Long History of Long-Term Money

The Moscow News
Newspaper № 522(522)
May 14,  00:05

Vladimir Loevetsky

In his interview to the Moscow News Director of Vnesheconombank’s Trust Management Department Alexandr Popov told about long-term investments, prospects for pension money and habits to change the rules of the game

- We can say that Russia is hunting for long-term money. The President, the Prime Minister, ministers and industrialists are all talking about long-term money. Long-term money is associated with prospects for economic growth and above all with infrastructure development. Many other projects are also in need of long-term investments. Besides direct investments from the state’s budget, which is already overloaded with allocations, where can we obtain long-term money? In the countries with advanced financial systems pension, insurance and investment funds have long become sources of long-term money. And what about us?

- Basically we have the same sources - both potential and real ones. Above all, I mean pension money and then companies associated with life insurance. Investment funds and banks hold third-fourth place. Although probably there will be no real long-term money in the banks until irrevocable deposits appear. Of course, theoretically such major banks as for example Sberbank have such resources as it holds half of all deposits. And even if its share of irrevocable deposits diminishes it will still hold a significant amount of these resources. But irrevocable deposits would play a significant role for the banking system as a whole. So far there are no irrevocable deposits, they are not allowed by law. If the Civil Code allows banks to introduce irrevocable deposits it will help them a lot to create long-term financial resources.

- People will probably be afraid of depositing money for a whole period without the right to withdraw their deposits.

Anyway we should try. We can’t force people to do it; they have the right to make a choice. But we know that we can interest them with higher interest rates. Irrevocable deposits will become guaranteed resources. And depositors will have higher interest rates for longer periods. Of course not all people will rush to make such deposits. But the most important thing is to observe the rules of the game. A new source of long-term money will gradually come into being. In general, it takes time to create such a source.

Alexandr Popov Director of Vnesheconombank’s Trust Management Department   Born in 1970. Graduated from Social Economic Department of the Institute of Asia and Africa under the Lomonosov Moscow State University. In 1995 started to work in Vnesheconombank as a trader. Since April of 2005 – Director of the Trust Management Department

As far as mutual investment funds are concerned the rules of the game play a great role here. Until a certain period of time incomes from selling units of these funds owned for more than three years were exempt from taxes. Then, this tax exemption was abolished, thus eliminating a significant incentive for long-term investors. And now the President ordered to equalize opportunities for those whose deposit in banks, mutual investment funds and other instruments. Without this, it will be difficult for us to create a significant financial base for such funds, nevertheless compared with bank deposits mutual investment funds are much lesser resources because it’s more difficult to deposit in such instruments as people need to have minimal financial literacy.

- What about life insurance?

Compared to investment funds life insurance is of course simpler. The problem here is how to make people deposit in them and what incentives we can use as well as how publicize these insurance products? At present, out of available instruments pension funds are the simplest products and most importantly they have existed since 2002. By the way, this system is developing pretty normally – in any way people become interested in their pension savings. Now 30% are no longer undecideds, they make decisions on their own and choose nongovernment pension funds. If the system didn’t work, people would remain passive. But unfortunately, by our Russian tradition if something starts working our patience runs out and we demand that the system should work in the most efficient way and they start to change the system fundamentally and we lose almost everything that we have achieved.

- Perhaps arguments over pension reform are not over yet. In its original version mandatory contributions for a funded portion of pensions were significantly reduced from 6 to 2%. And there were proposals to move to only voluntary contributions.

- On the one hand we have been talking so long about the need for long-term money. And pension funds gradually became such resources. And on the other hand these resources are being greatly reduced. 2% is already an absolute minimum.

- And then this version was somewhat softened. 2% for those who have never made a choice or written an application, that is for, “undecideds”. And 6% - for those who choose a non-government pension funds.

- This will significantly reduce investment potential of VEB as a state managing company. As far as nongovernment pension funds are concerned we don’t know yet how people will respond to this change. People have just started to get used to the existing system and rules and started to choose the nongovernment sector to a greater extent. Regulators also started to better understand how to better exercise control over the situation with pension savings funds. Initially, supervision was so strict that it was an obstacle to generating incomes rather than a means to secure the protection of pension funds. Only recently state managing companies have become able to work with more various instruments, strenuous efforts are also being made to ease restrictions for nongovernment pension funds. And the most important achievement is that inflation went down. At last, the real value of our pension money became positive - higher than inflation. Unfortunately, credit rates are high; they are also higher than inflation. But this is a normal economic situation when real rates are positive. And in the situation when the investment system started to operate a lot better, all the rules are being changed.

- In response to this they say: How come inflation went down but credit rates did not?

- First, inflation didn’t go down that much. And second, credit rates allow for inflationary expectations. This means that market players are not sure that inflation will go down further. Nevertheless, we are now in a position to perform our functions to really ensure the protection of pension savings funds so that yields on pension funds are at least no lower than inflation. And nongovernment pension funds are also in a position now to generate positive yields. But given that the whole funded pension system is changing, we don’t know exactly how people will respond. And it’s not that they might prefer nongovernment pension funds, they can lose interest in the funded pension system as such. And they started to become interested in it. And this interest could form the basis for voluntary pension savings. Behavioral patterns do not come into being fast. In this line of business a ten-year period is not a long period at all. And now the emerging behavioral pattern is being challenged.

- Mandatory pension savings already amount to 700 billion rubles.

- So far, we have no answers even to elementary questions: if you for example you want to remain in the Russian Pension Fund but retain six-percent contributions for a funded portion of your pension or on the contrary you have chosen a nongovernment pension fund but want to reduce contributions for a funded portion where are you supposed to submit your application to? To the Russian Pension Fund? To a nongovernment pension fund? To your employer? I couldn’t make sense of all those points and coefficients in the pension formula under consideration now, which should somehow link length of service, wages and etc. And it doesn’t allow people to understand if it’s better for them to increase insurance portion of their pension hoping that by the time of their retirement state finances will be in order or to rely on funded portion of their pension hoping for investment yields?

- Nevertheless, pension money is already being used in our economy and they plan use it to a greater extent. In this respect, they often talk about infrastructure bonds.

- I don’t like this term very much. They issue corporative bonds all over the world and funds from them are spent in accordance with an issue prospectus. They also issue project bonds the funds from which are used to finance specific projects. Basically, these bonds are in need of qualified investor. We of course can and should invest pension savings funds in infrastructure projects. The question is who should be provided with them and for what purpose. In our country project finance is in its infancy. Project development is not satisfactory as a rule. And it’s common knowledge that there are few specialists in this line of business. The other part of the problem is legislation associated with project finance. We have to improve it. We should for example create special business entities that are better protected against bankruptcy. It will be impossible to levy execution upon a project if a company failed to fulfill its other obligation in full. There are also other risks. And we can’t just say: stay clear of the project, it is of national significance. If the project is so important, it should be backed by a rating or a state guarantee. Then we can use pension funds to finance such a project.

- But if a project is backed by a state guarantee, we have to use funds from the budget.

- You are quite right. Here a lot depends on the quality of analytics and preparation of a project to be backed by state guarantees. Moreover, if the state provides guarantees for a project, it should mean that no obstacles will be raised upon its implementation and it will enjoy the state’s full support at its all stages. And in this case, the Finance Ministry would provide guarantees more readily. As far as pension savings funds are concerned our minimal objective is to manage them on a break-even basis and moreover they should generate incomes.

- In what projects is VEB as a state managing company investing pension money buying out this sort of bonds? What bonds are backed by state guarantees?

- The first projects that we partially funded using pension funds to buy out bonds of project engineering companies were the motorway Moscow – Saint Petersburg from 15^th to 58^th kilometer, the Odintsovo bypass, the construction of the Western High-Speed Diameter in Saint Petersburg. All these bonds are backed by state guarantees and they generate good incomes. Coupon is inflation rate plus 2-3% or a high fixed rate of more than 9% per annum.

- Are you sure that these projects will pay back the investment?

- Yes, they will. These are toll motorways designed to unclog extremely congested traffic arteries. Toll road tariffs are pegged to inflation. Everything is all right here. There is another problem here. We have so far bought project bonds. But as in this case VEB acts as a state managing company and invests pension funds we buy these bonds only if they are backed by state guarantees. In our capacity of a state managing company we are just investors and we are not in a position to be involved in an expert examination of a great number of projects. Who is supposed to analyze a project? If it has a credit rating, it means that a respected rating agency accredited under the Finance ministry is to study a project and assign a rating to it.

- And you will be able to make a decision based on this rating?

Yes, either guarantees or a rating. But there are various practices in the world. For example, in England there is a governmental institution engaged in project analysis. If it approves a project the state can invest budgetary money in this project, so here we have a sort of quality status stamp.

- Today there are plans to invest pension funds in RZHD, the Federal Grid Company as well as in Transneft and Rosatom. Their bonds are unlikely to be backed by state guarantees. So, you will buy such bonds on the basis of ratings?

- They have a rating. RZHD and the Federal Grid Company have a sovereign-level rating. Of course, it’s one thing if bonds are issued for a period of 5-7 years and it’s quite another thing if we have 15-20-year projects. But if a company is ready to pay inflation rate plus some percent above inflation we can invest pension funds. We can also buy long-term bonds but only from issuers with at least a sovereign-level rating. RZHD has such a rating from three international ratings agencies. And it is experienced enough in issuing long-term eurobonds.

- Nevertheless, if such a company stops paying?

- For this reason, such companies are required to have at least a sovereign-level rating. Such companies won’t disappear and won’t go bankrupt. Here I mean large companies with big capital. They all have a room for maneuver. If a specific project does not yield expected results, then they can transfer money from a successful project and make payments on bonds. There is no doubt that such large-scale projects like BAM (the Baikal-Amur Mainline) do not payback. But RZHD will not build BAM using pension money. It will if it gets budgetary funds. And it can invest pension savings funds in other commercially acceptable projects. And we are going to see if its ratings are not changing. In any case the issuer should have at least a sovereign-level rating.

- Today there pension savings funds worth 1.5 trillion rubles under Vnesheconombank’s management. Is this sum going to increase, diminish, will there be others who will want to receive this long-term money?

- It’s already 1.6 trillion. This sum looks big only at first sight. The fact is that the money has already been invested and not only in government bonds but also in corporate bonds and is already being used to fund the construction of motorways, railways and grid electric facilities. But the amount of money is limited and requirements for developing infrastructure, mortgage lending and for implementing other long-term projects are huge. As a state managing company VEB is the largest investor in mortgage bonds. As to our new investments, we expect to receive financial resources from the Russian Pension Fund. Last year we received 300 billion rubles from it and for various reasons we returned about 125 billion rubles. So, the net inflow was 175 billion rubles. But if mandatory contributions to funded portions of pensions go down to 2%, the situation will change radically. Undoubtedly, we’ll receive yields from investments in bonds already made plus funds from redeeming bonds. But our potential for investments in infrastructure companies, project bonds and mortgage lending will diminish significantly if not disappears.

- You manage long-term money as a state managing company. And what will happen to another source of investments – savings in nongovernment pension funds?

Nongovernment pension funds have more than 700 billion rubles in mandatory pension savings funds and these resources are becoming quite significant. And attitudes to this money are also changing for the better. Once a law on guaranteeing pension savings is enacted, a requirement for pension funds to be managed on a breakeven basis each year must go away, to tell you the truth this requirement is silly. First, it prevents nongovernment funds from making money. And second, given this requirement, it makes no sense to talk of long-term-money. If the law is passed, it will make nongovernment pension funds more attractive and they will be given a chance to make long-term investments. All this will probably require to exercise stricter control over their activities and for this purpose we need a mega regulator being created now whose functions are to be performed by the Bank of Russia.