## 1. Placing of Pension Assets by Type of Security, January 1, 2004

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---

### I. Pension reform in Kazakhstan — institutional and coverage summary
- Pension reform law enacted in June 1997 and implemented in 1998, transforming system from PAYG defined-benefit to fully funded, defined-contribution principles.
- Accrued entitlements for service prior to January 1, 1998 retained under old system; post-1998 service benefits from individual accounts.
- Total number of accounts: 6.4 million.
- Estimated number of contributors: 2.0–2.5 million; continuous contributors estimated at around 1.1 million.
- Contribution rate under the new system: 10 percent of earnings allocated to individual accounts.
- Number of pension accumulation funds in operation: 16, including the state pension fund (SAF).
- Pension funds had accumulated US$2.5 billion (almost 8½ percent of GDP) as of January 1, 2004.

### II. Portfolio composition and key statistics (January 1, 2004)
- Placing of Pension Assets by Type of Security (percents as reported):
  - State securities of Kazakhstan (RK) of which 53.6
    - RK Eurobonds 12.3
    - domestic securities of Ministry of Finance 17.9
    - National Bank of Kazakhstan (NBK) notes 23.3
    - local government securities 0.2
  - Deposits in commercial banks 6.9
  - Securities of International Financial Organizations 2.9
  - State securities of foreign issuers 2.4
  - Kazakhstani non-state securities, of which 29.9
    - shares 4.0
    - bonds, of which 25.9
      - denominated in US$ 10.6
      - denominated in tenge 15.3
  - Foreign non-state securities, of which 4.2
    - shares 3.0
    - bonds 1.2
  - Total 100.0
- Additional reported portfolio characteristics:
  - Some 35 to 40 percent of aggregate pension portfolios are either denominated or otherwise linked to the dollar.
  - Likely some 40 to 45 percent are held in short-term maturities.
  - In the beginning of January 2004, about 30 percent of the pension assets were invested in instruments denominated in U.S. dollar.
  - Corporate bonds constitute 24 percent of the private pension funds portfolio with maturities ranging from three to seven years.

### III. Risks identified
- Currency risk:
  - Large share of assets denominated or linked to U.S. dollar (35–40 percent linked; about 30 percent dollar-denominated cited).
  - Substantial portion of domestic corporate bonds—reportedly some 85 percent of bonds outstanding—are linked to the U.S. dollar through covenants (indexing, triggers, put/call options, capping/flooring).
- Reinvestment risk:
  - High-share short-term maturities (40–45 percent) and focus on short-term, high-yield investments increase ongoing reinvestment needs.
- Issuer and market volatility risk:
  - Concentration in short-term high-yield instruments and limited domestic long-term opportunities exposes pension assets to issuer risk and market volatility.
- Governance and methodology gaps:
  - Actuarial methods are not applied in making investment decisions.
  - Investment strategies are not aligned with long-term actuarial nature of pension liabilities.
- Liquidity and maturity mismatch:
  - Excessive accumulation relative to payouts and limited availability of tenge-denominated long-term securities.

### IV. Findings on current investment practices and objectives
- Present strategies are short-term, high-yield driven with insufficient consideration of long-term liabilities.
- Short-term focus exacerbates reinvestment risk and market exposure.
- Articulated ideal investment objectives:
  - Primary investment in long-term securities balancing capital preservation and returns.
  - Management consistent with stakeholders’ risk tolerance.
  - Prudent liquidity management to ensure cash flows for benefit payments while avoiding excess liquidity that increases reinvestment risk.

### V. Policy implications and recommended institutional practices
- Use of actuarial methods:
  - Actuarial projection models recommended to estimate financial inflows and outflows over long periods and to inform investment strategies and pay-out choices.
  - Actuarial involvement essential for annuity business, guarantees (including minimum guaranteed pension), and predicting fiscal implications.
- Asset valuation and reporting:
  - Appropriate method for asset valuation based on a “going-concern” assumption.
  - Transparent and informed reporting requirements.
  - Matching assets with future expected cash outflows.
  - Caution: marking to market could encourage short-term, high-yield seeking behavior; alternative approaches include Anglo-Saxon actuarial present value of future financial flows or cost basis adjusted for relevant factors.
- Diversification and management channels:
  - Encourage entry of experienced life insurance companies (possibly via legally separate affiliates) into second- and third-pillar fund management.
  - Consider trade-offs of quantitative restrictions on foreign investment: macroeconomic stability vs. loss of diversification and long-term return opportunities.
- Market development and regulatory reforms:
  - Government initiatives noted: early privatization, introduction of mortgage-backed securities, ambitious legal and regulatory reforms for financial sector and joint stock companies.
  - Government stated goal for capital account liberalization and regulatory compatibility with EU pertinent directives in 2007.
- Capacity building:
  - Advanced investment management requires high-quality mathematical and actuarial skills; actuarial profession in Kazakhstan: Society of Kazakhstani Actuaries established 2001–02 with 50 members of whom 30 have an actuary license.

### VI. Practical considerations for policy-makers
- Recognize and address currency, reinvestment, and issuer risks arising from current portfolio structure and limited domestic long-term instruments.
- Apply actuarial techniques to align investment choices with projected liabilities and to assess fiscal implications of guarantees.
- Design incentives and regulatory frameworks that promote long-term, prudently diversified investments while supporting domestic capital market development.
- Weigh restrictions on foreign investment against the need for diversification and higher long-term returns.

*Source: Agency of the Republic of Kazakhstan for Regulation and Surveillance of the Financial Market and Financial Institutions.*

### Capital markets: current structure and challenges
- Market capitalization is described as "rather low" and lags comparators such as Chile and Poland.
- Investor base:
  - Highly concentrated by institutional investors.
  - Dominated by pension funds.
- Market characteristics:
  - Lack both breadth and depth.
  - Suffer from illiquidity and consequent price volatility.
  - Illiquid, shallow markets are highly vulnerable to price manipulation.
- Key challenge: broadening the investor base in Kazakhstan.

### Pension assets and demand implications
- Pension assets growth:
  - Base of T 370 billion.
  - Monthly pace of T 7 billion to T 8 billion.
- In 2004:
  - Pension funds will need to place T 99 billion (US$642 million) of pension contributions in the market.
  - Additional need for T 70 billion of reinvestment due to short-term investment strategies.
- Projection: As the next phase of pension reform proceeds and the PAYG system is phased out, demand by pension funds may increase by seven- to eight-fold over the next several years.

### Supply-side shortages of long-term domestic assets
- Shortage of good domestic long-term investment assets.
- Contributing indicators:
  - Zero to negative real return of government bonds.
  - Signs of over-heating real estate markets in large population centers.
- Needed supply expansion:
  - Should come from private sector entering the market.
  - Government role: limited to its own issuance of securities, possible further privatizations, and providing conducive environment for a competitive private sector.

### Government Securities — role and strategy
- Current stance:
  - Government does not need to borrow at present due to high oil revenues and a cautious fiscal stance.
- Reasons to maintain presence in domestic debt markets:
  - Provide benchmark securities in absence of other securities.
  - Enhance development of tenge-denominated debt markets.
  - Maintain and nurture Kazakhstan’s credit rating internationally.
- Recommendation: consider developing a debt management strategy with objectives of market development and predictability for investors and issuers.
- Market liquidity and risks:
  - Excess liquidity in the system from robust economic growth, substantial capital inflows via syndicated loans and Euro-bond issuance.
  - Government bond yields hover around or barely cover the rate of inflation.
  - Continued stagnation risks larger fiscal contingencies in longer term.
  - Shortage of tenge-denominated assets exposes pension funds to significant currency risk and substantial investment risks.
- Suggested issuance approach:
  - Structure government issuance to improve secondary market operations and pricing base without necessarily increasing total outstanding paper.
  - Develop a domestically-derived yield curve up to 7 to 10 years.
  - Consider issuance schedule with less frequent but larger auctions of more standard, ‘plain-vanilla’ long-term bonds.
  - Consider a substantial proportion of fixed-income securities.
  - Set issuance schedule for a reasonable period in advance and make it transparent.
- Examine balance between domestic and international markets with objectives of domestic debt market development and sterilization of capital inflows.

### Mortgage-Backed Securities (MBS)
- Positive development: introduction of mortgage-backed securities.
- Concerns:
  - Unclear extent to which investment decisions are driven by implied government backing via complete NBK ownership of Kazakhstan Mortgage Company (KMC).
  - Some uncertainty among market participants on true quality of protection provided by the pool of collateral.
  - Perception that KMC securities are backed by the full faith of the NBK may lead to overconfidence.
- KMC divestiture:
  - Planned divestiture would alter perception of NBK backing.
  - Legal foundations for enforceability of the mortgage pledge and quality of protection of mortgage pledge pool should be clarified before NBK divests holdings in KMC.
  - Divestiture would address competition and market pricing issues.
- Limits of MBS:
  - Provides additional source of assets for pension fund managers, but even with rapid growth will be insufficient to fully cover pension funds’ investment needs.
  - Could trigger a real estate bubble given signs of over-heating in large population centers.
  - Limited mortgage origination network outside major cities; large banks with wide branches are not members of KMC program.
  - Funding mortgages through MBS unlikely to address fundamental housing stock and communal infrastructure needs; could primarily contribute to housing price inflation.
  - Funding infrastructure upgrades and utilities is important to support housing market development.

### Telecoms, Utilities and Infrastructure funding via capital markets
- Notable absence of long-term bond issues commonly found in developed markets (e.g., telecoms, utilities).
- Robust capital markets could finance utilities and infrastructure investments, supporting economic growth.
- Telecommunications sector: reportedly faces both high tariffs and high profitability.
  - Capital market funding for telecoms would need parallel tariff reforms to ensure investment costs are carried by users.
  - Competition policy issues are outside the scope of the FSAP.
  - Unclear whether telecoms’ long-term funding needs are met from retained earnings or bank borrowing.

### Corporate Securities: Bonds and Equities
- Constraints on private issuers:
  - Low level of competition in key sectors and influential financial-industrial groupings limit potential private sector issuers.
  - Mixed legacy of early privatizations, concerns over consequences from increased transparency, and perceived high cost of listing may discourage issuance.
- Structural dilemma:
  - Kazakhstan is a small, bank-driven economy where dominance of banks and related cross-ownership hamper capital market development.
  - Large commercial banks engage in wide financial activities and concentrate market share in conglomerate structures.
  - Corporate bonds yield less than bank deposits for investors.
- Market developments and impediments:
  - Corporate bond market has started to develop over past couple of years.
  - Government can enhance development through restructuring its own debt issuance.
  - Perceived adverse consequences of transparency (e.g., rent-seeking, hostile takeovers) could restrain new corporate bond entries and equity listings.
- Market activation hopes:
  - Market participants desire a government-backed blue chip listing (possibly via privatization) to invigorate the market; privatization is political and outside this note’s scope.
  - Key to positive developments: level playing field, issuance structure to widen/diversify investor base, and broad transparent distribution.
  - Any such issuance should be accompanied by public education campaigns on benefits of securities market investment, directly and via investment funds (assuming planned legislation is successful).

### Foreign Company Listings and Kazakhstani Depository Receipts (KDRs)
- Regulatory framework for KDRs has been enacted and authorities have taken measures to establish connections abroad.
- Ongoing work with the Federal Securities Commission of the Russian Federation to resolve certain Russian regulatory issues.
- Central Securities Depository (CSD) has established links with Clearstream.
- Economic viability requirement:
  - Foreign company listings or depository receipts must make economic sense for listing entities.
  - Even with resolved regulatory issues, substantial issuance is unlikely absent regulatory or tax benefits from the government.
  - Represents a limited additional source of investment alternatives.
- Longer-term potential: may grow if high-level political discussions on a possible Eurasian economic area lead to closer economic and market linkages.

### Other Asset-Backed Securities (ABS) and securitization
- New law on securitization is being drafted.
- Considerations for securitization law:
  - Careful selection of asset types suitable for securitization.
  - Appropriate accounting and reporting of risks.
  - Viable securitizable assets require sufficiently predictable cash-flow volume.
- Expected market size: likely to remain modest given early stages and small size of securitizable segments.
- Most potential securitization candidates: accounts receivable of extracting industries, though such companies have tended to fund themselves outside Kazakhstan to date.

### Foreign Investment Assets and currency/hedging considerations
- Without substantial domestic market progress, pension funds will invest sizable proportions of assets abroad.
- Likely increase in proportion of foreign currency denominated assets with pension fund growth and need for diversification and exit options.
- Prudence required:
  - Long-term investment horizon.
  - Maximize diversification benefits available in foreign markets.
  - Minimize investment risks.
- Currency risk:
  - Currency risks need to be hedged to the extent possible through diversification of currency exposure.
  - Tenge and U.S. dollar currency derivatives market unlikely to be deep enough for prudent hedging strategies by pension funds given their relative size to the market.
- Physical distance and information limitations:
  - Physical distance from international markets increases investment risks.
  - Insufficient information for informed decisions increases risk of investing in individual securities or active stock-picking; such strategies should be limited to a very small proportion of a pension fund’s assets.
- Use of index funds:
  - Investment restrictions do not allow use of funds as investment vehicles in some cases.
  - Established stock market—and to a certain extent bond—index funds in deep markets could provide suitable diversification vehicles.
  - Index funds are long-term instruments and can minimize reinvestment risk.
  - Clear and prudent criteria should be used for selection of markets and types of funds authorized.
  - Choosing markets in different countries with a minimum acceptable international rating may help diversify FX risk.
  - Authorities should refrain from ad hoc authorization of individual funds.

### Principal-Protected Notes (PPN)
- PPNs are widely used in pension investments in developed markets.
- Prudence principles for PPNs:
  - Issuers should have an investment grade rating.
  - Security should have wide enough distribution.
  - No complex covenants for maturity variation options.
  - Market should be sufficiently deep.

### Summary of key findings and recommendations
- Key short-term concern:
  - High-yield focused strategies of private pension funds that give insufficient consideration to the long-term actuarial nature of pension liabilities.
  - This reflects lack of long-term investment opportunities and inadequate understanding of underlying risks even for a defined-contribution plan.
- Reinvestment risk:
  - Short-term investment focus exacerbates asset management challenges via constant high reinvestment need to replace maturing assets.
  - Higher reinvestment need exposes pension assets excessively to market volatility risks.
- Prudent investment strategy principles for pension assets:
  - Diversification (breakdown between categories) and dispersion (breakdown within a given category);
  - Maturity matching (including liquidity principle); and
  - Currency matching, to the extent possible or, at minimum, hedging through diversification over different currencies.
- Regulatory framework:
  - It is probable that the regulatory framework indirectly encourages risky investment practices.
  - Review of the overall regulatory framework is needed for hidden incentives that do not promote prudent investment strategies appropriate for social safety net assets.
- Market development role:
  - Domestic market development is not a "magic bullet"; without substantial new issuance, shortage of good investment assets will worsen.
  - Market growth needs to come from private sector entry; government role should be limited to its own issuance, possible further privatizations, and creating a conducive environment for competitive private sector.
- Government issuance structuring:
  - Not the government's role to supply assets to satisfy pension demand, but structuring government debt issuance to be more conducive for domestic market development—without necessarily increasing outstanding paper—can improve secondary market operations and provide a more effective base for pricing mortgage-backed, other asset-backed, and corporate debt.
- Managing pension portfolios:
  - Exercise prudence with a long-term investment horizon.
  - Maximize diversification benefits available in foreign markets and minimize investment risks.
  - Consider enhancing diversification via investment in established reputable index funds.
  - Currency risks should be hedged to the extent possible through diversification of currency exposure.

*Source: _cr04337 - 22.      Still, capital markets in Kazakhstan are at a nascent stage of development with a (IMF PDF chapter content).*

### 1. Placing of Pension Assets by Type of Security, January 1, 2004..................................4

### 1. Placing of Pension Assets by Type of Security, January 1, 2004

### I. Pension reform in Kazakhstan — institutional and coverage summary
- Pension reform law enacted in June 1997 and implemented in 1998, transforming system from PAYG defined-benefit to fully funded, defined-contribution principles.
- Accrued entitlements for service prior to January 1, 1998 retained under old system; post-1998 service benefits from individual accounts.
- Total number of accounts: 6.4 million.
- Estimated number of contributors: 2.0–2.5 million; continuous contributors estimated at around 1.1 million.
- Contribution rate under the new system: 10 percent of earnings allocated to individual accounts.
- Number of pension accumulation funds in operation: 16, including the state pension fund (SAF).
- Pension funds had accumulated US$2.5 billion (almost 8½ percent of GDP) as of January 1, 2004.

### II. Portfolio composition and key statistics (January 1, 2004)
- Table 1 — Placing of Pension Assets by Type of Security (percents as reported)
  - State securities of Kazakhstan (RK) of which 53.6
    - RK Eurobonds 12.3
    - domestic securities of Ministry of Finance 17.9
    - National Bank of Kazakhstan (NBK) notes 23.3
    - local government securities 0.2
  - Deposits in commercial banks 6.9
  - Securities of International Financial Organizations 2.9
  - State securities of foreign issuers 2.4
  - Kazakhstani non-state securities, of which 29.9
    - shares 4.0
    - bonds, of which 25.9
      - denominated in US$ 10.6
      - denominated in tenge 15.3
  - Foreign non-state securities, of which 4.2
    - shares 3.0
    - bonds 1.2
  - Total 100.0

- Additional reported portfolio characteristics
  - Some 35 to 40 percent of aggregate pension portfolios are either denominated or otherwise linked to the dollar.
  - Likely some 40 to 45 percent are held in short-term maturities.
  - In the beginning of January 2004, about 30 percent of the pension assets were invested in instruments denominated in U.S. dollar.
  - Corporate bonds constitute 24 percent of the private pension funds portfolio with maturities ranging from three to seven years.

### III. Risks identified
- Currency risk:
  - Large share of assets denominated or linked to U.S. dollar (35–40 percent linked; about 30 percent dollar-denominated cited).
  - Substantial portion of domestic corporate bonds—reportedly some 85 percent of bonds outstanding—are linked to the U.S. dollar through covenants (indexing, triggers, put/call options, capping/flooring).
- Reinvestment risk:
  - High-share short-term maturities (40–45 percent) and focus on short-term, high-yield investments increase ongoing reinvestment needs.
- Issuer and market volatility risk:
  - Concentration in short-term high-yield instruments and limited domestic long-term opportunities exposes pension assets to issuer risk and market volatility.
- Governance and methodology gaps:
  - Actuarial methods are not applied in making investment decisions.
  - Investment strategies are not aligned with long-term actuarial nature of pension liabilities.
- Liquidity and maturity mismatch:
  - Excessive accumulation relative to payouts and limited availability of tenge-denominated long-term securities.

### IV. Findings on current investment practices and objectives
- Present strategies are short-term, high-yield driven with insufficient consideration of long-term liabilities.
- Short-term focus exacerbates reinvestment risk and market exposure.
- Ideal investment objectives articulated:
  - Primary investment in long-term securities balancing capital preservation and returns.
  - Management consistent with stakeholders’ risk tolerance.
  - Prudent liquidity management to ensure cash flows for benefit payments while avoiding excess liquidity that increases reinvestment risk.

### V. Policy implications and recommended institutional practices
- Use of actuarial methods:
  - Actuarial projection models recommended to estimate financial inflows and outflows over long periods and to inform investment strategies and pay-out choices.
  - Actuarial involvement essential for annuity business, guarantees (including minimum guaranteed pension), and predicting fiscal implications.
- Asset valuation and reporting:
  - Appropriate method for asset valuation based on a “going-concern” assumption.
  - Transparent and informed reporting requirements.
  - Matching assets with future expected cash outflows.
  - Caution: marking to market could encourage short-term, high-yield seeking behavior; alternative approaches include Anglo-Saxon actuarial present value of future financial flows or cost basis adjusted for relevant factors.
- Diversification and management channels:
  - Encourage entry of experienced life insurance companies (possibly via legally separate affiliates) into second- and third-pillar fund management.
  - Consider trade-offs of quantitative restrictions on foreign investment: macroeconomic stability vs. loss of diversification and long-term return opportunities.
- Market development and regulatory reforms:
  - Government initiatives noted: early privatization, introduction of mortgage-backed securities, ambitious legal and regulatory reforms for financial sector and joint stock companies.
  - Government stated goal for capital account liberalization and regulatory compatibility with EU pertinent directives in 2007.
- Capacity building:
  - Advanced investment management requires high-quality mathematical and actuarial skills; actuarial profession in Kazakhstan: Society of Kazakhstani Actuaries established 2001–02 with 50 members of whom 30 have an actuary license.

### VI. Practical considerations for policy-makers
- Recognize and address currency, reinvestment, and issuer risks arising from current portfolio structure and limited domestic long-term instruments.
- Apply actuarial techniques to align investment choices with projected liabilities and to assess fiscal implications of guarantees.
- Design incentives and regulatory frameworks that promote long-term, prudently diversified investments while supporting domestic capital market development.
- Weigh restrictions on foreign investment against the need for diversification and higher long-term returns.

*Source: Agency of the Republic of Kazakhstan for Regulation and Surveillance of the Financial Market and Financial Institutions.*

### 22.      Still, capital markets in Kazakhstan are at a nascent stage of development with a

### 22.      Still, capital markets in Kazakhstan are at a nascent stage of development with a mismatch between supply and demand.

### Capital markets: current structure and challenges
- Market capitalization is described as "rather low" and lags comparators such as Chile and Poland.
- Investor base:
  - Highly concentrated by institutional investors.
  - Dominated by pension funds.
- Market characteristics:
  - Lack both breadth and depth.
  - Suffer from illiquidity and consequent price volatility.
  - Illiquid, shallow markets are highly vulnerable to price manipulation.
- Key challenge: broadening the investor base in Kazakhstan.

### Pension assets and demand implications
- Pension assets growth:
  - Base of T 370 billion.
  - Monthly pace of T 7 billion to T 8 billion.
- In 2004:
  - Pension funds will need to place T 99 billion (US$642 million) of pension contributions in the market.
  - Additional need for T 70 billion of reinvestment due to short-term investment strategies.
- Projection: As the next phase of pension reform proceeds and the PAYG system is phased out, demand by pension funds may increase by seven- to eight-fold over the next several years.

### Supply-side shortages of long-term domestic assets
- Shortage of good domestic long-term investment assets.
- Contributing indicators:
  - Zero to negative real return of government bonds.
  - Signs of over-heating real estate markets in large population centers.
- Needed supply expansion:
  - Should come from private sector entering the market.
  - Government role: limited to its own issuance of securities, possible further privatizations, and providing conducive environment for a competitive private sector.

### B. Government Securities — role and strategy
- Current stance:
  - Government does not need to borrow at present due to high oil revenues and a cautious fiscal stance.
- Reasons to maintain presence in domestic debt markets:
  - Provide benchmark securities in absence of other securities.
  - Enhance development of tenge-denominated debt markets.
  - Maintain and nurture Kazakhstan’s credit rating internationally.
- Recommendation: consider developing a debt management strategy with objectives of market development and predictability for investors and issuers.
- Market liquidity and risks:
  - Excess liquidity in the system from robust economic growth, substantial capital inflows via syndicated loans and Euro-bond issuance.
  - Government bond yields hover around or barely cover the rate of inflation.
  - Continued stagnation risks larger fiscal contingencies in longer term.
  - Shortage of tenge-denominated assets exposes pension funds to significant currency risk and substantial investment risks.
- Suggested issuance approach:
  - Structure government issuance to improve secondary market operations and pricing base without necessarily increasing total outstanding paper.
  - Develop a domestically-derived yield curve up to 7 to 10 years.
  - Consider issuance schedule with less frequent but larger auctions of more standard, ‘plain-vanilla’ long-term bonds.
  - Consider a substantial proportion of fixed-income securities.
  - Set issuance schedule for a reasonable period in advance and make it transparent.
- Examine balance between domestic and international markets with objectives of domestic debt market development and sterilization of capital inflows.

### C. Mortgage-Backed Securities (MBS)
- Positive development: introduction of mortgage-backed securities.
- Concerns:
  - Unclear extent to which investment decisions are driven by implied government backing via complete NBK ownership of Kazakhstan Mortgage Company (KMC).
  - Some uncertainty among market participants on true quality of protection provided by the pool of collateral.
  - Perception that KMC securities are backed by the full faith of the NBK may lead to overconfidence.
- KMC divestiture:
  - Planned divestiture would alter perception of NBK backing.
  - Legal foundations for enforceability of the mortgage pledge and quality of protection of mortgage pledge pool should be clarified before NBK divests holdings in KMC.
  - Divestiture would address competition and market pricing issues.
- Limits of MBS:
  - Provides additional source of assets for pension fund managers, but even with rapid growth will be insufficient to fully cover pension funds’ investment needs.
  - Could trigger a real estate bubble given signs of over-heating in large population centers.
  - Limited mortgage origination network outside major cities; large banks with wide branches are not members of KMC program.
  - Funding mortgages through MBS unlikely to address fundamental housing stock and communal infrastructure needs; could primarily contribute to housing price inflation.
  - Funding infrastructure upgrades and utilities is important to support housing market development.

### D. Telecoms, Utilities and Infrastructure funding via capital markets
- Notable absence of long-term bond issues commonly found in developed markets (e.g., telecoms, utilities).
- Robust capital markets could finance utilities and infrastructure investments, supporting economic growth.
- Telecommunications sector: reportedly faces both high tariffs and high profitability.
  - Capital market funding for telecoms would need parallel tariff reforms to ensure investment costs are carried by users.
  - Competition policy issues are outside the scope of the FSAP.
  - Unclear whether telecoms’ long-term funding needs are met from retained earnings or bank borrowing.

### E. Corporate Securities: Bonds and Equities
- Constraints on private issuers:
  - Low level of competition in key sectors and influential financial-industrial groupings limit potential private sector issuers.
  - Mixed legacy of early privatizations, concerns over consequences from increased transparency, and perceived high cost of listing may discourage issuance.
- Structural dilemma:
  - Kazakhstan is a small, bank-driven economy where dominance of banks and related cross-ownership hamper capital market development.
  - Large commercial banks engage in wide financial activities and concentrate market share in conglomerate structures.
  - Corporate bonds yield less than bank deposits for investors.
- Market developments and impediments:
  - Corporate bond market has started to develop over past couple of years.
  - Government can enhance development through restructuring its own debt issuance.
  - Perceived adverse consequences of transparency (e.g., rent-seeking, hostile takeovers) could restrain new corporate bond entries and equity listings.
- Market activation hopes:
  - Market participants desire a government-backed blue chip listing (possibly via privatization) to invigorate the market; privatization is political and outside this note’s scope.
  - Key to positive developments: level playing field, issuance structure to widen/diversify investor base, and broad transparent distribution.
  - Any such issuance should be accompanied by public education campaigns on benefits of securities market investment, directly and via investment funds (assuming planned legislation is successful).

### F. Foreign Company Listings and Kazakhstani Depository Receipts (KDRs)
- Regulatory framework for KDRs has been enacted and authorities have taken measures to establish connections abroad.
- Ongoing work with the Federal Securities Commission of the Russian Federation to resolve certain Russian regulatory issues.
- Central Securities Depository (CSD) has established links with Clearstream.
- Economic viability requirement:
  - Foreign company listings or depository receipts must make economic sense for listing entities.
  - Even with resolved regulatory issues, substantial issuance is unlikely absent regulatory or tax benefits from the government.
  - Represents a limited additional source of investment alternatives.
- Longer-term potential: may grow if high-level political discussions on a possible Eurasian economic area lead to closer economic and market linkages.

### G. Other Asset-Backed Securities (ABS) and securitization
- New law on securitization is being drafted.
- Considerations for securitization law:
  - Careful selection of asset types suitable for securitization.
  - Appropriate accounting and reporting of risks.
  - Viable securitizable assets require sufficiently predictable cash-flow volume.
- Expected market size: likely to remain modest given early stages and small size of securitizable segments.
- Most potential securitization candidates: accounts receivable of extracting industries, though such companies have tended to fund themselves outside Kazakhstan to date.

### H. Foreign Investment Assets and currency/hedging considerations
- Without substantial domestic market progress, pension funds will invest sizable proportions of assets abroad.
- Likely increase in proportion of foreign currency denominated assets with pension fund growth and need for diversification and exit options.
- Prudence required:
  - Long-term investment horizon.
  - Maximize diversification benefits available in foreign markets.
  - Minimize investment risks.
- Currency risk:
  - Currency risks need to be hedged to the extent possible through diversification of currency exposure.
  - Tenge and U.S. dollar currency derivatives market unlikely to be deep enough for prudent hedging strategies by pension funds given their relative size to the market.
- Physical distance and information limitations:
  - Physical distance from international markets increases investment risks.
  - Insufficient information for informed decisions increases risk of investing in individual securities or active stock-picking; such strategies should be limited to a very small proportion of a pension fund’s assets.
- Use of index funds:
  - Investment restrictions do not allow use of funds as investment vehicles in some cases.
  - Established stock market—and to a certain extent bond—index funds in deep markets could provide suitable diversification vehicles.
  - Index funds are long-term instruments and can minimize reinvestment risk.
  - Clear and prudent criteria should be used for selection of markets and types of funds authorized.
  - Choosing markets in different countries with a minimum acceptable international rating may help diversify FX risk.
  - Authorities should refrain from ad hoc authorization of individual funds.

### I. Principal-Protected Notes (PPN)
- PPNs are widely used in pension investments in developed markets.
- Prudence principles for PPNs:
  - Issuers should have an investment grade rating.
  - Security should have wide enough distribution.
  - No complex covenants for maturity variation options.
  - Market should be sufficiently deep.

### V. SUMMARY OF KEY FINDINGS AND RECOMMENDATIONS
- Key short-term concern:
  - High-yield focused strategies of private pension funds that give insufficient consideration to the long-term actuarial nature of pension liabilities.
  - This reflects lack of long-term investment opportunities and inadequate understanding of underlying risks even for a defined-contribution plan.
- Reinvestment risk:
  - Short-term investment focus exacerbates asset management challenges via constant high reinvestment need to replace maturing assets.
  - Higher reinvestment need exposes pension assets excessively to market volatility risks.
- Prudent investment strategy principles for pension assets:
  - Diversification (breakdown between categories) and dispersion (breakdown within a given category);
  - Maturity matching (including liquidity principle); and
  - Currency matching, to the extent possible or, at minimum, hedging through diversification over different currencies.
- Regulatory framework:
  - It is probable that the regulatory framework indirectly encourages risky investment practices.
  - Review of the overall regulatory framework is needed for hidden incentives that do not promote prudent investment strategies appropriate for social safety net assets.
- Market development role:
  - Domestic market development is not a "magic bullet"; without substantial new issuance, shortage of good investment assets will worsen.
  - Market growth needs to come from private sector entry; government role should be limited to its own issuance, possible further privatizations, and creating a conducive environment for competitive private sector.
- Government issuance structuring:
  - Not the government's role to supply assets to satisfy pension demand, but structuring government debt issuance to be more conducive for domestic market development—without necessarily increasing outstanding paper—can improve secondary market operations and provide a more effective base for pricing mortgage-backed, other asset-backed, and corporate debt.
- Managing pension portfolios:
  - Exercise prudence with a long-term investment horizon.
  - Maximize diversification benefits available in foreign markets and minimize investment risks.
  - Consider enhancing diversification via investment in established reputable index funds.
  - Currency risks should be hedged to the extent possible through diversification of currency exposure.

*Source: _cr04337 - 22.      Still, capital markets in Kazakhstan are at a nascent stage of development with a (IMF PDF chapter content).*

### introduction of a multi-pillar pension system is likely to increase the worker’s sense of

### _cr04337 - introduction of a multi-pillar pension system is likely to increase the worker’s sense of

### Regulations applicable to private pension funds
- Private pension funds (the second pillar) function as a system of deferred income through tax breaks; tax legislation is the first level of control and lays down rules regarding methods and limitations to tax relief.
- Technical regulations:
  - Concern actuarial methods, choice of technical definitions, interest rates, and mortality tables.
  - May set minimum reserves and solvency rules to ensure pension funds deliver pensions.
- Business regulations:
  - Lay down minimum requirements regarding the soundness of supplementary pension schemes; often coupled with tax and/or technical regulations.
- Accounting regulations:
  - Ensure pension liabilities are transparent in company financial statements to protect shareholders and creditors of companies that set up private pension funds.

### OECD-derived principles and guidance for regulation and supervision
- Principles that may provide guidance, particularly for transition economies:
  - Adequate regulatory framework
  - Appropriate regulation of financial markets
  - Rights of beneficiaries
  - Adequacy of the private schemes
  - Regulatory system and separation
  - Funding
  - Calculation Techniques: Appropriate calculation methods for asset valuation and liabilities’ funding, including actuarial techniques and amortization rules based on transparent and comparable standards.
  - Supervisory structures
  - Self-supervision
  - Fair competition
  - Investment
  - Insurance mechanism
  - Winding-up
  - Disclosure and education
  - Corporate governance

### PRINCIPLES FOR THE REGULATION OF INVESTMENTS BY PENSION FUNDS — Objectives and basic principles
- Objectives:
  - Regulation must pursue twin goals of security and profitability: guarantee commitments while generating financial income.
- Basic principles for prudent investment policy (whether via quantitative restrictions or prudent-person rules):
  - Diversification (breakdown between categories) and dispersion (breakdown within a given category)
  - Maturity matching (including liquidity principle)
  - Currency matching, in the broad sense

### Quantitative regulations — constraints and design considerations
- No minimum level of investment should be prescribed for any given category except on an exceptional and temporary basis for compelling prudential reasons.
- "Maximum" levels by category may be justified on prudential grounds but should avoid excessive constraints; where used, consider:
  - Allowing firms to exceed ceilings under certain conditions and possibly subject to prior authorization by competent authorities.
  - Differentiating between maxima depending on whether they are included in solvency calculations, and allowing ceilings to be exceeded on that basis.
  - Taking account of valuation methods and the actual impact of valuation on quantitative restrictions (e.g., effect of ceiling differs if shares are valued at market or book value).
- Limits on investment in a given asset as a proportion of the pension fund’s total portfolio; special risks can justify stricter limits including limits on shareholdings of that asset.
  - Self-investment (investment in parent and affiliated companies) should be strictly limited; the recommended maximum being 5–10 percent.
- Certain categories may need strict limits (for instance, loans without appropriate guarantees, unquoted shares, company’s shares that raise major risk of conflict of interest). It may be relevant to set limits on investment by pension funds in companies (or investment vehicles) holding a large volume of such assets.
- Matching maturities of assets and liabilities is essential; investment regulation should take the portfolio of commitments into account and integrate asset/liability management techniques.
- Currency matching is a basic principle; derivatives may be used to achieve such a match provided they help achieve matching.
- Valuation methods vary; enhance compatibility and comparability and seek maximum transparency:
  - Use of any one valuation method should be accompanied by full disclosure of results that would have been obtained using main alternative methods (e.g., supplement historical cost valuation with market or net present value and vice versa).
  - Incorporate valuation considerations into investment regulations to prevent unexpected cumulative or clashing effects.

### Prudent-person principles — conditions and responsibilities
- Prudent-person principles can reduce the number of quantitative regulations when adequate; prerequisites include government confidence in private pension industry’s investment management and control.
- Essential prerequisites:
  - Competent and honest managers; authorities should adopt criteria concerning the expertise required of investment managers.
- Where prudent-person principles are applied and quantitative rules eased:
  - Greater financial and legal responsibility should be attached to imprudent transactions by corporate officers who abuse the granted freedom.
  - Companies must justify existence of appropriate control structures for decisions taken under prudent-person principles (for example, nomination of another qualified person within the board or executive staff).
- Applicability:
  - Relying solely on prudent-person principles may not be applicable in less-developed markets, but where possible they should be incorporated into an appropriate regulatory framework that provides a minimal body of rules varying according to market characteristics.
- Application of these principles may vary substantially from one country to another.

*Source: _cr04337 - introduction of a multi-pillar pension system is likely to increase the worker’s sense of (IMF PDF).*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2004/_cr04337.pdf_