Government fighting with pension system

BUENOS AIRES — The administration of new Argentine president Nestor Kirchner has launched a full-fledged assault on the AFJP private pension system by decreeing the conversion of its dollar-denominated guaranteed loans to pesos, calling company executives "useless," accusing fund managers of price gouging and suggesting they skirted their fiduciary responsibilities.

The biting remarks came from the finance and justice ministries of the new government, which assumed power in May 2003. Argentina declared default on $140 billion of government debt in January 2002 and ended the one-dollar-equals-one-peso convertibility plan shortly thereafter, resulting in a devaluation of up to 75% in the peso.

The pension funds are suing to keep the government from reneging on the terms of the guaranteed loans, following Mr. Kirchner's recent announcement that they would be included in his upcoming debt restructuring. When the pension funds swapped high-interest bonds for the loans, maturities on the bonds were extended and interest rates were cut, while the assets were guaranteed against tax revenues and thus protected from a subsequent default.

The government's harsh words also coincided with the opening of debt negotiations with creditors, which include the AFJPs, or Administradoras de Fondos de Jubilaciones y de Pensiones. The AFJPs are private companies created in 1994 to manage most of Argentina's social security system, though a smaller pay-as-you-go government system remains in place. The largest Argentine AFJPs are controlled by firms including the Spanish Santander Central Hispano and Banco Bilbao Vizcaya Argentaria, as well as Citigroup and HSBC Holdings.

Mr. Kirchner has already authorized his labor and finance ministries to begin crafting a pension system reform bill, and while rumors abound regarding the changes that might be proposed, industry experts say it seems apparent that the government is seeking to discredit the AFJPs to win public support of at least a partial return to the state-run system.

When default was declared, the AFJPs had about 75% of their combined US$20.8 billion in assets exposed to government obligations, most of which were converted to pesos in early 2002 at the rate of US$1 to 1.40 pesos (the dollar now quotes freely at AR$2.90). Nevertheless, the AFJPs never considered themselves subject to the peso conversion as they had negotiated a swap with the government in late 2001, when they exchanged high-yielding public bonds and treasury notes for a 7% guaranteed note in U.S. dollars.

While most local creditors accepted the conversion of their dollars to pesos, the AFJPs have argued that the guaranteed note is not subject to such a conversion. But in late September, with the government seeking to take a blanket 75% cut on the nominal value of all its obligations, the Finance Ministry decreed that the notes be transformed immediately back to defaulted bonds and converted to pesos.

The AFJPs reacted with outrage, claiming the matter should be decided in the courts, which have ruled in some cases that the government's dollar-denominated obligations had to be honored. The pension industry association — the Uni%F3;n de AFJP — also re-tendered its proposal that Argentina extend the maturities of its obligations with the AFJPs by 15 to 30 years, together with a four-year grace period on interest and a drop in interest rates to LIBOR plus 2%. Horacio Canestri, the executive director of the association, argued that this structure would give the government time to honor its obligations while insuring that the 9 million current AFJP affiliates receive decent pensions.

But this "we're different" stance by the AFJPs is what caused Finance Minister Roberto Lavagna to lambaste their executives for not having seen the writing on the wall and accepting the conversion. "Frankly, I would love to see how much the AFJPs pay their executives because they are truly useless," he said at a recent press conference.

Meanwhile, accusations were flying from other areas of the government. Justice Minister Gustavo Beliz declared that the courts should step in if any irregularities are found in the AFJP's past trading methods, administration of affiliate assets, or collection of fees, though no investigation has been announced. And the cabinet minister, Alberto Fernandez, suggested that AFJP affiliates be allowed to return to the state-run pay-as-you-go system.

Mr. Lavagna, who was named to his position in early 2002 by interim President Eduardo Duhalde some months after the default and devaluation, also said the AFJPs should be subject to shareholder lawsuits because of the "bad management" of their assets, and went on to suggest that the AFJPs inject more capital into their businesses if they feel they haven't done a good job meeting investor expectations.

Mr. Lavagna's statements reflects the public's long-running disgust for the AFJPs, which are accused of exacting exorbitant fees from the workers they serve only to turn the assets back over to the government in the form of debt purchases. The AFJPs charge average fees of 2.25% of workers' salaries, while payroll deductions were originally 11% and later reduced to 6%. In other words, the AFJPs' fees take $2 to $5 out of every $10 deducted from affiliate paychecks. Since inception in 1994, the AFJPs have collected 25 billion pesos in fees, while workers have 45 billion pesos in total assets, according to the Uni%F3;n de AFJP, which notes that the fees — which cover early-death and disability insurance premiums for workers — will drop considerably over time as a percentage of total assets.

As for Mr. Lavagna's claims of mismanaged investments, the AFJPs point out that they had little chance to diversify away from Argentine debt since the launch of the system. The local stock market is highly illiquid, there have been very few corporate-debt issues, and the regulatory process for approving trusts and securitized notes has been very tedious because of understaffing at regulatory agencies. On top of that, the cap on international investments has historically been 10%.

But in the months leading up to the default, as noted by Daniel Marcu, executive director of Towers Perrin Marcu y Asociados, Buenos Aires, the AFJPs were obligated by then-Finance Minister Domingo Cavallo to sell off CD, mutual fund and equity investments and buy additional government obligations. In fact, during the 12 months prior to the default, virtually all new flows from affiliates went straight to the government, based on an agreement between the finance ministry and the AFJP association. According to Mr. Canestri, the AFJPs acceded to this arrangement in order to make a "patriotic contribution" and keep the government solvent when international funding dried up.

Mr. Marcu stressed that the least painful approach for AFJP affiliates and the government would be for the government to accept the proposal of the Uni%F3;n de AFJP. "The worst scenario is for a large part of the portfolio to be valued at 25% of face value," he said, adding that he thinks there is a good chance the government will accept the proposal.