
companies, and the uneasiness or the difficulties that banking systems in
Latin America have faced when trying to expand their loans to small and
medium enterprises.
Why are we thinking of banks? Banks are the best-equipped
institutions in our countries to assess credit risks. And although there are
problems and companies may find it difficult to get a loan, there's nobody
else around to do it. And, in fact, as of today banks have a portfolio of
loans to large, medium and small companies that could be packaged in
these structured products and partially sold to the pension funds.
If we think of Basel II and of the trend that it is generating in
terms of securitization and transfers of risk from the banking industry to
insurance and other sectors of the financial industry, by implementing
these kinds of proposals what we're doing is bringing the pension funds,
which are major players in our countries, to facilitate this process to lead
to a healthier lending process which should not impair the banks' health,
because we need healthy banks, and at the same time bring players that
may invest in that.
So what these products are really helping us is strengthen the
ties within the financial industry, be it banks, insurance companies which
will play a role in guaranteeing some of these obligations, and the pension
funds. And it needs a concerted effort to reform regulations because it's
not only pension fund regulations. We have to look into banks, we have
to look into insurance, capital markets and, of course, fiscal problems. So
banks may have difficulties, but they are the institutions that are best
equipped.
And by the way, I would like to refer you to one of our
previous statements which dealt with some recommendations on small and
medium enterprise financing in Latin America which you may find as an
interesting complement to what we're talking about today.
MS. ROJAS-SUAREZ: Yes, just one point to complement
what Ruth said because I think this is very important to your question.
We believe that these kinds of reforms will strengthen the banking
system. Why? Because remember this instrument that we just described
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where you have different tranches. Well, the different tranches have to
actually be respected, right?
I mean, if I tell you that you have seniority and there is a
judicial problem, then that has to be enforced. So you actually--for this
to work, you need better judicial institutions to actually support that this
work, which will enhance the other activities that banks do such as ?
and the problems related to that--so, yes, without the adequate set of
institutions, clearly neither banks nor capital markets work.
Heinz [ph], thank you so much for being so patient. Please
introduce yourself.
MR.
: I'm Heinz Rugel [ph], currently with the IMF,
formerly with the Ministry of Finance of Chile. I share with you your
views in terms of the gap between supply and demand, and I share also the
concern regarding future pensions of people in the context of low returns
coming basically from bank loans and government bonds.
However, you proposed four different instruments and after
all the explanations you have given, actually what you are saying is
countries need to improve their infrastructure, their financial
infrastructure. And that's the bottom line, because you just mentioned,
for example, that you need to improve the judicial system.
For example, if you want to launch infrastructure bonds, what
you need at the end of the day is to have very clear--that the ? rights
may be very clear for everybody. If you want to launch securitized loans,
you need a good rating agency.
I mean, if you want to have five different tranches, who's
going to rate that? Who's going to say, well, this is really first-grade? I
mean, you need strong rating agencies, and that's why I get confused when
I heard Ricardo saying, well, we cannot do everything at once. What do
you think? In trying to lower the kind of--the requirements for offering
these bonds to the market that the pension funds may increase the level of
risk that they are taking?
I'm not quite sure if what you are saying is, well, let us
improve the infrastructure, the financial infrastructure of the countries.
In that way, the pension funds will be able to buy some better products,
some better instruments, or if you are saying, well, since countries have
very small loans to very--I mean banks take very small loans to small
companies; well, let's try to work with that and let's see where it ends up.
MS. ROJAS-SUAREZ: My colleagues are going to expand a
lot on this because you have raised a very, very important issue. I just
want to make one comment on something very specific that you said. You
asked us, are you proposing that the pension funds increase the risk of
their portfolios?
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You know what? In Latin America where most of the
components of the pension funds are government bonds that have actually
defaulted in a number of countries, I don't think so. I don't think that
pension funds right now are holding safe assets.
MR.
: What I think at the end of the day what should
happen is that people should decide the level of risk that they want to
take. And if there's people that just--old people that just want to get
involved in fixed bonds, it's fine, I mean, and young people that want to
get involved in more risky instruments, it's their decision. So what we
should focus in the future is try to let the people to decide what kind of
assets and what kind of risk/return they're willing to take.
MS. ROJAS-SUAREZ: Okay. Ricardo.
MR. HAUSMANN: I share your views on risk. I think what
we're talking about is sort of like independent of the risk issue. It's a
separate issue from the risk issue. What we are talking about is not you
should take more risk or less risk.
What we're talking about is essentially that we have created a
huge pension fund system on a non-existent capital market and we have
regulated the pension funds to buy capital market instruments.
Now, why is it that the capital market is small relative to
GDP in Latin America, while it is huge relative to GDP in the U.S.?
Well, essentially because the guys generating the GDP are not in the
capital market. Now, that is the flow of income that needs to be financed
that is going to pay for the liabilities. That's the reality.
Now, you have to ask yourself the question, why is it that
GDP is generated by companies that are not in the capital market. Well,
one reason is that capital markets have these very high fixed costs and
these very high thresholds; that smaller companies find it inefficient to
fund themselves by going to the capital market.
Whether these costs are actual costs because you can only
fund yourself with very--you know, a $20 million bond issue is a small
bond issue. It's a ridiculously large amount of funding for the bulk of the
enterprises, so that you find, say, in a country like El Salvador, to go to
the extreme, there are no companies that now or ever-- with good
judiciary systems or with bad judiciary systems, that will find it
advantageous to go through costs of an initial public offering and a traded
security relative to the costs and the risks of simply going to the banks
and accepting shorter-term lending.
So part of the problem is that we have forced an amount of
savings into a set of instruments that are too small to be invested in. So
that is the nature of the problem. Now, you can say, well, the solution is
to wait for the corporations to grow and develop and formalize
themselves, and so on, so that in the future these savings might be used.
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But we're forcing the workers now to put the money into
these pension funds and we owe it to them to have that money invested
productively and to have an adequate return for them, not for anybody
else. So that is the nature of the problem.
That is associated with the fact that we have been unable to
transform the claims on the GDP that is being generated outside of the
capital market into financial instruments that can be purchased by the
pension funds.
So what we are saying is you need to have instruments that
bridge this gap between what funding is needed in the economy and the
risk characteristics that are acceptable to pension funds.
So I'm not saying anything about whether pension funds
should be risky or less risky. I think that obviously they should want to
benefit from the yield curve. They have long-term liabilities. What are
they doing investing in short-term assets and foregoing the benefits of the
yield curve?
They could potentially invest in a lot of other stuff, but given
the regulation they have, they're forced to invest in only these very large
and relatively highly-regulated utilities. So there is a lot of the economy
that is out of their reach.
And so the argument is that in order for this to work, we have
to find the instruments whereby you can get these sorts of savings to the
corporate structure as it is, because the funds are coming at a fast speed
and the speed of corporate transformation or institutional transformation
is much slower. It's markets that have to be developed. It's not long term
the development of institutions because the money is flowing much faster
than the speed at which these institutions are going to take place.
So market development is the challenge, and for market
development you need some kind of--we would like to put the attention on
the fact market development is the binding constraint; focus on relaxing
the regulatory or institutional constraints that are preventing this to
happen. That's the nature of the issue.
MS. ROJAS-SUAREZ: Please limit your questions to a
couple of minutes. I'm going to ask the panel to limit their answers to
very brief statements because there's a number of you who want to talk
and we're preventing you from talking.
So can I please--I think Elliot [ph] was the first who--can you
take the mike, please? And then, Desmond [ph], would you follow? And
then I forgot--well, okay, then if you could continue in the line.
MR.
: Thank you, Liliana. Yes, following up a little
bit on what Heinz was saying--Elliot Kalter [ph] at the IMF--one, I very
much agree that these imbalances are becoming increasingly important,
and I'm seeing it from the perspective of the work that I'm doing.
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And I want to raise a couple of issues that I think you already
addressed, but just wanted to indicate for me the importance. One, why
one would want to see capital markets become important in terms of
offering finance for corporations. One reason would be that they require
transparency, they require good governance. And in the end, that in itself
would be a factor reducing risks.
So it would be important to me that when you package these
commercial loans that it be done in a way that this transparency of the
individual companies that were part of this basket--it was still required.
Otherwise, you're getting around one of the major positives of capital
markets.
A second thought is that in Chile, as Heinz knows better than
I, you have now the corporate sector is taking advantage of capital
markets. And I think you already do this, although I haven't read the
paper yet. But in addition to coming up with new instruments that would
be appetizing for the pension funds, given changes in regulations, what
are other countries doing that are having success? So what can we learn
from--it's true that Chile is in a different stage. It has a political system
that has allowed various regulations to take hold. But what can we learn
from Chile--and you mentioned Colombia--before going to new
instruments?
And just a third thought is while I was on a plane going
somewhere recently, I sat next to a fellow who works for an investment
bank here in Washington and he was going to Latin America to buy
packaged commercial bank loans that sound very much like what you're
talking about. So it may exist, but I now have to call him and see if this
is what he was talking about.
MS. ROJAS-SUAREZ: Roberto, you want to--okay, why
don't I collect some questions so that everybody has a chance? Okay.
MR.
: I'm Desmond Glauckman [ph] from the
American Enterprise Institute. I'd just like to go to a point that was
raised by Mr. Zahler which I think really goes to the essence of the
problem, whether the panel could discuss a little bit more about the
incentives for the banks to package their loans to give it to pensions
when, in fact, it would seem to me that banks have got a captive source of
funds right now from the pension funds. You know, I'm not sure that I
see what the incentive would be for them to do it.
You know, I'd just make the observation that in the United
States it seemed that the whole idea of collateralized bond offerings were
developed by investment banks who were promoting a process of
disintermediation out of the regular banking system. I just don't know
how the panel would address that, you know, whether there's a role for
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investment banks, in general, or foreign investment banks, in particular,
to actually do this packaging.
MS. ROJAS-SUAREZ: Thank you.
Please.
MR.
: Alejandro Escobar [ph] from the IDB. I'm just
wondering if with regards to the small and medium enterprise financing if
the solution really is around, you know, these diverse sets of financing.
You mentioned El Salvador, Honduras. For some of these
countries, the main source of GDP is SMEs, and I'm thinking that here in
the U.S. a lot of these sized companies don't go to the capital markets.
They go to venture funds and venture capital funds.
And I'm not sure a bank which will have more access to a
diverse set of instruments will actually lend--as you say here, they see a
very high risk in these organizations--and compared to what a venture
capitalist would do, get engaged more in the management, governance,
financing alternatives prior to their going to the capital markets.
I'm wondering if really more access to liquidity in this
manner would make sense for SMEs in Latin America, where what they
need more is ? venture capitalists would get engaged in the business
and in the sector.
MS. ROJAS-SUAREZ: There was another question. If you
could just please--yes, if people could just approaching the micro-MR.
: I'm Marco Brukes [ph] from the International
Finance Corporation. One idea that I mean you may wish to consider is
something we've been trying, not without a lot of success, but I think the
comment made by Mr. Hausmann on the capital markets is key.
I think, I mean, the cost of getting entities to the capital
markets is very expensive. So one idea that may be worth exploring--and
I'd like to get your views--is getting the pension funds to get some sort of
participation on balance sheet. In other words, for example, the problem
with SMEs. You cannot take SMEs to the capital markets, but if you
could be able to take some risk on a portfolio basis in some banks'
balance sheets and then the regulators would give some capital relief to
the commercial bank, that could be a good way to bridge, I mean, the
development of the capital markets until they reach a level where those
funds can be deployed.
MS.
: Thank you.
MR.
: Christopher Herman [ph]. I'm with the
Environmental Protection Agency. I can explain later why I'm here.
[Laughter.]
MR.
: I was just hoping that the other panelists would
take a few minutes to respond to the question that was flagged by the IMF
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earlier--and you said there would be a number of responses--with respect
to the risk profile of the pension fund. Thank you.
MR.
: I'm Richard Jones [ph]. I'm a UK actuary
currently working at IFC. Two points. First of all, I think as in every
economic issue, there's a supply and demand, and you have to address the
demand side. And in any pension situation, people ideally should be able
to manage their risk profiles. So creating a broader range of choices for
the members of the AFPs has got to be a good thing, and that in itself will
create a demand. So in that sense, one would support the sort of things
you are proposing.
The second point is a much more general one; that is, that the
privatization of pension funds around the world has generally been the
case of governments trying to get rid of a problem. I think governments
have to recognize that privatization doesn't completely remove them from
the scene and that they have an ongoing obligation to ensure that the
privatized pension industry actually functions, and functions effectively.
And by that, it's not just a question of security, but also delivering the
returns that will enable people to get sensible pensions, having sacrificed
their income for so many years.
And you made the point earlier on that this is a purely sort of
Latin American or developing country issue. In some ways, it's not.
There's a much broader issue that has different manifestations. For
example, in the developed world the issue where pension funds are much
more mature and where the balance between savers and retirees, people
drawing an income, is rather different.
The issue there is actually shortage of long-term secure
assets. And as governments have reduced their budget deficits and have
reduced particularly their stock of long-term debt, the ability to find
suitable assets for annuity, to invest back in annuities, for example, has
become a huge problem. That has forced down the yield on long-term
government stock to almost ridiculous levels. So annuities are very
unattractive. Governments have to realize they have an ongoing
responsibility for the health of the pension industry. It's not just a
question of getting rid of the liability.
MS.
: My name is Tatiana Namagan [ph] from the
World Bank.
MS. ROJAS-SUAREZ: A little bit-MS.
: Okay. Can you hear me now?
MS. ROJAS-SUAREZ: Yes.
MS.
: I work at the World Bank and we have just
been carrying out an assessment of the Brazilian financial sector from a
corporate governance point of view. And, there, we actually see that
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pension funds are starting to experiment with investing in unlisted
companies, but this is where the problem comes in.
For example, let's take the case of the pension funds for the
telecom industry. They are trying to go into non-listed companies
directly, kind of like a venture capital type involvement. And I don't need
to tell you the conflict of interest that are a potential in this kind of
involvement.
So how confident are you--and this exactly directly speaks to
my IMF colleague's questions--that a sophisticated financial
intermediation industry can get developed in the either medium or short
term in order to cover the gap that you're concerned with that anyway in
the long term will be covered in other ways?
MR.
: I am Sol Hadano [ph]. I manage the retirement
plans office of IDB. Apparently, everybody is trying to chase investment
and chase yields. I'm sure that if these instruments are so good as you
apparently are hoping, you will have a lot of competition from foreigners
to go and purchase the same type of securities.
My concern is that you are talking about an environment
where governments have failed all over the place. The banking system
has failed all over the place. So I'm very much afraid, as much as
government discharge their responsibilities by forcing pension funds to
buy securities in Argentina and in many other places by crowding out the
rest of the system. And the banking system could be the same type--or
could exercise the same type of attitude by starting to lend irresponsibly,
packaging this loan into securitization, and giving it up to the pension
funds.
Everybody knows everybody, so the system is not so
transparent. So I very much agree with the issue of governance and
transparency. Definitely, those firms that do not want to make themselves
transparent couldn't be a good instrument of investment.
But nobody has mentioned here as much as the competition
from foreigners chasing high yields in Latin America, why not the pension
funds investing somehow outside, abroad. That, I was saying, should be
part of the whole package.
Thank you.
MS. ROJAS-SUAREZ: Is there any other question?
One more.
MR.
: Roberto Garcia [ph] from the IMF. Probably,
something was relating in another question is an obvious instrument can
be thinking on developing the annuity markets, but this raises the issue of
how do you regulate annuities. And probably I would like to hear
specifically from Mr. Zahler on how is this dealt with in Chile.
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MS. ROJAS-SUAREZ: Okay, let me start. I think all of my
colleagues have something to say about the different components, and so
why don't we start with Roque Fernandez and we'll take the different
issues.
MR. FERNANDEZ: Well, I think that we have two
problems. One is to evaluate how the system has behaved after the
privatization that we had in the last few decades. So part of the work that
we did in our review is just to consider what has been produced in the
literature in the evaluation of the performance of the pension funds.
And, of course, what we have is probably the sample data
going from '81 to today from Chile and a small amount of data from
another country that started the reform later on. But one of the works that
we reviewed emphasized what was the social impact of the binding
constraint in the portfolio allocations in the case of Chile.
So what would happen if you just remove a little bit the limit
that you have in the prudential regulation in each of the portfolio
allocations that you may have, and what would have been the impact of
removing those binding constraints a little bit?
And so this research paper implies that the impact would have
been to increase the yield in about 10 percent, and if you consider it in
terms of U.S. dollars, that means that each pensioner could have improved
the situation between $500 and $1,000. That is a paper produced by--I
don't remember the author, but it's a Chilean author that did that sort of
analysis.
So that would be one part of the analysis. So when you
regulate, you can produce two types of errors, either to be too strict or to
be too lax in the regulation. And that would be a sort of type one error,
type two error, and then the idea of evaluating regulations would be just
to try to do the right thing, trying to minimize some of these errors when
you are just trying to represent the principal that will be the worker that
eventually will get an annuity, okay. So that's one part of the information
that we have been analyzing. And, of course, more research on those
projects--I think that is going to be very useful to check out how
regulation is going on in the pension funds.
The second issue is the question was fortunately ?
to
Robert Zahler, so I just will give one brief answer that I think that
regulating the annuities market is really very difficult, especially when
you consider that annuities could be the sort of traded good, so in which
way we regulate the market for annuities and how we restrict the citizens
of different countries to participate in that world market.
I think that that is a big issue that has to be analyzed. We
have not analyzed that topic in this report, but the question is really very
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well taken and I think that it is a very interesting point for future
research.
MS. ROJAS-SUAREZ: [INAUDIBLE.]
MR.
: Yes. There were many issues raised. Maybe
there is one that I would say maybe there is a semantic issue that because
we are economists, we tend to always put things into negatives. So we
talk about problems and relaxing regulations.
I think that in this case, I tend to think more of an
opportunity that is presented by this gap. And the relaxation of regulation
is not to be implied that we want pension funds to run into higher risks,
but simply adopting something that was initially set very rigid on reforms
that, you know, were not really conscious about these dynamic
developments and really adapt the regulations to the reality of countries.
And this is certainly a long process, so I think that it should
be very clear that we don't want really to increase necessarily the risk
profile, but simply to provide more flexibility. And the important issue is
that many times when one talks about creating markets in Latin America,
many times that is a question that the regulators put themselves and they
start out of the blue with some legislation or some regulation and say,
well, this is the way we are going to create markets.
I think that the opportunity here is that we really have
funding there. So there may be a moment in which a combination of
actions actually can have a real impact, okay. So I think that is sort of a
philosophical sort of context of what we are trying to transmit.
MS. ROJAS-SUAREZ: Ricardo.
MR. HAUSMANN: I would just like to mention the issue of-I again would like to repeat that the issue of risk is really not key to what
we are talking about. It's not about more risk or less risk. It's about
market development, because if the market was bigger and more
diversified, it would be less risky. And financial engineering can always
sort of like allocate the risk and only let that portion of the risk that is
adequate for pension funds to be there.
We have a very different legal tradition from that of the U.S.
The U.S. regulation tends to be based on what they call the prudent man
principle. So you leave a lot of--sort of like it's very jurisprudence. So
there is a way of doing things. You know, if somebody tries, his
response--he can be sued by his customers. He adopts his own sort of like
prudential principles and there's a practice that evolves over time. There
are market opportunities. Practice changes and sort of like adapts.
We are more of a French approach. We put everything in a
code, and we put things in a code before the world exists. And then we
assume that the world has to fit in our codes, and then changing the code
is a headache, right?
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So in some sense what we are saying is, look, we took
American institutions translated into French and read it in Spanish, okay?
And the sum of those three things is that the markets are not there. So
let's see if it was in the French, in the translation. You know, we may be
destroying more markets than reducing risk. That is the nature of the
problem that we may have, and consequently we need a policy process
that recognizes those inflexibilities.
MS. DE KRIVOY: I would like to address some of the
issues that were raised in terms of, number one, confirming that we are
aware that there are infrastructure weaknesses for the financial sector, and
these have to be addressed with or without the pension fund problems. If
we don't address them, our financial sectors won't develop. So that's not
under discussion.
Second, our question-and-answer period concentrated a lot on
the collateralized loan obligations and on small and medium enterprises.
Those are important, but they're not the only ones. And that's why we
focus on four asset classes that could bridge the gap between supply and
demand for long-term funds, and that includes mortgage securities.
Mortgage lending is prevalent in all of our countries. We'll continue to
have a demand for that.
Infrastructure finance bonds. We have a high and growing
need for infrastructure and there may be a point in finding ways in which
to fund it and also collateralized loan obligations which allow us to
securitize a very diverse type of future flows of income or existing loan
obligations.
Banks may have an incentive to get rid of part of their
portfolios. If not, we wouldn't have securitization there at all. And there
is an experience throughout the world when you take a very high-risk loan
like a credit card loan and you package credit card receivables and you
can securitize them and you can market them.
Will this be so attractive that foreigners will come and buy
it? Maybe, hopefully. Okay, so what? If they do come, what we're doing
is adding to the flow, and we do not intend to restrict this market and
make our pension funds the preferred investors in these instruments.
Furthermore, this is not a one-size-fits-all for all Latin
American countries, and we should bear in mind that we range from
countries like Chile, which started in '81 and has gone a long way in
developing its pension funds and its capital markets and its banking
system and its institutions and its infrastructure, and so on, to countries
that haven't even started a pension fund reform, like my country.
And in between, you find countries that have done some.
Countries have multi-pension funds systems. Others have single-fund
pension fund systems. Some allow for foreign investment of pension
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funds, others don't. So what we're saying is this is a gap, this is a
problem; it is an opportunity and here are a set of solutions.
And what we're trying to launch is a thought process where
each country finds its way and where we can eventually trigger also a
cross-fertilization among Latin American countries where we can learn
from each other. And we don't have to necessarily follow the same path,
but if we have problems, maybe we can learn and do something.
And there's sort of a marginal comment in one of the ending
paragraphs where we say maybe at the end of the road, there's room for a
Latin American harmonization of pension funds regulations. Maybe if we
have these financial sector development commissions in each country and
there can be an exchange of views and multilateral institutions such as the
IDB or the Andean Development Fund can serve as a forum for this
exchange, maybe there is a role for harmonization of pension fund
regulations along the way.
And maybe we could even make an allowance for pensioners
in one country to invest in pension funds of another country, provided
they are well-supervised, well-regulated, strong enough for a marginal
portion. I mean, we want to open up the discussion and not keep it
constrained to pension funds that were designed to invest in high-priority
assets, I would say, socially which are government bonds and bank
deposits because we have to keep the banks into the picture. So maybe
this broadens the scope of our statement and allows for each of these
issues to be put into perspective.
MS. ROJAS-SUAREZ: Roberto.
MR. ZAHLER: Yes. Regarding the issue of annuities which
Roberto Garcia asked me, in practice I would say that when you in Chile
talk about pension funds, we are always thinking of pension funds plus
insurance companies. It's a real--you cannot talk today of one without the
other. So I think that's something you have to incorporate because it's
basically those are institutional investors related to the pension fund
system. I would put it in that way.
And in a sense, of course, annuities is one of the possibilities
that people use very commonly of using the pension funds, accumulated
funds, through insurance companies. So they are very, very linked.
I wanted to make a couple of other comments regarding some
of the questions. Today, I would say an interesting development in Chile
has been the multi-fund approach, which means that although funds are
managed by the pension funds, there are different--the degree of riskiness
in funds are different according to the age and risk profile of people. So
in a sense, you have more possibilities of choosing where do you want
your money to be invested, although the administration is with the
pension fund system.
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Regarding foreign investment of the pension funds, that's also
something that Chile has increased a lot. We have around 30 percent of
the total amount of the pension funds--the resources of the pension funds
managed are invested abroad. It's a quite significant amount, although, of
course, there are restrictions in which type of instrument you can invest it
abroad. And I think that has been an important development.
However, I think that something that one has to keep in mind
is that there, regarding currency risk, is something that you need the
domestic market to provide for possibilities of hedging against currency
risk. And that's something that Chile has also increased the--the
derivatives market has been quite active, and today the hedging is done, I
will not say a hundred percent, but almost a hundred percent by pension
funds. And I think that's an important component of the possibility of
opening pension funds abroad because basically the basket of pensioners
is mostly non-traded sort of goods.
And the other thing which we discussed in the statement and
which I think is important regarding pension funds and capital markets
which we have not mentioned here is that we have seen a lot of
experiences where, because of the type of regulation we have, which is to
the prudent man's approach, whenever markets perceive or anticipate
changes in the percentage--changes in the limits of the different sort of
facets which pension funds have to maintain, they tend to generate very
significant changes in key macro prices such as interest rates, prices of
stocks, even exchange rates, which is something which the Chilean
experience tells you that there is a challenge there, also; in a sense, the
macro implications of changes in the regulatory limits of pension funds.
And this is basically because pension funds are becoming an increasingly
very, very significant component of the capital market.
Finally, I would like to mention an interesting thing
regarding the question of Chile. Chile has, I would say, two
characteristics in the last years which make it, I would say--I think people
tend to say Chile has a very developed capital market. Probably, it's true
that Chile has also a very developed capital market without having
pension fund reform.
But Chile has a situation where Ricardo mentioned we have a
fiscal surplus already for two or three years. And the government is not
issuing paper, so that there is--we have a positive problem, in a sense, but
a problem for the pension funds.
Mortgages, which until now represent around 13 to 15 percent
of the total resources managed by pension funds, practically are nonexistent anymore. Today, the competition in the banking system and the
demands of consumers is such that banks are not issuing mortgages
anymore and they have not become competitive, and that was one of the
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main sources of paper that was until now issued and that satisfied pension
fund investments.
And so when you look at the numbers, you see, for example,
that no more than--Chile still has today--to give an idea, 23 percent of the
pension fund resources are invested in deposits in the banking system--23
percent, which is a very significant amount which doesn't appear to be
something very reasonable. And only 7 percent of the total pension fund
resources are invested in bonds.
So, in fact, as we mentioned here, the type of institutions, of
corporations that can issue bonds in Chile, and bonds that could be bought
by pension funds, are very, very small. And so we still have a problem
there which I would say is very relevant. And for a country like Chile,
perhaps these sorts of elements are very crucial, these sorts of instruments
that we have developing here.
And let me insist on one point I mentioned, but I think it is
important. Let me tell you one of the reasons why, for example, in my
country you find it difficult to create these instruments today. I'm saying
"today" because I hope that can change.
On the one hand, still banks are very, very much worried
about market share. They don't want to sell an important part of their
loans because they compete on market share regarding credits. You may
think that that's irrational, whatever you want, but that's the practice that
works that way. Banks are--it's very complicated to convince them to do
that.
Secondly, a fact that still occurs. Securitization is quite
expensive in Chile, very, very expensive. And so banks consider--some
banks consider that getting financing from deposits or from issuing their
own bonds is much cheaper than securitization. So it's not so simple, you
know. These sort of instruments--you require many agents to be really
interested and able and find it profitable to do this sort of investment.
And, finally, in the Chilean case you find that most banks
have excess capital today. So given that, you really don't need it. So
these sort of instruments which, of course, we think are an important
component of what we think would be a further development of the capital
market and the pension funds in our region, require that most all of the
agents that are players in this sort of game should be interested and
should be motivated and should be incentivized.
Thank you.
MS. ROJAS-SUAREZ: Okay. Just let me close with a final
thought that summarizes what my colleagues have been saying. As a
committee, something that distinguishes us from so many other
committees and points of view is that the experience of the members here
have made them arrive to one conclusion and it is that the production and
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financial structure in Latin America today differs significantly from that
of industrial countries. And in that context, just importing regulation
might not only not be effective, but even have undesirable consequences.
Once we start from that recognition, our role is to say, all
right, given the constraints that we face today, what kind of regulatory
practices and modifications are the most suitable to actually get the same
goals that we're all trying to get. That is what characterizes us and what
motivates the kind of statements that we produce.
With this remark, I want to thank all of you for coming here,
and hopefully you will keep interchanging your views with us, as we will
not disappear from the map.
Thank you.
[Applause.]
[END OF TAPED RECORDING.]
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