The article discusses the opportunities and challenges for foreign asset managers in the pension markets of eight Central and Eastern European countries that joined the EU on May 1, 2004. While the potential for growth is large, early entrants have faced significant regulatory, distribution, and cultural barriers. The Polish pension market is the largest and most promising but still restricts foreign investment and third-party management. Overall distribution challenges and a need for local infrastructure make it difficult for foreign firms to penetrate these emerging markets.

1. GLOBAL INVESTOR MAGAZINE
May 2004 – Features
Attacking a new market
Eight Central and Eastern European countries joined the EU on May 1, providing foreign asset managers with an untapped market. Yet early entrants have found
significant regulatory, distribution and cultural barriers. Jonathan Stapleton reports.
The fall of the Berlin Wall on November 9, 1989 is the definitive marker for the end of the communist era in Central and Eastern Europe. Subsequently, the dramatic collapse of
the Soviet Union in 1991 enabled the independence of a whole raft of countries from the Baltic to the Black Sea. Less than 15 years later, on May 1, 2004, eight of these
countries – Estonia, Latvia, Lithuania, Poland, Slovakia, Slovenia, the Czech Republic and Hungary – joined the European Union.
The opportunities afforded by these accession countries have been coolly assessed long before now, and some major fund groups have already begun their penetration of the
markets. For some, this is due to geographic proximity and cultural similarities – Nordic groups like Nordea, Danske Capital and SEB have already begun staking their claim to
the Baltics, for example. But for other groups like Unicredito, which owns Pioneer, it is part of a long-term gameplan to reach out to these untapped markets. As these eight
economies advance, pension and investment savings will enter a period of growth, which will no doubt entice many more foreign fund managers into the east.
Pension schemes in these eight countries alone are already substantial – with around Euro 14 billion under management. Yet many of these pension schemes, only set up in
the last few years, hold significant potential for the future (see Fig 1). Estimates from Allianz Dresdner Asset Management show that these markets could have anywhere
between Euro 110 billion and Euro 150 billion under management by 2010 – a sum that is interesting asset management firms across Europe.
Dorothee Fleischer, senior vice president and head of pensions research at Allianz Dresdner Asset Management explains: “Currently the markets are tiny but the
potential, of course, is more interesting.” Glenn Wellman, European chief operating officer and the man responsible for Central and East European markets at Credit Suisse
Asset Management, agrees. “These mandatory schemes give you contribution rates that are several percent of GDP year in, year out,” he says. “It has grown from a zero base
but it has grown very fast and it will be very easy to get up to large numbers quickly.”
Yet even though the market as a whole could be worth as much as Euro 110 to Euro 150 billion in six years’ time, this is only half the sums that are currently invested in
German occupational pension schemes. And when you realise that these amounts have to be split between eight different countries and a myriad of different pension schemes,
then some of the assets available look very small indeed. The most promising market thus far has been Poland, where fund managers already hold a sizeable chunk of assets.
This pension market is estimated to be worth between Euro 73 and Euro 95 billion by 2010 (see Fig 2).
Yet even in a large market such as Poland, life can be difficult for foreign fund management firms who want to manage pension scheme money. While many foreign groups
have set up pension fund operations in Poland, regulations currently forbid third party management of domestic assets. Even worse is the fact that Polish pension schemes are
only allowed to invest 5% of their assets in foreign investments.
Regulatory restrictions
These regulations affect most of the accession countries’ pension schemes to some extent – not least because foreign fund managers tend not to have too much experience in
the domestic markets of these countries and can only offer foreign products. So, while Poland allows 5% of its investments to be made in foreign investments just 1.5% of
pension scheme assets have been invested abroad. Similarly in Hungary, which allows 30% of assets to be invested outside the country, only 4.2% have been. Even in the
Czech Republic, which allows 100% non-domestic investment, only 4.6% of assets have actually gone abroad.
These investment restrictions have fuelled fears that an asset price bubble could be building up in these markets. However, Rolf Elgeti a debt and equities analyst at
Commerzbank Securities, says that because pension funds are in no better shape than any of the other EU states in terms of demographic issues, dependency ratios and so
on, this will ensure the bubble does not burst.
“The effect that will outweigh anything else will be the fact that there will have to be many more inflows into these pension systems so we should continue to expect the local

2. equity markets in particular to benefit from these inflows,” Elgeti notes. “While there may be a risk that these pension funds have to diversify into other countries, this will only
really appear when these countries enter the euro as well because currency matching will be important then.”
Even if the local markets can avoid a bubble, they are likely to look at investing a greater proportion of their assets abroad only after they grow in size. Allianz Dresdner Asset
Management’s Fleischer notes: “You need a certain volume of assets to be able to invest abroad because of cost, minimum investment amounts etc.”
Local competition
But the real problem facing asset management firms hoping to win pensions business in these accession countries is being able to gain a foothold in the local market – with all
the main local banks already having significant or total foreign ownership. Foreign firms such as Raiffeisen, Credit Suisse Asset Management, UniCredito and ING have built up
their presence in the accession markets through buying up local banks or by establishing their own asset or insurance businesses in these markets. They are unlikely to want to
throw this presence away and take on third party asset managers more likely they will push their own asset management products. “If you have spent the best part of a decade
building up a business advantage, you would be foolish to throw it all away by opening up to third party asset management,” says one asset manager.
But if the pension fund market is looking like it will be difficult to penetrate for foreign asset managers, then the investment fund market could prove more appealing – especially
when you realise that funds under management have more than doubled between the end of 2000 and 2002 (see Fig 3). Unfortunately, many of these assets are currently
being invested in fixed income and money market funds – mostly with locally based asset managers (see Fig 4).
Yet Jan Kees van Heusde, an executive director at Schroders, is optimistic that this situation will change. He explains that regulatory changes which will come into force as
these countries join the European Union will make it possible to distribute UCITS funds in these countries under the passporting system – making these savers more accessible
to international fund managers.
At the same time, as the accession countries integrate into the EU, their savers are likely to become more sophisticated and will demand more international products. Also, as
the domestic capital markets in these countries tend to be relatively small, this would drive demand for pan-European equity and bond products.
Jan Kees van Heusde says that these shifts are failing to occur at present because of regulatory hurdles and currency volatility. As the currencies in the accession countries
tend to be much more volatile than the euro, domestic investors investing in foreign securities are incurring a large currency risk.
But van Heusde thinks that there is a third reason why there has been little investment in foreign funds. He notes that while there has already been some convergence on
interest rates there is still a yield spread with most of the accession countries that makes it quite attractive for investors to stay within their own fixed income markets.
Daniel Kingsbury, CEO of the New Europe division at Pioneer Investments, says that interest rate convergence is the key issue affecting the take-up of either domestic or
foreign investment funds – an issue that he dubs the euro convergence story. Kingsbury points to Pioneer’s experience in Italy and explains that in 1995 only 4% of Italian
household savings were in mutual funds as people could earn such a good rate of interest from a deposit account. Yet as the Italian government committed itself to joining the
euro, interest rates slowly began to converge with the rest of Europe, which meant that people started to shift their savings into mutual funds. By 2000, around 17% of
household savings in Italy were in mutual funds. “This happened in Italy, Spain, Greece and Portugal as those economies all converged with the euro and the exact same story
is being repeated – starting about three years ago – in Hungary, the Czech Republic, Poland and more recently Slovakia,” he says. “It is the same driver in each case, a shift
out of deposits into fixed income and money market products. May 1 is only a confirmation of something that already started three years ago.”
Indeed, as this trend has taken off Pioneer’s assets under management in its New Europe division have rise from Euro 500 million at the end of 2000 to over Euro 2.5 billion at
the end of last year. But significantly, Pioneer’s parent Unicredito had prepared the way by going on a buying spree in the Eastern European markets, snapping up banks in
Poland, Bulgaria, Romania, Slovakia, Croatia, the Czech Republic and Turkey. The aim is to take its successful Italian bancassurance model and apply that in Eastern Europe,
leaveraging the distribution arm for wealth management and savings sales.
However, Dariusz Nowak, a partner at PricewaterhouseCoopers, says that distribution channels remain dominated by local banks – most of whom have a closed
distribution platform and will not admit third party funds. But there is some cause for optimism: “As soon as the market opens up, there will be a higher rate of
product innovation,” Nowak explains. “Some of the domestic players will need to consider if they can keep up with that innovation.”
Nowak says that local banks are currently acting as both product manufacturer and distribution agent – so they could find themselves trying to be master of all
trades. Breaking this link will herald massive changes in the market. “Opening up will be a big decision and a break in the value chain,” he says. “Before this can
happen, fund managers will have to be comfortable that they can make money out of distribution and also comfortable that they do not want to manufacture.”
Lost in translation
Credit Suisse Asset Management’s Wellman, believes that there are other barriers to entry facing foreign fund managers. While he agrees that the EU passporting scheme will

3. allow asset managers to sell their funds in the accession countries, he says that actually getting people to buy these funds is a costly business – which will mean that the
number of new entrants will be limited. “Creating the infrastructure, the local language websites, sales materials and translating the fund prospectus is quite a time-consuming
and expensive exercise and maintaining it is costly as well,” Wellman explains. “Unless you have people on the ground that is not an easy thing to do.”
PwC’s Nowak agrees and says that the main way to overcome this problem will be through links with the existing local distribution networks. Until these banks
open up to third party distribution – which has failed to happen on any major scale thus far in Western Europe – then mutual fund distribution will remain difficult
for foreign firms who do not have a local distribution presence.
While many of the eight countries were freed from communism in 1989, another wall was coming down in Western Europe. In October 1989 UCITS funds were first permitted –
a move that enabled asset managers to market their funds anywhere in Europe, following the appropriate registrations.
But ominously for the accession countries, notes Pioneer’s Kingsbury, very few groups actually sell UCITS in more than two or three countries. “Everyone got all excited in
October 1989, and registered their funds all across Europe,” he notes. “You look at the market 15 years later and you see that Europe is full of UCITS, but few of these funds
are sold from one country to another.” Instead UCITS are often registered in Luxembourg or Dublin and then just sold back into the group’s home market.
“Being part of the European Union will make many things much easier in theory, but the reality in Western Europe since 1989 is that distribution was the critical element and
that reality will be no different in these accession countries,” he says.
A brave new market?
The growth potential of pension markets in the eight Central and East European countries that joined the EU on May 1 is enormous. While most
of the growth will come from Poland, Hungary and the Czech Republic, the Baltic markets
also show a strong potential for growth in real terms.
The forecasted pension growth is urgently needed to provide retirement income to supplement low state benefits – a supplement that is likely to
fall far short of what is needed.
Allianz Dresdner estimates that to provide a pension of 70% of average net income, the pension schemes in these eight countries will have to
grow to Euro 230 billion by 2010. As can be seen in the table below, this is unlikely to happen.
Using conservative estimates of 5% investment growth, assets in these countries are only expected to rise to Euro 111 billion – less than half of
what will be needed to fund a pensions shortfall in retirement.
Even using a more optimistic scenario, where individuals pay higher contributions, assets will only rise to Euro 148 billion by 2010 – still over
Euro 80 billion short of target.

4. Fig 1: Central and East European pension fund market
Rank Pension AUM 2002 (Euro bn) AUM 2010 (Euro bn) AUM 2010 (Euro bn)
2002 worst case best case
1 Poland 7.80 73.70 94.50
2 Hungary 3.20 21.80 26.30
3 Czech Republic 2.30 8.80 17.60
4 Slovakia 0.19 3.20 4.30
5 Estonia 0.06 1.10 1.40
6 Latvia 0.03 0.70 0.90
7 Slovenia 0.03 1.20 2.40
8 Lithuania 0.00 0.30 0.40
13.60 110.80 147.80
Source: National Statistics and Allianz Group Economic Research
Funding Polish retirement
With almost Euro 11 billion under management in its mandatory pension schemes, set up in 1999, the Polish pension market already holds a
large amount of assets.
Currently, 11.5 million people – or around 30% of the Polish population – contribute an average of PLN 99 (Euro 20.6) each month into a
scheme.
But the Polish market is quite concentrated, with only 16 players left, down from 21 in 1999, and the four largest funds account for a combined
market share of over 73% (see table below).
The market is dominated by international players – with three of the top four groups, who represent 60% of the market, being non-domestic
firms.
The market can be lucrative. Pension funds can charge a front-end fee of up to 7% and an asset based fee of up to 0.05% per month.
Poland already has by far the largest pensions market of any of the accession countries. And this market is set to get much bigger – with the
Allianz Group estimating that there will be between Euro 75 billion and Euro 95 billion in these funds by 2010.
Yet the challenge for foreign fund managers is how to capitalise on these business opportunities. Foreign investment of scheme assets is currently
restricted to 5% of the pension fund assets. Allianz expects that it will take until the advent of the euro in 2009 before the market will fully open
up to EU asset managers.

5. Fig 2: Polish pension fund market April 2004
Rank Pension Fund AUM (PLN m) AUM (gm*) Market Share
1 Commercial Union BPH CU WBK 14,049.48 2,926.98 28.18
2 ING Nationale-Nederlanden Polska 11,180.89 2,329.35 22.43
3 PZU Zlota Jesien 6,974.43 1,453.01 13.99
4 AIG 4,274.22 890.46 8.57
5 Skarbiec-Emerytura 1,741.49 362.81 3.49
6 Zurich 1,659.92 345.82 3.33
7 Sampo 1,568.03 326.67 3.14
8 Bankowy 1,549.68 322.85 3.11
9 Allianz 1,342.77 279.74 2.69
10 Credit Suisse Life & Pensions 1,325.90 276.23 2.66
11 Pocztylion 1,048.96 218.53 2.1
12 Ergo Hestia 1,026.12 213.78 2.06
13 DOM 828.22 172.55 1.66
14 Pekao 805.64 167.84 1.62
15 Kredyt Bank 279.79 58.29 0.56
16 Polsat 202.81 42.25 0.41
49,858.35 10,387.16 100
* Exchange rate based on Euro 1 equalling 4.80 PLN
Source: Global Investor calculations based on www.emerytura.hoga.pl

6. FIG 3: Central and East European investment fund market
Country No of Funds AUM (s bn)* No of funds AUM (s bn)*
(31 Dec 2000) (31 Dec 2000) (31 Dec 2002) (31 Dec 2002)
Poland 77 1.83 107 5.66
Hungary 86 2.07 90 3.82
Czech Republic 70 2.14 76 3.14
Slovakia 18 0.1 39 0.35
251 6.14 312 12.97
*Domestically domiciled UCITS assets
Source: FEFSI
FIG 4: Central and East European investment fund market asset allocation
Country Equity Bond Balanced Money Market Fund of Funds Other
Poland 5 63 7 17 0 8
Hungary 6.2 70.4 1.5 20.4 1.3 0.1
Czech Republic 1.3 18.4 30.2 49.5 0.6 0
Slovakia 4 36 34 26 0 0
Source: FEFSI
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