Pension fund management options being considered

JP Morgan’s offer to do its best to cancel the structural Greek government bond issue, which has been at the center of a heated political debate for the last several weeks, may help the government limit the political damage and perhaps escape a difficult situation. However, it will not do much to cure the lack of sufficient competence, know-how and misunderstanding about bonds, pension fund management and other related issues on the part of the government, the political parties, the media and even some Greek entrepreneurs. On the positive side, this whole affair has left the real economy, the local stock market and Greek government bonds unscathed, showing Greece’s participation in the eurozone has made the country less vulnerable to this kind of turbulence. JP Morgan Chase & Co announced on Friday it was offering to undo the controversial structural Greek government bond and the accompanied swap agreement by buying back the 280 million euros of Greek structured bonds it underwrote in February. The US bank stood ready to purchase the bonds from North Asset Management LLP, a UK-based asset manager, at 92.95 percent of face value. For this transaction to be undone, all parties involved must agree to it, namely Greek state, which is the issuer, North Asset Management, Germany’s HVB, the local brokerage Acropolis, which the Capital Markets Commission decided to close down last week, and, of course, the end investors, that is, the Greek pension funds. It is clear that the government will consent and it is likely that the other parties involved, including North Asset Management, will agree as well, according to market people. It should be noted that the total commission shared by the parties involved exceeded 12 percent of the total -280 million, meaning it approached -34.3 million, an unacceptably high figure by international standards, according to bankers. The usual commission for the private placement of these structured products ranges between 3 and 5 percent but it can go lower if there is some kind of bidding. We should remember that the Greek state collected -280 million from the issuance of these structured bonds, the same amount the pension funds paid to buy them in the end. However, the interest rate swap agreement between the Greek state and JP Morgan Chase, which accompanied the bond issue, had a positive net present value of 12.25 percent of the notional amount, that is, -280 million. This value placed the fair value of the structured bond at 87.75 (100-12.25) of its face value. So, the end investors, the pension funds, which bought it at 100 of its face value, paid an inflated price. Looking beyond the technicalities, this particular bond issue sparked a debate which revealed poor knowledge of these instruments by Greek society in general, including the political establishment, the media, industrialists and many others. Of course, this is a pity since Greece is one of the most indebted countries in the European Union with its public debt-to-GDP exceeding 100 percent and tapping the international capital markets every year, borrowing some -30 billion or more. One would expect the government, the media and all the others to know more about bonds but this is obviously not the case. Confusion We think the public is today more confused and less educated about bonds in general and structural bonds in particular. This is quite dangerous because it is vulnerable to accepting unrealistic proposals which will harm the country’s interest in the long-run. There is little doubt that the government authorities and the boards of the pension funds in particular will choose to invest the social security funds’ money in the most conservative way to avoid criticism for taking excessive risks. This means they will likely adopt a fund management method which suits local vested interests instead of the interests of the people who pay the social security contributions. Moreover, they will heavily favor time bank deposits and government fixed-rate bonds, retaining the country’s central bank as the biggest asset manager. Moreover, in a clear disrespect of the conflict of interest rule, the government pushed for the approval of a new law regarding the appointment of the boards of pension funds, giving the central bank governor the final say in approving their chairmen. Therefore, the head of the central bank will give his blessing to the people who will play a critical role in determining who is going to manage the pension funds’ money. Similar conflicts of interest arise if one looks at the composition of the committee responsible for submitting the final draft containing the proposals for the new institutional framework to govern the management of pension funds’ reserves. According to all accounts, the committee, on which participates the chairman of IKA, the country’s largest social security fund to be affected by the proposals, will suggest the creation of a few mutual fund management companies (AEDAK) by pension funds to manage their money. This is not the most popular pension fund management method internationally but it is the one local banks advocate since it gives them a bigger chunk from the huge commission pie to be distributed. The other most popular and widely used method of discretionary management with segregated accounts does not suit local vested interests. According to the second method, financial institutions are given clear cut mandates by the pension funds to produce the best possible returns for an acceptable level of risk within a certain period of time by investing internationally. If the pension funds are not satisfied with their performance, they are dropped and are replaced by others. The government may recuperate from the bond scandal. However, the scars left on the bulk of society from the inaccuracies, the mistakes and misconceptions about bonds and proper pension fund management may not go away for generations and this is quite unfortunate.

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