PENSION FUND GOVERNANCE. Prof. Adam Samborski Poznan School of Banking

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1 PENSION FUND GOVERNANCE Prof. Adam Samborski Poznan School of Banking

2 INTRODUCTORY REMARKS The corporate governance has failed, becoming one of global financial crisis causes. Currently, the future shape of its basic principles is an issue for an international agenda in an ongoing debate.

3 INTRODUCTORY REMARKS On the one hand, there are calls for an increase in the responsibilities of top management, or the involvement of a wider range of stakeholders in decision-making, on the other, a return to the economic roots of corporate governance is advised

4 WHAT IS CORPORATE GOVERNANCE Corporate governance examines such issues as: the primary purpose of business activity (what primary objective are corporate executives to carry out?), the legitimate claims of interest groups (who has legitimate claims against the corporation?),

5 WHAT IS CORPORATE GOVERNANCE Corporate governance examines such issues as: the key variables (questions about the ownership structure, divisions, cultural groups, etc.), universalism or local significance (is standardized corporate governance needed?).

6 WHAT IS CORPORATE GOVERNANCE In terms of the corporate governance it means the control over the use of company s resources, in other words an appropriate decision-making framework in business, especially preconditions for strategic decisions.

7 WHAT IS CORPORATE GOVERNANCE Two of these aspects come to the foreground: these are harmonizing the interests of the parties involved in the company and ensuring supply of adequate financial resources to enable the company s development

8 CG IN THE PERSPECTIVE OF NEW INSTITUTIONAL ECONOMICS The corporate governance is a set of rules and regulations (formal and informal) that defines the action choices of players involved in the functioning of corporations.

9 C.G. IN THE PERSPECTIVE OF NEW INSTITUTIONAL ECONOMICS Formal institutions are the legal system, which covers a very wide spectrum, from the constitution to the internal regulations of companies. Whereas informal institutions are the rules of conduct contained in customs, traditions, routines, believes, or the mentality of an individual

10 INSTITUTIONAL ANALYSYS OF C.G. This speech aims to analyze the formal institutions of corporate governance in open pension funds operating in Poland. The new institutional economics lays the theoretical foundations for the conducted analyses.

11 INSTITUTIONAL ANALYSYS OF C.G. It is assumed that each pension fund has a specific institutional arrangement for itself, which determines to a large extent its effectiveness. Such an arrangement sets the pension fund under the influence of many stakeholders.

12 INSTITUTIONAL ANALYSYS OF C.G. The primary objective of regulations in the governance area of pension funds becomes a minimization of potential agency problems, conflicts of interest that may arise on the line the fund members - those responsible for the fund s management.

13 PRINCIPAL AGENT PROBLEM In the agency theory the relationships between participants of a project are presented in the form of the so-called agency relationships. Agency relationships are understood as contracts under which a constitutor (principal) engages a third party (agent) to perform certain actions on their behalf.

14 PRINCIPAL AGENT PROBLEM Between the agent and the principal there is an asymmetry of information, namely we are dealing with the agency problem here.

15 PRINCIPAL AGENT PROBLEM Agency problem can be limited in three ways: reduction of information asymmetry, objectives harmonization of the principal and the agent, building trust.

16 PRINCIPAL AGENT PROBLEM Firstly, there are two options to reduce information asymmetry, namely: screening (the principal keeps track of the agent in the corporation), and signalling - (the agent gives specific signals the principal (e.g. reports)).

17 PRINCIPAL AGENT PROBLEM Another solution is to combine the interests of the principal and the agent by introducing incentive schemes (such as managerial options). A third way to reduce the agency problem is to build reputational capital by agents

18 AGENCY PROBLEM IN PRIVATE PENSION FUNDS AND THE WAYS OF LIMITING IT Pension fund governance is a mirror image of corporate governance in joint stock companies, which consists of a set of relations between the company's management, Supervisory Board, shareholders and other stakeholders

19 AGENCY PROBLEM IN PRIVATE PENSION FUNDS AND THE WAYS OF LIMITING IT Pension fund governance, as well as corporate governance, deals with the posting of property rights by the principal to the agent, and consequently relying on the professional skills and management effectiveness of the agent.

20 AGENCY PROBLEM IN PRIVATE PENSION FUNDS AND THE WAYS OF LIMITING IT Private pension plans operate on the basis of the agency relationship between the plan members and its beneficiaries, and the persons or rather entities involved in administering or funding a retirement plan.

21 AGENCY PROBLEM IN PRIVATE PENSION FUNDS AND THE WAYS OF LIMITING IT Governance under such plans includes all of the relationships between the entities and persons involved in the operation of a retirement plan. Governance provides the structure through which the objectives of retirement plan are established, and the means to meet those objectives and monitoring performance

22 AGENCY PROBLEM IN PRIVATE PENSION FUNDS AND THE WAYS OF LIMITING IT Governance in private pension plans and funds includes managerial control of the organization and means of regulation, including liability of management, and how it is monitored.

23 AGENCY PROBLEM IN PRIVATE PENSION FUNDS AND THE WAYS OF LIMITING IT The primary objective of the regulation in pension funds governance is to reduce the potential agency problems or conflicts of interest that may arise between fund members and those responsible for managing the fund, which could negatively affect the security of retirement savings

24 AGENCY PROBLEM IN PRIVATE PENSION FUNDS AND THE WAYS OF LIMITING IT From this perspective, pension fund governance comes down to two issues, namely: to protect the rights and interests of pension funds members, as well as ensure the safety of sources of funding for future retirement benefits.

25 AGENCY PROBLEM IN PRIVATE PENSION FUNDS AND THE WAYS OF LIMITING IT Governance structure should provide the appropriate division of operational and supervisory responsibilities, and define the responsibilities and abilities of those entrusted to pension fund responsibilities.

26 AGENCY PROBLEM IN PRIVATE PENSION FUNDS AND THE WAYS OF LIMITING IT In pension funds there should be developed appropriate control mechanisms, communication and incentives to encourage good decision-making, proper and timely implementation, and regular reviews and assessments.

27 ADDRESSING THE AGENCY PROBLEM IN PENSION FUNDS IN THE LIGHT OF POLISH EXPERIENCE Analyzing governance solutions in pension funds in Poland the considerations will be limited to open pension funds (OFE).

28 Structure of pension system Public pensions: - The new system is based on notional accounts; - Age determines membership of old or new scheme Private pensions: occupational (voluntary): - Employee pension fund (PPE) Private pensions: personal (mandatory): - Open pension fund (OFE) Private pensions: personal (voluntary): - Individual retirement account (IKE, IKZE)

29 ADDRESSING THE AGENCY PROBLEM IN PENSION FUNDS IN THE LIGHT OF POLISH EXPERIENCE Open pension funds are mandatory. They function as open-end mutual funds. Open pension funds can be created only by the general pension society (PTE), acting as a joint stock company.

30 ADDRESSING THE AGENCY PROBLEM IN PENSION FUNDS IN THE LIGHT OF POLISH EXPERIENCE The dominant shareholders of general pension societies are various financial institutions, including international insurance companies, the Polish financial institutions and various consortia of Polish and international financial institutions.

31 ADDRESSING THE AGENCY PROBLEM IN PENSION FUNDS IN THE LIGHT OF POLISH EXPERIENCE The governing bodies of the Society are: the Board of Management; the Supervisory Board; the General Meeting.

32 The member of the Management Board of the Society may be a person who meets the following requirements: 1. Has full legal capacity; 2. Has not been convicted of an offense against property, credibility of documents, business transactions, trading in money and securities, tax offense; 3. Has higher education; 4. Holds a work experience of not less than 7 years; 5. Gives guarantee of the due performance as the Board member. At least one third of the Board should hold a university degree in law, economics, or be included in the list of investment advisors.

33 The Supervisory Board member of the Society may be a person who meets the requirements for the Management Board members in the points 1 and 2 and gives guarantee of due performance as a member of the Supervisory Board. At least half of the Society Supervisory Board members should have a degree in law or economics. Moreover, at least half of the Supervisory Board members of the general pension society are appointed from the outside of shareholders circle of the Society,

34 ADDRESSING THE AGENCY PROBLEM IN PENSION FUNDS IN THE LIGHT OF POLISH EXPERIENCE The Society is responsible to the members of the fund for any damage caused by failure to perform or improper performance of their duties in managing the fund and its representation.

35 ADDRESSING THE AGENCY PROBLEM IN PENSION FUNDS IN THE LIGHT OF POLISH EXPERIENCE The pension society receives from the pension fund a fee levied in the form of a percentage deduction from the amount of premiums paid, not more than 3.5%. In addition, the pension society charges a fee at the rate specified in the Articles of Association. This rate cannot exceed the amount calculated according to the scale specified by law.

36 The rates of management fees decrease with exceeding the successive assets thresholds by the fund. Costs related to transactions of purchase or sale of fund assets and costs associated with the storage of assets by the depositary are covered of the fund assets. In addition, pension societies incur a fee for the contributions transfer and the costs of supervision and the Insurance Ombudsman. We must also mention the cost of the guarantee fund

37 ADDRESSING THE AGENCY PROBLEM IN PENSION FUNDS IN THE LIGHT OF POLISH EXPERIENCE The pension fund invests its assets in accordance with the law, seeking to achieve a maximum degree of safety and profitability of the investments made. The fund is obliged to choose a depositary, whom, by an agreement, entrusts the storage of its assets. A depositary can be a bank only. The open fund is obliged, once a year, to publish a prospectus in a national daily newspaper dedicated to the fund announcements and advertising.

38 FINAL REMARKS Pension funds have been established in the majority of cases by the societies in which dominant shareholders are financial institutions. As a result, financial institutions very easily introduce their candidates to the supervisory boards of societies. It may turn out that the financial institution controls both the Supervisory Board and the Management Board. It is, therefore, proposed to take steps aimed at increasing the independence of supervisory boards in general pension societies.

39 FINAL REMARKS Furthermore, the low level of society s economic awareness and the low interest in retirement issues encourage Societies to undertake expensive marketing campaigns to attract as many members as possible. Such campaigns usually do not lead to improved investment performance of the fund, but only to higher administrative costs and fees incurred by fund members. Hence statutory reduction of fees charged by pension societies and linking their pay to the results of open pension funds investment is proposed.

40 Thank You Prof. Adam Samborski Poznan School of Banking