1. International Forum on Pension Reform June, 2007 (Re)designing regulatory framework for pension reform and development of financial markets: Estonian experience financial markets: Estonian experience Veiko Tali Ministry of Finance of Estonia

2. Impact of pension reform for development of financial markets the earlier you will start with reform – the higher the impact - the earlier you will start with reform – the higher the impact - comparing with the relative level of development of financial markets the bigger the potential financial volumes – the higher the impact - the bigger the potential financial volumes – the higher the impact - mandatory character and level of contributions the smaller the country – the higher the impact ?

3. Impact of pension reform for development of financial markets the long term (30) impact is more important than short (5) and medium (10- 15) term one the long term (30) impact is more important than short (5) and medium (10- 15) term one (adaptivity is crucial) redesigning possibilities can be restricted redesigning possibilities can be restricted (eg. justified expectations of voluntary switchers) Flexibility versus reliability ?

4. Reformed pension system FIRST publicly managed compulsory PAYG ER-16 % 1999/2000 SECOND privately managed Optional/ compulsory funded 4(ER)+2 (EE) 2002 THIRD privately managed voluntary funded 1998

5. Preconditions for implementation of pension reform (II pillar) Regulatory framework Regulatory framework Supervisory capabilities Supervisory capabilities Market infrastructure (registration, central depository (1995), stock exchanges (TSE in 1996) Market infrastructure (registration, central depository (1995), stock exchanges (TSE in 1996) Level of market development (banks, insurance) Level of market development (banks, insurance)

6. Financial Supervisory Authority Financial Supervisory Authority (2002) Banking Inspectorate (dep of BoE) Securities Inspectorate (dep of MoF) Insurance Inspectorate (dep of MoF) Depositary Banks Management Companies Insurance companies

7. Reform of financial supervision - FSA Integrated (at Bank of Estonia) Integrated (at Bank of Estonia) Independent (special two-level management structure, 3/4 appointment) Independent (special two-level management structure, 3/4 appointment) Financed by market participants (budget ca 3 million euro) Financed by market participants (budget ca 3 million euro) Competent and capable (70 staff) Competent and capable (70 staff)

8. Impact of pension reform design For development and structure of financial services INDUSTRY – For development and structure of financial services INDUSTRY – (higher level of competition, higher volumes, more diversified and viable financial sector) For development of capital MARKETS For development of capital MARKETS (new instruments; more issue(r)s; deeper, more liquid and stable markets, domestic long-term investments, higher savings rate)

9. Impact for industry 1 Product design Product design pension fund structure parallel products or not (II vs III pillar) differentiation of accumulation and decumulation stages annuity vs. programmed withdrawal Provider design Provider design asset managers vs. insurance companies vs. banks centralized or decentralized provision fully or partly specialized providers role of depositories (conflict of interests)

10. Impact for industry 2 Choice options Choice options product options (unified, restricted) switching conditions (full or partial switch or starting with new fund) Fee structure Fee structure single or several fees (entry, exit) restrictions –ceilings disclosure requirements (incl expenses) Capital requirements, marketing rules etc Capital requirements, marketing rules etc

11. General framework of II pillar Employer Employee Tax Board ECSD Accounts FSA LIC Pension funds DB II phase Guarantee fund PFMC I phase

12. Pension fund management company Management company Investment funds Individual portfolios Depositary bank Pension funds (II+III pillar) unit holders

13. Initial results for financial services industry Real boom of asset management and investement funds (incl. PF-s) industry Real boom of asset management and investement funds (incl. PF-s) industry More diversified financial services sector – but clearly dominated by banking sector More diversified financial services sector – but clearly dominated by banking sector Increased competition (new providers) but (still) highly concentrated, lack of competition in pension fund management (fees unchanged) Increased competition (new providers) but (still) highly concentrated, lack of competition in pension fund management (fees unchanged) Export of financial services (Competence center – FC?) Export of financial services (Competence center – FC?)

14. Financial sector framework MINISTRY OF FINANCE (DRAFTING LEGAL ACTS, ISSUING SECONDARY LEGISLATION) FINANCIAL SUPERVISION AUTHORITY (FINANCIAL SUPERVISION, ISSUING GUIDELINES) BANK OF ESTONIA (ISSUING SECONDARY LEGISLATION, MACRO-SUPERVISION) Investment firms (6) Investment firms (6) Management Management companies (9) companies (9) Investment funds (24) Investment funds (24) Pension funds (22) Pension funds (22) ASSET MANAGEMENT + Insurance companies Insurance companies (14) (14) Branches (5) Branches (5) Insurance brokers (23) Insurance brokers (23) Insurance agents (…) Insurance agents (…) INSURANCE Credit institutions (7) Credit institutions (7) Branches (8) Branches (8) BANKING Listed shares (16) Listed shares (16) Listed bonds (4) Listed bonds (4) STOCK EXCHANGE I N D U S T R Y

15. Number of institutions in Estonian financial sector

16. Foreign ownership (end of 2006) 20% 40% 60% 80% 100% % of share capital % of total assetsListed shares held by non- residents All shares held by non-residents BankingShares * The biggest management companies of pension funds are subsidiaries of the foreign-owned banks

17. Financial market concentration (2006) 53% Hansapank 27% SEB 13% Sampo ERGOLHV Investment Funds (by assets) Pension Funds (by assets) Banks (by loans to nonfinancial sec.) Life insurance Companies (by gross premiums) 54%22%6% HansapankSEB 16% Trigon 48%30%9% HansapankSEB 9% NordeaSampo 43% Hansapank 25% SEB 21% Sampo 5%6% ERGOSeesam

18. Estonian current account

19. Investments by sectors in Estonia

20. Financial structure of Estonia (% of GDP) 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% Debt securities InsuranceAssets of investment funds* Stock market capitalisation* Loans and leasings*** 2003200420052006 * Incl. pension funds' assets ** Stocks listed on Tallinn Stock Exchange *** Loans and leasings to households and non-financial undertakings

21. Financial deepening (growth rates) -40% -30% -20% -10% 0% 10% 20% 30% 40% 50% 60% 70% 200420052006 GDP growth Growth of debt securities Growth of insurance premiums Growth of investment funds assets Growth of stock market capitalisation Growth of loans and leasings

22. Profitability of financial institutions: (ROE in solo basis) 0% 5% 10% 15% 20% 25% 30% 35% 40% 45% 50% 2003200420052006 Credit institutions Management companies Investment firms

23. Payments by payment instruments

24. Investment funds sector Total investment funds – 46 funds (18 equity, 15+7 pension, 6 debt) – 9 fund management companies – assets: 30,2 billion EEK (2 billion EUR,14% of GDP) in march 2007 II Pillar pension funds – 15 mandatory pension funds – 5 pension fund management companies – assets: 9 billion EEK (0,6 billion EUR, 4% of GDP) in may 2007 – ca 530 000 investors

25. Investment funds assets 0 5000 10000 15000 20000 25000 30000 199819992000200120022003200420052006 0,0% 2,0% 4,0% 6,0% 8,0% 10,0% 12,0% 14,0% Assets M EEK% of GDP

26. Market share of investment funds 2002200320042005 87% 14% 71% 14% 31% 44% 23% 46% 24% 27% Debt funds Equity funds II pillar funds III pillar funds 2001 94% 4,4 b EEK3,0 b EEK7,2 b EEK10,9 b EEK18,1 b EEK 51% 19% 28% 2006 26,9 b EEK

27. Asset Management (% of GDP) 0% 1% 2% 3% 4% 5% 6% 7% 8% 9% 10% Debt fundsEquity fundsMandatory pension funds Voluntary pension funds Individual portfolios 200420052006 Total size of asset management in the end of 2006 – 2 781 mln EUR

28. Size of II pillar assets (mln EUR) * 2007 – 2025: estimation

29. II pillar pension funds fees in practice Management fee Unit issue fee 1% 2% 3% SEB 00 SEB 50 ERGO 00 ERGO 50Hansa K1 Hansa K2 Hansa K3 Sampo 00Sampo 25Sampo 50 LHV DVLHV MALHV KVLHV TSLHV UT Unit redemption fee

30. Management fees by fund type and country Source: ZEW/OEE database. Data from Feri FMI Fund File, ZEW calculations; the data refer to the maximal fees included in the prospectus.

31. III pillar in practise PENSION FUNDS: – 7 pension funds – 31 984 members (5% of employed) – 866 million EEK (0,4% of GDP) – average nominal investment return around 20% (yearly basis, from beginning) PENSION INSURANCE: – 5 life insurance companies – 81 463 contracts (13% of employed) – 1651 million EEK (0,78% of GDP)

32. III pillar assets Pension funds Pension insurance 0,5 1,5 2,0 1,0 2,5 Billion EEK 200220032004200520012000 0,25% 0,75% 1 % % GDP 0,50% 2006

33. Impact for markets Investment rules Investment rules Quantitative vs. prudent man rule Diversification rules Instrument based restrictions (equity, non- listed, non UCITS funds, real estate etc) Country based restrictions (home, EEA, third countries) Self-investment restrictions (same group) Switching rules, taxation etc. (long-termism)

34. Investment restrictions – main asset class rules into equity (incl. equity funds) – up to 50% into non-listed securities – up to 10% into bank deposits – up to 35% into money market instruments – up to 35% into non-UCITS funds – up to 30% into real estate – up to 10%

35. Main three types of pension funds D Debt pension funds – all assets must be invested into debt instruments. Each pension fund manager must have at least one this type of fund under management. Equity pension funds – up to 50% of assets can be invested into equity. Balanced (mixed) pension funds Balanced (mixed) pension funds, which can invest up to 25% of assets into equity.

36. Assets of II pillar pension funds 2002 0,17 2003 0,99 2004 2,48 2005 4,65 2 1 3 4 5 Billion EEK 50% debt - 50% equity 75% debt - 25% equity 100% debt 6 2006 7,43 1% 2% 3 % % GDP 4 %

37. Investment rules – country based investment restrictions no restrictions for EEA or OECD investments securities issued by third country issuer – up to 30% securities traded only in third country – up to 20% currency matching rule – not less than 70% in EUR or EEK

38. II pillar investment by asset type (2006) Equities Units of equity funds Units of other investment funds Money market instruments Bonds Bank accounts Real estate Other 41,1% 3,1%14,8% 12,4% 3% 24,5%

39. II pillar investment by asset type 0% 20% 40% 60% 80% 100% 30.06.2004 30.09.2004 31.12.2004 31.03.2005 30.06.2005 30.09.200531.12.200531.03.2006 30.06.2006 30.09.2006 31.12.2006 31.03.2007 Equities Units of equity funds Units of other investment funds Money market instruments Bonds Bank accounts Other

40. II pillar investment by region (2006) USA EU-10 (except Estonia) Russia Other Estonia EU-15 54,5% 9,8% 2,5% 19,1% 3,3% 11%

41. II pillar investment by region

42. Investments into Estonia (2006) 0 200 400 600 800 1000 1200 1400 1600 1800 30.06.200430.09.200431.12.200431.03.200530.06.200530.09.200531.12.200531.03.200630.06.200630.09.200631.12.200631.03.2007 5% 10% 15% 20% 25% Assets M EEK % of assets

43. Investments into Estonia (2006) Equities and units of funds 34% Money market instruments 8% Bonds 38% Real estate 2% Bank accounts 17% Other 1% 3/4 of investments into Estonia are in real economy 1/4 is actually invested outside of Estonia

44. Growth of Estonian GDP and TSE index

45. Investments to Tallinn Stock Exchange (end of 2006)

46. Tallinn Stock Exchange (2001 – 2006) : incl. shares and bonds * Incl. de-listing of Hansapanks shares

47. Nordic-Baltic Capital Markets Relative Size, End-2006 Denmark181 60683%413 202188% Iceland27 375219%13 371107% Sweden467 072152%207 63168% Norway232 55687%117 7144% Finland234 691140%55 86433% Estonia4 52135%3923% Lithuania7 72433%1 1705% Latvia2 03913%6494% Bond MarketsStock Markets Country Outstanding Stock (mln ) % of GDP Capitalization (mln ) % of GDP

48. General government debt 70,9 7,6 6,4 5,7 6,2 4,7 4,4 5,3 70,4 69,2 69,4 70,4 72,8 74,2 74,9 75,1 5,0 0 20 40 60 80 19961997 1998 1999 2000 2001 2002 2003 2004 % of GDP Euro areaEstonia 69,4 4,5 70,8 4,0 2005 2006

49. Loans and leasings (% of GDP) 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% 19992000200120022003200420052006 Households Debt/GDP Non-financial corporations Debt/GDP

50. Annual interest rates of loans granted to individuals

51. Financial deepening (growth rates) -40% -30% -20% -10% 0% 10% 20% 30% 40% 50% 60% 70% 200420052006 GDP growth Growth of debt securities Growth of insurance premiums Growth of investment funds assets Growth of stock market capitalisation Growth of loans and leasings

52. Savings in Estonia %GDP

53. Investment return of II pillar PFs Debt instr PF 3% 3,5% Mixed PFs 6,6% 9,3% Equity PFs 11% 15,5% 5% 15% 20% 10% From beginning Last 12 months

54. Investment return of II pillar PFs 2002200320042005 100 150 120 130 110 140 EPI 100 EPI 75 EPI 50 EPI 2006 160

55. Initial conclusions for capital market development Overregulated – too strict quantitive investement restrictions – negative real rate of returns of debt pension funds. Overregulated – too strict quantitive investement restrictions – negative real rate of returns of debt pension funds. Lack of long-term views in investment strategies (short-termism) Lack of long-term views in investment strategies (short-termism) Moderate level of impact to domestic capital market (no corporate and mortgage bond market boom, no new long-term instruments) Moderate level of impact to domestic capital market (no corporate and mortgage bond market boom, no new long-term instruments)

56. Redesigning regulatory framework Removing investment restrictions Removing investment restrictions - real estate and real estate funds up to 40% - venture capital funds up to 50%(+20%) - ? increasing 50% equity ceiling (70% or 100% for equity funds) for III pillar funds already 100% - ? allowing 10 % equity for most conservative fund (10 %, 40%, 70% instead of 0,25,50) Making fee structure more transparent Making fee structure more transparent removal of entry fee removal of exit fee if 5 years before retirement regressive ceilings for management fee Payment phase (annuities etc) Payment phase (annuities etc)

57. Contacts www.pensionikeskus.ee veiko.tali@fin.ee