‘Link foreign workers to home country pension systems’

This is the seventh and last part of Arab Monetary Fund and World Bank Group report on Pension Systems in the Arab Region: Trends, challenges and options for reforms.

— Editor

There are then six specific categories.

Actuarial Soundness: Guidelines 58-61 (which will deliver financial stability);

Enforcing Prudent Person: Guidelines 62-70 (which will deliver sound investments);

Prevention and Control of Corruption and Fraud, and Service Standards for Members and Beneficiaries Guidelines 71-75 (which deliver Member Coverage, Contributions, Benefits and Services);

HR Policies and Investments in Information and Communications Technology: Guidelines 76-85 (which refer to Resources).

A clear and consistent process is needed to set a realistic long-term target (figure 28):

A dynamic approach is needed because (hopefully) the capital market will develop over time as part of a proactive campaign by governments and market participants to broaden and deepen the market. This will improve the instruments available to channel increasing supplies of longrun assets toward those who need long-run finance to deliver enhanced returns for pension members. The need for this dynamic approach is shown using the example of Mexico, which has seen a progressive move away from nearly 100 percent pension fund investment in government bonds into a much more-diversified domestic and international portfolio across multiple asset classes (figure 29).

Cost discipline is essential because not all costs lead to higher netof-fee returns (or help to achieve the same level of returns with reduced volatility). Benchmarking work shows that if anything higher costs lead to lower net of fee returns. But the message is not simply that low cost is always good but that pension institutions need to have the expertise to determine if they are paying for something that will add value. The worldwide trend to greater use of index or passive investment (particularly in deep and liquid markets) is a testament to the lack of results in aggregate from active management in these markets. But equally, some of the strongest returns have also been direct investments in private equity and real estate by large funds operating in-house investment teams who enjoy a cost advantage against external funds and in particular fund of-fund structures that add additional layers of fees (figure 30). (figures 32 and 33).

As mentioned above, recent developments have affected Arab countries by increasing their financing needs and widening their budget deficits. This has prompted many Arab countries to set up bond issuance plans such as Saudi Arabia, Kuwait, United Arab Emirates, and most recently Algeria, but domestic bond markets are still in the development stage in many Arab countries, and lack of a critical mass of local companies that are candidates for public listing or issuance of rated bonds constrain them (see figures 32 and 33). Sukuk markets, corporate bonds, and PPP schemes are also in a nascent phase.

Arab capital markets, especially in GCC countries, can play a major role in supporting Arab infrastructure projects; there are signs that project bonds could play an increasingly important role in infrastructure finance deals, most likely as a post-construction refinancing tool. The perception persists that project bonds are not likely to be a viable solution for the initial funding requirements of most regional Greenfield projects because of the limited appetite in the project bond market for construction risk, the volatility of the debt capital markets, and the “cost of carry” associated with debt capital markets issuances. That said, project bonds offer a valuable pool of additional liquidity in certain situations, such as postcompletion refinancings and expansions, and using project bonds in this way should help free up liquidity in the bank markets that could then be redeployed in other Greenfield projects in the region. The World Bank recently launched the ‘Cascade Decision Making Approach’ which provides guiding principles to support infrastructure finance. As the document sets out: “The guiding principles for projects deemed as presenting development benefits and value for money would be as follows:

Prioritize non-governmental guaranteed, cost effective commercial financing, broadly defined as financing that subjects the borrower to the discipline of the market;

Where commercial financing is not cost effective or viable due to perceived risks or market failures … focus support on addressing these market failures through upstream reforms to strengthen country and sector policies, regulations, and institutions, and, where justified, welltargeted subsidies;

Where risks remain high, raising the cost of commercial capital beyond that afforded by project or corporate revenue generation, explore the potential for lowering the financing cost by deploying concessional and public resources in risk-sharing instruments;

Where commercial financing is not cost-effective or viable for needed public infrastructure services despite sector reform and risk mitigation, public and concessional resources will be applied.”

The development of Arab capital markets, within a sound regulatory framework, requires a number of institutional and structural reforms including a macroeconomic environment that is conducive to increasing the private sector share in the economy and the strengthening of market forces through improving the flow of information, accounting standards, property rights, pricing efficiency and tax reforms. Some institutional reforms which are necessary are set out below.

Pension funds and insurance companies typically play a major role in the development of government securities markets. These institutions help reduce the predominance of banks, alleviate the occurrence of one-way markets in volatile periods, and stimulate the demand for longterm instruments, especially during the accumulation phase of pension funds.

What is lacking so far in Arab capital markets to increase their depth is the full range of institutional investors, mostly represented by pension funds and insurance companies. The investor base is generally small in Arab countries. There are many opportunities to increase the role that pension funds and insurance companies in the region play because, except in GCC countries, pension funds and insurance companies account for less than 5 percent of GDP.

A number of public pensions operate under a hybrid of partly prefunded and partly pay-asyou- go systems, such as in Egypt, Morocco, and Jordan, making their reserves a high proportion of GDP (33, 29, and 30 percent respectively). This ranks them as the largest institutional investors in each country, yet their public nature and the absence of alternative investments place them in the position of captive investors, with a less-important role in creating competition in debt markets. In Morocco, for example, public pension funds play a more-active role in public debt markets, particularly the Caisse de Dépôt et de Gestion, which holds 9 percent of public debt. It is the most-important participant in the primary market and the second largest in the secondary market for government securities. This has raised concerns about its potential to influence public debt market prices.

What successful savings markets have in common is a regulatory framework for pensions and insurance that includes prudential investment guidelines to ensure safety and liquidity of investments. Portfolios, whether publicly or privately run, would have to adhere to regulations that would include minimum portfolio allocations for highly rated or risk-free assets, including Sukuk. Regulators and market participants should deepen their cooperation on sharia-compliant money market instruments and hedging. Arab countries should improve the basic requirements for institutional investors in the region for conventional and sharia compliant. What is needed is a comprehensive look at private savings and a commitment to promoting them.

Ongoing reforms in the pension sector of a number of Arab countries, including making sure that adequate funds are set aside for future pension commitments, has resulted in rapid growth of the institutional investor base. These reforms have in turn accentuated the need to provide local institutional investors with domestic investments that match their longterm investment horizons, focusing the attention of governments in the Arab region on deepening the local institutional funding base. criticized for lack of transparency and shortcomings in corporate governance. Family companies continue to avoid the capital markets and seek other means of financing for the usual reasons of maintaining confidentiality and flexibility. As nonrated, largely non-listed entities, they do not need to respond to shareholder demands to maximize return on equity.

Moreover, the owners of such companies may find it difficult to realize value from their investments. These factors, among others, limit transparency and disclosure standards, in particular, and corporate governance practices in general. Although the corporate governance framework is already in place in many Arab countries, there is room for improvement in transparency, disclosure, protection of non-controlling shareholders, directors’ independence, qualifications, and compensation. The challenges the region is facing regarding legal and regulatory frameworks and property rights can also be considered barriers to proper corporate governance.

The regional primary markets, conventional and Islamic, have generated sufficient scale to justify greater expectations for the secondary market; although strides have been made, liquidity and price transparency could be boosted. There is a broad view that there is room for better indices to serve the buy side. Greater price transparency and index inclusion will further enhance the value proposition and go a long way toward drawing more global investors to this rapidly evolving new market, including Sukuk.

Rather than the availability of funding being the constraining factor, the main constraints may lie closer to the investment side. Especially in the infrastructure sectors, an important constraint may be that there is no pipeline of “investible projects” that could form the basis of corporate bond issuances and be suitable for pension funds to invest in once a suitable number of such issues are available. There is a dearth of well-structured, viable projects and project structuring skills among local sponsors. Thus, a case can be made for facilitating investment by providing risk mitigation to pilot projects that also can be used to strengthen the institutional infrastructure in terms of project preparation and with a view to strengthening the facilitating legal and regulatory framework.

The trend of successfully introducing new products to the market should continue and help shape the market in the future. The trend to diversify issuer types should continue as smaller companies become more familiar and comfortable with the market and what is required to access it.

If the markets are to realize their potential, a vision has to be developed and implemented. The single most important thing that could be done to underpin a debt capital market would be action by the states to develop government yield curves in their own currencies. Bond markets contribute to the region’s development, and recent years have seen tremendous growth. There needs to be consensus on a regional vision and an organized official commitment involving the states, central banks, and national regulators, with help from industry.

This report has set out a broadbased analysis of the key challenges facing countries in the Arab region. The AMF and the WBG stand ready to support countries, particularly ministries and regulators within countries, to develop and improve their pension systems where good quality projects have secure funding to proceed.

The first step on this journey was to convene the conference held in Abu Dhabi in January 2017. This report is the next step. It provides insights to the issues and the potential solutions that will be useful to countries committed to analyzing the issues and creating the political will to deliver meaningful reform. Simply doing more studies will not be enough to tackle the growing issues faced in all Arab members.

The aim is to improve the coverage of good quality pensions – where good quality means sustainable and affordable pensions that deliver adequate income in old-age in a way that is efficient in terms of costs, investment returns and impact on the capital and labor market, overseen by expert regulation and supervision that can ensure assets and accrued rights are secure. It is important to note that the recommendations would pursue what is best for the individual countries given their specific overall development objectives, as well as each country specific institutional and policy environment. It is equally important to emphasize that the needed pension reforms should be considered in the context of the current overall trends and reforms regarding Labor Markets policies, and Social Protection systems (e.g.: efforts to promote private sector employment, labor mobility, and more efficient welfare state/wealth redistribution mechanisms).

The first recommendation is for the development of adequate data to understand the pension system. Without good data, it is not possible to use powerful tools such as microsimulation of pension entitlements or income distribution analysis to support equity in delivery or use the World Bank Pension Database to benchmark countries against subregional, regional and global peers.

Secondly, the national identification and information technology systems to support delivery of public and private pensions need to be reviewed. Without good ID and IT even a perfectly designed pension scheme will fail to deliver. The WBG has tools to review both elements, which could be used by any country with gaps in these areas.

Third is the need to focus on improving the sustainability, equity and affordability of pensions. For most Arab countries, sustainability issues are similar to the rest of the world. For GCC countries the pensions are also facing sustainability challenges in the sense that contributions will cover benefits due to government contributions but now with lower oil prices such payments are increasingly unaffordable – or will crowd out other priority areas of spending. In all cases, there is a need to look at parameters such as accrual rates, contribution rates and retirement ages as well as survivorship and disability pensions. The WBG PROST tool can analyze the situation and develop reform options.

Fourth is a focus on expanding coverage of pensions in a way that improves the diversification of public and private pension provision. In all countries, the role of the employer is critical in improving access to pensions. For countries with high levels of informality in the labor market (nearly all non-GCC countries) the focus on the employer needs to be supplemented by building systems that can be accessed by people without a formal employer. For those countries with very high participation of foreign born resident workers who are likely to retire in their home country, the debate should focus on mobility saving accounts and linking workers automatically to their home country pension systems if this is high quality. The Outcome Based Assessments for Private Pensions (OBA) tool can be used to develop implementable recommendations across private pensions.

A fifth group of issues relate to improving the efficiency of pension systems – reducing costs and fragmentation, improving investment strategy and governance and improving the capital market. It is important to address fragmentation of schemes, improve governance, investment expertize and execution to improve returns to members, or to improve asset-liability matching. Developing the capital markets in Arab countries is an important milestone. Reforms are needed to corporate governance, to improve liquidity in secondary markets. The new ‘cascade’ approach from the World Bank can enhance the ability of capital markets to support infrastructure finance.

The sixth and final area of focus on enhancing the security of pension systems through developing or creating regulators and supervisors that can successfully supervise pensions. Among other tools that can be used is the introduction of Outcomes and Risk Based Supervision (ORBS) that ensures a regulator looks at the long-run outcomes a system is aiming to provide and prioritizes action against the biggest risks to these outcomes – by choosing the most effective tools – from new regulations, to training or communication through to on-site supervision and enforcement.

The AMF and the World Bank have come together to create the initial pension conference and this report to set out the challenges and the potential solutions that can be deployed. They stand ready to support countries, sub-regional groups or the whole AMF membership where viable projects can be created and financed. As well as the six key areas highlighted above, perhaps the most important message to reiterate is the need to develop the political and social case for change – and the commitment of the AMF and the World Bank to support willing partners in their journey to improve their pension systems now and in the future. The initial priorities and road maps will differ between countries, but it is hoped that the commitment to improve pension outcomes in the longrun is shared broadly.