Schroders has put its plans to develop a distribution channel in Russia on hold as the country’s politicians decide how to move forward with pension reform, and rules on funding pension contributions.
Schroders sees opportunities to distribute its investment products in Russia as the largest market in the Eastern European region, but its efforts are slowed by the stalling of the pension reform.
Thierry Clarke, director for Central & Eastern Europe and the Mediterranean at Schroders, says: “From an asset management perspective, the biggest opportunities lie in the second and third pillar of the pension system.”
However, Moscow has recently decided on a new pension reform strategy, which proposes cutting the funded section of pension contributions from 6% currently to 2%.
This is disastrous for managers of pension money, for whom the biggest opportunities lie in the funded part. Cutting contributions to this by two thirds will significantly reduce the pot of available assets.
The new law is expected to come into force on 1 January 2013, but is being protested by the Ministry of Finance and the Ministry of Economic Development of the Russian Federation.
The International Monetary Fund (IMF) has tagged the pension reform a “key policy challenge” in Russia.
VTB Capital chief economist Maxim Oreshkin says: “The funded part should be increased, not decreased. The longer term savings component would help the Russian financial market.”
As a result of these recent developments, Schroders is putting its plans to develop a strong distribution channel in Russia on hold for the time being. But Clarke still sees business potential in the country. “It is a market that is so large we cannot afford to ignore it, so we are actively looking for opportunities,” he says.
He sees opportunities in some of the inefficiencies of the Russian pension system. For example, one of the key problems with the local legislation is the restriction imposed on pension funds. Currently, they must guarantee 12-month positive returns to their clients.
This “puts shackles on pension fund managers”, Clarke explains, as they cannot invest in risky assets, such as equities and alternatives, with a longer term view.
This is an opportunity for a sophisticated global manager. Schroders has been looking at structured solutions to assist pension funds in providing short-term positive returns.
Another opportunity is in the insurance sector. Recent legislation changes are set to allow the development of unit linked products in Russia, which will open a gateway for large global insurers to enter the Russian market.
Schroders has partnered with some of the large global players already beginning to develop their unit-linked platforms in Russia in a move to prepare for the regulatory change.
Clarke said he would “not be surprised if we see some large global insurance companies making a move into the Russian market”.
The intermediary distribution market, however, does not look as appealing as the institutional universe. Clarke blames the Russian public’s lack of financial literacy and trust in the financial system for the underdevelopment of mutual funds in Russia.
While in Hungary and Poland the average size of the mutual fund industry is around 6.5-7% of gross domestic product, in Russia it barely makes up 0.3% of GDP. The total size of open ended and interval mutual funds is a meagre $3.3bn.
In order for this situation to change, large local banks such as Sberbank and VTB Capital need to make a significant push into wealth management, Clarke says. At the moment, however, they are much more focused on loans, deposits, mortgages and corporate finance as their core business.
As a result, international private banks are doing much better in offering wealth management to local clients. Much of the money is therefore flowing out of Russia, to London, Luxembourg, Cyprus and Switzerland.
A factor that stands in the way are the high bank deposit rates. Clarke says markets with high deposits rates tend to have a limited choice of investment options abroad, making the backdrop a tricky one for external asset managers.
For the time being, Schroders does not have a distribution channel in Russia, but is involved in cross-border sales, partners with local provider and has Russian speakers on its Eastern European desk to facilitate access to local information.
However, Schroders is the only foreign fund provider to have a Russian language website. It also holds regular financial training sessions in the country in the hope to awaken the appetite of Russian investors for fund products.
“Russia has a population of 143 million, so the potential is huge!” Clarke concludes.