Those who had hoped that the scandal involving purchases of overpriced regular and structured Greek government bonds may have given rise to a modern institutional framework allowing social security funds to manage their assets must lower their expectations. For although the basic outlines of the relevant legislation passed in Parliament last week may be an improvement on the current framework, the new law falls short of creating the modern framework Greek funds most needed. Compounding its first mistake, which was to employ traditional political means to deal with what is essentially a technocratic problem, and which indeed had political ramifications and appeared to close the gap with the main opposition socialist PASOK party, the ruling conservative New Democracy party then clearly chose to close the bond affair as soon as possible. The scandal provided a golden opportunity to get rid of an antiquidated fund management system and replace it with a modern European one. But it would appear that this came second in the government’s political priorities. Recognizing the need to appoint suitably qualified individuals to the boards of pension funds, the government laid down a number of criteria which candidates would have to meet. And this would have been a move in the right direction, if it managed to avoid clear conflicts of interest. According to the new law, the governor of the Bank of Greece, the country’s central bank, and the head of the Capital Markets Commission will approve the chairmen of the boards of the social security funds. But the Bank of Greece is the country’s leading manager of social security fund reserves, which gives rise to a conflict of interest because it will have the final say in the selection of the people who ultimately decide whether to mandate the bank to manage the pension fund assets. Near-unanimity Apart from the complaints of some labor union leaders and a few commentators, no one else in the government or the opposition parties voiced any objections and the law passed. The Bank of Greece is estimated to manage more than -12 billion worth of Greek government bonds on behalf of the country’s social security funds. It is the single largest asset manager if one takes into account the fact that the value of the property of all Greek state social security funds was put at around -30 billion at the end of 2006. It should be noted that the central bank earns a fee for managing the assets and this generates sizeable revenues. According to some estimates, the bond portfolio of social security funds at the central bank returned about 3.5 percent last year, despite the fact that the benchmark JPMorgan Greek Government Bond Index achieved just 0.2 percent. The difference is largely due to the accounting method utilized by the central bank to calculate returns. This method is not used by any European asset manager of pension fund money to calculate returns on bond portfolios. In addition, the government set up a committee made up of ministry, central bank, Capital Market and Athens Exchange officials to propose a new institutional framework for managing the reserves of social security funds by the end of June. According to sources, ministry officials asked members of the committee to complete their work as soon as possible and rely on the report of another committee that had been given the same task and which had been headed by the deputy governor of the Bank of Greece. On the basis of the outlines of the relevant legislation presented by the recently appointed labor minister last week, the committee finished its work well ahead of time and, to no one’s surprise, its findings contained more or less the same proposals as those found in the report of its predecessor. The legislation calls for the establishment of two committees, one to advise on and the other to supervise the investments of social security funds. Moreover, it retains the current investment ceiling, according to which social security funds can invest up to 23 percent of their total assets in equities and real estate, and gives funds which currently exceed the quota a 5-year period to reduce their holdings in stocks and real estate to comply with the 23 percent rule. It also allows pension funds to invest in structured financial products up to only a very small percentage and urges them to team up and set up Mutual Fund Management Companies (AEDAK) and create Mutual Funds to administer their assets. It is worth noting in this respect that IKA, the country’s largest social security fund, has set up an AEDAK and two mutual funds which are managed by local banks. The returns of the two domestic mutual funds have been very good to date. However, this model is not the most popular abroad, where it accounts for less than 20 percent of cases according to experts. Still, it remains the preferred management model of local banks which want a large piece of the pie. At the same time, individuals with expertise in the management of foreign pension funds express doubts about whether this bureaucratic system of two committees advising and supervising funds can really function effectively. They say they are not aware of any similar system operating in another eurozone country. Outdated quota In addition, they point out that the 23 percent quota is outdated. Most European pension funds tend to allocate more money to equities and real estate and less to government bonds in order to gain superior returns on their investments in the medium term. They also say that diversification is an even more important issue for Greek funds which have put almost all of their stock holdings in 3 or 4 listed companies, mainly local banks, and are thus exposed to high risks if these banks fail to impress investors. And they are right. The proposed institutional framework for the management of the assets of social security funds falls short of expectations because it is not aimed at producing the best system but rather at closing the bond scandal and limiting the political fallout. In this respect, and given the Greek political establishment’s abhorrence of political risk, the country has lost a golden opportunity to modernize the investment framework of its social security fund system.