Title: THE IMPACT OF PENSION REFORM ON CORPORATE GOVERNANCE PRACTICES AND REGULATIONS: THE CASE OF CHILE *
1THE 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.
2I. 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.
3Pension 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.
5Investment 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.
7Equity 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.
12II. 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.
13a. 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.
14Chile pension funds and reserves of life
insurance companies(december of each year)
15a. 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.
16Chile 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.
19Chile 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.
21Chile Participation of pension funds in
ownership of stocks
1997
22Chile 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.).
24b. 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.
26c. 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).
27Latin America regulation on the vote of pension
funds in shareholders meetings
NR Not regulated NA Not available
28c. 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.
29Chile 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.
31III. 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.
32Latin America concentration in pension fund
industry
33III. 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
37III. 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.