National Pension Commission   Managing Risks Under A Contributory Pension Scheme May 19 th  & 20 th  , 2009 Presented  by ...
Outline <ul><li>Background </li></ul><ul><li>The Pension Reform Act </li></ul><ul><li>Global Crisis and Pension Funds- Are...
Background <ul><li>The 2004 pension reform act saw the birth of a contributory pension scheme in Nigeria </li></ul><ul><li...
The Pension Reform Act <ul><li>The primary objective of the scheme is to ensure safety of the fund </li></ul><ul><li>Featu...
The Pension Reform Act <ul><li>Risks associated with the scheme include the following; </li></ul><ul><ul><li>Market/ syste...
Global Crisis and Pension Funds- Are there Linkages? <ul><li>The global economy has witnessed a huge diminution in value i...
Global Crisis and Pension Funds- Are there Linkages? <ul><li>There may be a link between the crisis and pension fund perfo...
Impact of Crisis On Pension Assets <ul><li>The Nigerian financial crisis has manifested as follows; </li></ul><ul><ul><li>...
Impact of Crisis On Pension Assets <ul><li>It’s true that only a maximum of 25% of pension funds should be affected by sto...
Impact of Crisis On Pension Assets <ul><li>This is not the case because; </li></ul><ul><ul><li>Only 30% of Nigerian workfo...
Impact of Crisis On Pension Assets <ul><li>RSA funds recorded unrealized losses of about N33.21billion (approx. 7% of the ...
Challenges Facing Pension Managers <ul><li>How to meet redemptions based on a mark to market approach which crystallizes t...
Challenges Facing Pension Managers <ul><li>Prior to now studies were carried out by the commission to establish the risk i...
Challenges Facing Pension Managers <ul><li>That exercise was carried out in the context that the variables were known and ...
Challenges Facing Pension Managers <ul><li>Fund managers and the commission must not confine themselves only to domestic r...
Managing Investment Risks Associated With Pension Assets <ul><li>In order to optimise the risk reward trade off of pension...
Managing Investment Risks Associated With Pension Assets <ul><li>It also involves  </li></ul><ul><ul><li>improving the ris...
Managing Operational Risks Associated With Pension Assets <ul><li>The due diligence of the fund manager must include build...
Managing Operational Risks Associated With Pension Assets <ul><li>It helps put in place multiple points where red flags co...
Managing Regulatory Risks Associated With Pension Assets <ul><li>The regulatory framework must seek to reduce the level of...
Managing Regulatory Risks Associated With Pension Assets <ul><li>There must be a clear delineation between the supervisory...
Managing Regulatory Risks Associated With Pension Assets <ul><li>Adoption of a conservative investment strategy is a key d...
Managing Risks Associated With Pension Assets <ul><li>Specific measures that can be taken to ensure safety of pension fund...
Managing Risks Associated With Pension Assets <ul><ul><li>Collaborating with SEC and NSE to ensure disclosure of pension c...
Limitations To Effective Risk Management <ul><li>Some of these arise from regulatory imperfections but misconceptions abou...
Limitations To Effective Risk Management <ul><li>Remember that the adequacy of risk rating in the management of investment...
Mark Haynes Daniel <ul><li>“ Looking ahead, these risks that we face are increasing in scale and complexity.  Unfortunatel...
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Managing Risks Under the Contributory Pension Scheme2

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Managing Risks Under the Contributory Pension Scheme2

  1. 1. National Pension Commission Managing Risks Under A Contributory Pension Scheme May 19 th & 20 th , 2009 Presented by B.J Rewane FINANCIAL DERIVATIVES COMPANY LIMITED
  2. 2. Outline <ul><li>Background </li></ul><ul><li>The Pension Reform Act </li></ul><ul><li>Global Crisis and Pension Funds- Are there Linkages? </li></ul><ul><li>Impact of Crisis On Pension Assets </li></ul><ul><li>Challenges Facing Pension Managers </li></ul><ul><li>Managing Risks Associated With Pension Assets </li></ul><ul><li>Limitations To Effective Risk Management </li></ul>
  3. 3. Background <ul><li>The 2004 pension reform act saw the birth of a contributory pension scheme in Nigeria </li></ul><ul><li>A brief history of the Nigerian pension scheme is as follows; </li></ul>
  4. 4. The Pension Reform Act <ul><li>The primary objective of the scheme is to ensure safety of the fund </li></ul><ul><li>Features of the scheme are; </li></ul><ul><ul><li>Transfer of risk from employer to employee </li></ul></ul><ul><ul><li>Employer makes a commitment and employee makes compulsory contributions as below </li></ul></ul><ul><ul><li>Fund is invested in market securities and exposed to risks </li></ul></ul>
  5. 5. The Pension Reform Act <ul><li>Risks associated with the scheme include the following; </li></ul><ul><ul><li>Market/ systemic risks </li></ul></ul><ul><ul><li>Investment risks </li></ul></ul><ul><ul><li>Operational risks: </li></ul></ul><ul><ul><ul><li>Systems, processes and people </li></ul></ul></ul><ul><ul><li>Regulatory risks </li></ul></ul>
  6. 6. Global Crisis and Pension Funds- Are there Linkages? <ul><li>The global economy has witnessed a huge diminution in value in asset prices </li></ul><ul><li>Pension funds have come under limited pressure owing to; </li></ul><ul><ul><li>Robustness of their prior reforms </li></ul></ul><ul><ul><li>Most importantly; diversification of their portfolios across sectors and continents </li></ul></ul><ul><li>In the US, pension funds have lost an average of 20% of their values when compared to hedge funds and mutual funds </li></ul>
  7. 7. Global Crisis and Pension Funds- Are there Linkages? <ul><li>There may be a link between the crisis and pension fund performance </li></ul><ul><li>The problems of the Nigerian pension scheme could be attributed to structural weaknesses within the Nigerian Capital and financial markets </li></ul>
  8. 8. Impact of Crisis On Pension Assets <ul><li>The Nigerian financial crisis has manifested as follows; </li></ul><ul><ul><li>Increased volatility of all asset classes </li></ul></ul><ul><ul><li>A burst of the asset price bubble in the Nigerian stock market </li></ul></ul><ul><ul><ul><li>Losing 80% cumulatively (at its peak) and 21.16% year to date </li></ul></ul></ul><ul><ul><li>Higher returns in fixed income and government securities and portfolios are now skewed in favour these securities </li></ul></ul><ul><ul><li>General fear and pessimism which has questioned the safety of the Nigerian banking system </li></ul></ul>
  9. 9. Impact of Crisis On Pension Assets <ul><li>It’s true that only a maximum of 25% of pension funds should be affected by stock market downturn as the regulation limited PFAs investment to this percentage. </li></ul><ul><li>PFAs actually complied with this limit. They actually took a “flight from equity” before year end 2008 which reduced the actual exposure of RSA funds to about 12% </li></ul><ul><li>Growth from additional contribution should not be affected by the crisis as unemployment rate has been modest </li></ul>
  10. 10. Impact of Crisis On Pension Assets <ul><li>This is not the case because; </li></ul><ul><ul><li>Only 30% of Nigerian workforce are in compliance with the act </li></ul></ul><ul><ul><li>Returns from equity investments accounts for approx. 50% of total returns </li></ul></ul><ul><li>Thus a decline in the Nigerian stock market had more than a profound impact on pension assets </li></ul>
  11. 11. Impact of Crisis On Pension Assets <ul><li>RSA funds recorded unrealized losses of about N33.21billion (approx. 7% of the RSA portfolio) as at 31/12/08. </li></ul><ul><li>Compares favorably to the entire Nigerian stock market loss of 45.77% loss in NSE ASI and 31.66% loss in market capitalization as at 31/12/08. </li></ul><ul><li>Total value of pension assets is about N1.1trn </li></ul><ul><li>A diminution in pension assets has both </li></ul><ul><ul><li>Moral impact: deter prospective companies to the scheme </li></ul></ul><ul><ul><li>Economic impact: loss in value of assets </li></ul></ul>
  12. 12. Challenges Facing Pension Managers <ul><li>How to meet redemptions based on a mark to market approach which crystallizes the risks associated with market securities? </li></ul><ul><li>How do we manage the investment, operational and regulatory risks? </li></ul><ul><li>What strategies should be adopted in ensuring compliance and safety of the assets? </li></ul>
  13. 13. Challenges Facing Pension Managers <ul><li>Prior to now studies were carried out by the commission to establish the risk inherent with pension investments in the capital market </li></ul><ul><li>A summary of the findings were that </li></ul><ul><ul><li>The Nigerian capital market was over-valued </li></ul></ul><ul><ul><li>The guidelines were adequate but must be refined to extend the asset classes to include real estate investments </li></ul></ul><ul><ul><li>It also called for liberalization of the fee structure of PFAs </li></ul></ul>
  14. 14. Challenges Facing Pension Managers <ul><li>That exercise was carried out in the context that the variables were known and could be measured </li></ul><ul><li>Current events show that the variables are no longer confined to domestic imponderables </li></ul><ul><li>The impact of exogenous shocks must be part of the risk equation </li></ul>
  15. 15. Challenges Facing Pension Managers <ul><li>Fund managers and the commission must not confine themselves only to domestic risks and must play out the scenarios and their possible outcomes i.e. </li></ul><ul><ul><li>Domestic Stability and A Global Crisis </li></ul></ul><ul><ul><li>Domestic Crisis and Global Stability </li></ul></ul><ul><ul><li>Domestic Crisis and A Global Crisis </li></ul></ul>
  16. 16. Managing Investment Risks Associated With Pension Assets <ul><li>In order to optimise the risk reward trade off of pension funds, </li></ul><ul><li>managers and custodians must be able to identify and measure the risks </li></ul><ul><li>Managing the risk elements go beyond identifying them </li></ul><ul><li>It begins by </li></ul><ul><ul><li>formulating a risk strategy that will help in preserving pension funds. </li></ul></ul><ul><ul><li>Taking a proactive stand in relation to changes in the business environment </li></ul></ul><ul><ul><li>integration of the risk management framework with the strategy. </li></ul></ul>
  17. 17. Managing Investment Risks Associated With Pension Assets <ul><li>It also involves </li></ul><ul><ul><li>improving the risk awareness to all stakeholders, </li></ul></ul><ul><ul><li>clearly defining roles and responsibilities, </li></ul></ul><ul><ul><li>building risks and simulating stress testing scenarios, </li></ul></ul><ul><ul><li>and effective portfolio management that avoids concentration risk. </li></ul></ul><ul><li>using leading economic indicators helps managers to pre-empt the risks that may occur or that are about to crystallize. </li></ul>
  18. 18. Managing Operational Risks Associated With Pension Assets <ul><li>The due diligence of the fund manager must include building a proper business structure i.e. staffing – experience level, organisation size, e.t.c. </li></ul><ul><li>Clear articulation and documentation of the risk policies or contingency plans does not only aid a proactive risk management framework but institutionalises the process </li></ul><ul><li>Decentralizing the risk process has proven to be the most effective in developing a proactive risk framework </li></ul>
  19. 19. Managing Operational Risks Associated With Pension Assets <ul><li>It helps put in place multiple points where red flags could be raised in the risk management process. </li></ul><ul><li>Contingency planning will aid the development of an effective risk management framework. </li></ul><ul><li>Seeking expert opinion, embracing the use of technology to deploy risk mitigants are some of the concepts used in developing an enterprise risk management framework. </li></ul>
  20. 20. Managing Regulatory Risks Associated With Pension Assets <ul><li>The regulatory framework must seek to reduce the level of subjective uncertainty in relating to pension fund management. </li></ul><ul><li>The Knightian theory of uncertainty states that when subjective uncertainty is greater that objective uncertainty, it leads to extreme risk aversion and economic paralysis. </li></ul><ul><li>Fund managers and the pension commission have been extremely risk adverse owing to the increased volatility in asset prices. </li></ul>
  21. 21. Managing Regulatory Risks Associated With Pension Assets <ul><li>There must be a clear delineation between the supervisory and regulatory roles of the commission. </li></ul><ul><li>The regulatory role of the commission must be able to address the issue of compliance to the investment guidelines by PFAs and to the act by companies </li></ul><ul><li>A periodic review of the guidelines, collaborating with other regulatory bodies and the enactment of laws that will enforce strict compliance and sanctions may be considered as an objective means of tackling the problem. </li></ul>
  22. 22. Managing Regulatory Risks Associated With Pension Assets <ul><li>Adoption of a conservative investment strategy is a key determinant in preserving the value of pension funds. </li></ul><ul><li>The fund manager must be seen as a counter party in the entire risk management process. </li></ul><ul><li>Several closed pension funds which have adopted a conservative investment strategy i.e. limited investment in equities and mutual funds which account for less than 25% of total funds have performed optimally amidst the crisis. </li></ul>
  23. 23. Managing Risks Associated With Pension Assets <ul><li>Specific measures that can be taken to ensure safety of pension fund assets are; </li></ul><ul><ul><li>Evaluating fund performance on a mark to market basis. </li></ul></ul><ul><ul><li>Measuring PFA’s by returns only leads to reacting after the deed has been done. </li></ul></ul><ul><ul><li>Strict sanctions should be put in place to ensure compliance to investment guidelines </li></ul></ul><ul><ul><li>Increasing the placement limits on some permissible asset classes reduces the possibility to going above limits e.g. participation in corporate and state bonds </li></ul></ul>
  24. 24. Managing Risks Associated With Pension Assets <ul><ul><li>Collaborating with SEC and NSE to ensure disclosure of pension contribution in the annual reports may encourage participation. </li></ul></ul><ul><ul><li>The risk management process must seek innovative ways of raising red flags when there is a breach of the guidelines. </li></ul></ul><ul><ul><li>Increase awareness campaign on safety rather than on returns. </li></ul></ul><ul><ul><li>Rating the security is only part of the risk management process. </li></ul></ul><ul><ul><li>Risk management should not be confined to professionals. </li></ul></ul>
  25. 25. Limitations To Effective Risk Management <ul><li>Some of these arise from regulatory imperfections but misconceptions about risk management have even greater implications. </li></ul><ul><li>The lessons from the global financial crisis points to the fact that there are linkages between the meltdown and improper risk management. </li></ul><ul><li>Some of these misconceptions are; </li></ul><ul><ul><li>“ the size of the commitment is a sufficient measure of risk, an approved rating by an agency bestows the risk quality. </li></ul></ul>
  26. 26. Limitations To Effective Risk Management <ul><li>Remember that the adequacy of risk rating in the management of investment risks is a necessary but an insufficient tool. </li></ul><ul><li>Risk ratings are done with historical data which may be inadequate in quality or quantity, </li></ul><ul><li>And the fundamentals used in determining the rating may change at any time. </li></ul><ul><li>Institutions and funds with investment grade ratings have failed in recent times. </li></ul>
  27. 27. Mark Haynes Daniel <ul><li>“ Looking ahead, these risks that we face are increasing in scale and complexity. Unfortunately our ability to respond has not kept pace” </li></ul><ul><li>Lesson: We must strive to be ahead of the pack. </li></ul>
  28. 28. Thank You

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