Although controversial, investment and other "draconian" regulations for private pension funds are suitable for countries with weak capital markets and little tradition of private pension provision. But regulations should be relaxed as private pension funds gain in maturity.
Like other financial institutions, private pension funds require a panoply of prudential and protective regulations to ensure their soundness and safeguard the interests of affiliated workers. These regulations include authorization criteria (such as minimum capital, "fit and proper," and business plan requirements), asset segregation and external custody, professional asset management, external audits and actuarial reviews, extensive information disclosure, and effective supervision. These regulations resemble those applied to banks and insurance companies and are not particularly controversial.
But private pension funds in developing countries are often subject to structural and operational controls that are more controversial. Such controls include special authorizations and market segmentation, "one account per worker" and "one fund per company" rules, nondiscrimination provisions, regulations on fees and commissions, investment limits, minimum profitability rules, and state guarantees.
Vittas discusses the use of such regulations in developing countries that have implemented systemic pension reforms. He draws a distinction between this approach and the more relaxed regulatory regime that relies on the "prudent person" rule found in more advanced countries. He argues that the "draconian" regulatory approach can be justified on several grounds, but especially by the compulsory nature of the pension system, the absence of strong and transparent capital markets, and the lack of a long tradition of private pension funds. But the regulations should be progressively relaxed as private pension funds and their affiliated workers gain in experience, sophistication, and maturity.
This paper—a product of the Development Research Group—is part of a larger effort in the group to study pension funds and institutional investors. Copies of the paper are available free from the World Bank, 1818 H Street NW, Washington, DC 20433. Please contact Paulina Sintim-Aboagye, room MC3-422, telephone 202-473-8526, fax 202-522-1155, Internet address psintimaboagye@worldbank.org. (37 pages)
The full report is available in PDF format.