THE IMPACT OF PENSION REFORM ON CORPORATE GOVERNANCE PRACTICES AND REGULATIONS: THE CASE OF CHILE * - PowerPoint PPT Presentation

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THE IMPACT OF PENSION REFORM ON CORPORATE GOVERNANCE PRACTICES AND REGULATIONS: THE CASE OF CHILE *

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Title: THE IMPACT OF PENSION REFORM ON CORPORATE GOVERNANCE PRACTICES AND REGULATIONS: THE CASE OF CHILE *


1
THE IMPACT OF PENSION REFORM ON CORPORATE
GOVERNANCE PRACTICES AND REGULATIONS THE CASE OF
CHILE
  • Augusto Iglesias P.
  • PrimAmérica Consultores
  • September, 1999


Presented at the thirteenth Plenary Session of
the Advisory Group on Privatisation, Organisation
for Economic Co-operation and Development. Paris,
France, 21-22 September, 1999.
2
I. Background information
  • Since the early eighties, pension funds have
    become important players in capital markets of
    many Latin American countries. This has been the
    consequences of radical reforms to their social
    security systems.
  • Corporate governance practices depend, among
    other variables, on the size of capital markets,
    the characteristics of their regulation, and the
    ownership structure of firms. All these
    dimensions are affected by the development of
    institutional investors.

3
Pension Reformin Latin American(as of march
1999)
4
...
  • To understand discussion on relationship between
    corporate governance and institutional investors
    in L.A. is necesary to know some basics facts
    regarding each one of this dimensions.
  • Fact N 1
  • In L.A., pension fund investments are strictly
    regulated. All countries apply quantitative
    restrictions that include a list of authorized
    assets diversification rules conflicts of
    interest regulation valuation rules etc.

5
Investment rules for pension funds in Latin
America
6
...
Fact N 2 Allthough, in general, investment
rules do allow investment in stocks in some
countries the stock market is non-existent or is
too small. So, only the pension funds of few
countries invest in stocks.
7
Equity investments of pension funds in Latin
America(as of march 1999)
8
...
Fact N 3
  • Pension funds face important liquidity
    constraints. In many cases they can not sell
    their holdings of shares of one company without
    putting downward pressure on prices.
  • Also, there is no index investment because
    trading by pension funds would move the index.
  • Because of these particular characteristics of
    the capital market, pensions funds have a bias
    in favor of an active role on corporate
    governance.

9
...
  • Fact N4
  • Pension funds that are part of the social
    security system are not company plans.
    Individuals select the pension fund manager they
    want. Also, regulation limits the investments of
    the fund in assets issued by firms related to the
    pension fund managers.

10
...
  • Fact N5
  • The particular design that has been selected for
    the new pension fund systems in L.A. (private
    management and individual freedom to select
    pension fund manager), means that there is low
    risk of political interference on investment
    decisions (and so, on corporate governance).

11
...
  • Fact N 6
  • In general, ownership is concentrated (family
    ownership). So, as pension funds invest in
    stocks of one company they become partners of
    few big shareholders. Maybe because of this
    reason, the main purpose of regulation seems to
    be the control of conflicts of interest between
    minority and majority shareholders, and not the
    control of conflicts of interest between
    shareholders and the management of the firm.

12
II. Impact of pension reform on corporate
governance
  • The development of institutional investors has
    influenced corporate governance (in Chile) in
    three differents ways
  • Pension funds and life insurance companies have
    an important presence in capital markets
  • To protect social security funds, new regulations
    have been introduced to capital markets with
    impact on corporate governance practices
  • Pension funds have appointed independent board
    numbers in many firms were they hold
    participation.

13
a. Pension funds, capital markets and
corporate governance
  • Pension funds plus reserves of life insurance
    companies amounted more than US40 billion in
    1998 (55 of GNP). Social security savings are
    14 of total savings and 3.4 of GNP.

14
Chile pension funds and reserves of life
insurance companies(december of each year)
15
a. Pension fund, capital markets and
corporate governance
  • Pension funds plus reserves of life insurance
    companies amounted more than US40 billion in
    1998 (55 of GNP). Social security savings are
    14 of total savings and 3.4 of GNP.
  • Pension funds hold more than 50 of the
    outstanding debt of the government 16 of total
    time deposits and bonds issued by commercial
    banks 50 of mortgage bonds 53 of long term
    corporate debt and 10 of the stock traded in
    the market.

16
Chile share of pension funds in financial
markets 1/
1/ Pension fund holdings of each asset class as a
of total assets in each class
17
...
  • Until 1986, pension funds only invested in debt.
    So, their influence on corporate governance was
    only because their role as lenders of
    corporations who began to issue bonds as the
    market for long term debt developed
  • Pension funds and life insurance companies helped
    to the development of the market for long term
    debt
  • Corporation who wanted to issue debt were forced
    to have an independent risk rating
  • Pension funds and life insurance companies did
    use their bargaining power to improve protections
    being offered to creditors.
  • In short, the cost of long term debt did
    decrease the cost of monitoring corporations was
    reduced and the quality of the information that
    firms provide to the market did improve.

18
...
  • Since 1986, pension funds have been active
    investors in the stock market.
  • As a proportion of the portfolio, investment in
    stocks did reach a maximum in 1994 (32,2).
    Since then the proportion has decreased, mainly
    because international diversification of the
    portfolio.

19
Chile Pension funds investment portfolio
a/ Include Debt issued by Financial Institutions
20
...
  • Since 1986, pension funds have been active
    investors in the equity market.
  • As a proportion of the portfolio, equity
    investment did reach a maximum in 1994 (32,2).
    Since then the proportion has decreased, mainly
    because international diversification of the
    portfolio.
  • First, they did invest in state owned firms that
    were being privatized (most of them in the public
    utilities sector). Then they begin to invest in
    a broader range of firms.

21
Chile Participation of pension funds in
ownership of stocks
1997
22
Chile Participation of pension funds in
ownership of open public corporations(december
1998)
  • Pension funds hold 10 of equity of open public
    corporations
  • They participate in 99 firms (total number of
    firms traded in the market is 286).
  • In two firms participation is greater than 30
    (but less than 35).
  • In four firms, participation is between 20 and
    30.
  • In seven firms participation is between 15 and
    20
  • In twelve firms participation is between 10 and
    20
  • In seventy four firms, participation is less than
    10

23
...
  • The incorporation of pension funds and - to some
    extent - life insurance companies to the stock
    market did help to increase its liquidity (at
    least for small investors, exit became an
    alternative in case of firms performing below
    expectations).
  • Also, pension funds did begin to produce regular
    and independent opinions on the performance of
    firms. Later, they became the main clients for
    investment banks doing the same job.
  • Because they are part of the mandatory social
    security system, pension funds are exposed to
    close public scrutiny. This also apply to firms
    were they invest.
  • Firms who want to go public and sell shares to
    pension funds, must meet certain minimum
    conditions (positive results in the last years
    disclosure of relevant information etc.).

24
b. Pension funds and capital market
regulations
  • The development of pension funds has had an
    effect on the design of capital market
    regulation. In turn, this regulation has had an
    impact on the role of institutional investors in
    corporate governance.
  • Pension funds were created by law. They are part
    of a mandatory social security system.
    Therefore, there are some implicit - and explicit
    - state guarantees over results of the system.
    Capital market regulation was reformed with the
    purpose of reducing the cost of these guarantees.
    These changes in regulation have benefited not
    only pension funds, but also small investors and
    minority shareholders.

25
...
  • The changes in capital market laws and
    regulations with direct influence on corporate
    governance practices are
  • Mandatory risk rating
  • Control of conflicts of interest
  • Because of this, for shareholders and creditors,
    the conditions to participate in corporate
    governance have improved after pension reform.

26
c. Pension funds and monitoring of conflicts
of interest
  • Because of regulation, pension funds are forced
    to participate in shareholders meetings and to
    vote in each one of the decisions (including the
    election of board members), that are presented to
    the shareholders (this is not only in Chile but
    also in other L.A. countries).

27
Latin America regulation on the vote of pension
funds in shareholders meetings
NR Not regulated NA Not available
28
c. Pension funds and monitoring of conflicts
of interest
  • Because of regulation, pension funds are forced
    to participate in shareholders meetings and to
    vote in each one of the decisions (including the
    election of board members), that are presented to
    the shareholders (this is not only in Chile but
    also in other L.A. countries).
  • Pension funds face liquidity constraints (they
    can not sell their holdings in a short period of
    time without depressing prices). So, for them
    voice and vote are the most important tools for
    monitoring performance of firms.
  • Then, because of regulations and market
    conditions, pension funds have been active in
    shareholders meetings and have elected
    independent board members.

29
Chile Impact of pension funds on the election of
board members
Board members (Total)
Board members
Class of firm
elected with votes
from at least
one pension fund
Chapter XII
80
30 (37,5)
Other
631
41 ( 6,5)
Total
711
71 (10,0)
30
...
  • Independent board members are playing an
    important role as monitors of potential conflicts
    of interest between mayority and minority
    shareholders (foreign institutional investors
    are playing a similar role).
  • Because of the demand for independent board
    members by pension funds (an other institutional
    investors), a new class of professional board
    member is beginning to develop.

31
III. Some unsolved problems
  • In Latin America, there is some concern for the
    large relative size of pension funds in capital
    markets and the increasing concentration of this
    industry. Regulators fear that controllers of
    pension fund companies could control the firms in
    which the funds are invested, against the
    interest of the affiliates.

32
Latin America concentration in pension fund
industry
33
III. Some unsolved problems
a) Fist problem
  • In Latin America, there is some concern for the
    large relative size of pension funds in capital
    markets and the increasing concentartion of the
    industry. Regulators fear that controllers of
    pension fund companies could control the firms in
    which the funds are invested, against the
    interest of the affiliates.
  • Regulators also understand that, effective
    participation of pension funds in corporate
    governance is important for the protection of
    minority shareholders.

34
...
  • A mix of regulations is being used to balance
    both objectives
  • Maximum investment limits as a of the
    outstanding shares of the company
  • Special (reduced) limits, when there is some
    interest of pension fund managers in the firms
    where they want to invest
  • Mandatory and public voting of pension funds
  • Limits to form coalitions with other pension
    funds
  • Strong restrictions on voice.

35
...
  • In our opinion, the result of all these
    regulations is to weaken the potential influence
    of institutional investors on corporate
    governance (restrictions to voice and to form
    coalitions are the most questionable regulations).

36
...
b) Second problem
  • Some important institutions for corporate
    governance have not yet been developed
  • Audit committes
  • Compensation committes

37
III. Final Remarks
  • Corporate governance practices evolve as a result
    of both law and tradition. In Latin America,
    pension reform did force regulators to create, in
    a very short period of time, a new legal
    framework for capital markets and the banking
    sector with the purpose of reducing investment
    risk and the cost of government guarantees in the
    social security system. These changes in
    regulation have had a strong influence on
    corporate governance.

38
...
  • Regulations plus liquidity constraints have force
    pension funds to take an active role on corporate
    governance. However this situation could change
    as local capital markets develop and as pension
    funds begin to invest outside their domestic
    market.
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