Iceland’s pension system has expanded to a size that now eclipses its domestic economy, with the Central Bank of Iceland warning that legislation governing the sector has fallen behind reforms in other parts of the financial system.

Its Special Publication no. 18: Activities of pension funds in the financial market and desirable amendments to pension fund legislation, reiterated calls for an “urgent” review of the Pension Fund Act.

Figures from the bank show that pension assets stood at ISK 7.7trn at the end of 2023 – equivalent to 184 per cent of gross domestic product (GDP) – having grown tenfold since the turn of the century.

The funds’ combined assets are now larger than those of the Icelandic banking system and insurance sector combined, and more than sufficient to buy all listed equities, bonds and bills in the country.

At the same time, the system has become increasingly concentrated. Whereas 96 funds operated in 1980, only 21 remain today, with the three largest controlling around half of total assets.

The Central Bank noted that while consolidation has brought economies of scale, it also raises challenges for how pension funds are managed and the extent to which they should exercise influence as shareholders in Icelandic companies.

Therefore, the bank stressed the need for a review of the Pension Fund Act.

“Certain elements of the act should be adapted to align with other legislation on supervised financial activities – i.e., banking and insurance activities – which has been amended significantly for the better in recent years,” the report stated.

Furthermore, it reiterated its call for the regulation on pension funds’ mortgage lending to be brought in line with the requirements for banks.

It is a suggestion that does not have the support of the pension funds, as they argue that they are unique due to the social role pension funds play in society.

Detailed legislation on pension funds’ internal monitoring systems should also be reviewed, it said – including governance, key functions, risk management, and outsourcing – and harmonised with other financial market legislation.

“In the bank’s assessment, the requirements made of pension funds’ key functions should be more stringent than they are currently, and special legislation on personal pension savings custodians should be passed.

"Furthermore, when the Pension Fund Act is reviewed, consideration should be given to the findings of impartial appraisers such as the International Monetary Fund (IMF),” it stated, referencing the IMF report that also called for a regulatory update.

With assets dwarfing available domestic opportunities, Icelandic pension funds are under growing pressure to expand abroad. The Central Bank has warned, however, that large capital outflows from such a small currency area risk fuelling volatility in the króna and affecting the balance of payments.

It, therefore, argued that investment authorisations should be guided by the prudent person principle, replacing rigid quantitative limits, while ensuring that foreign investment takes place at a measured pace.

“The benefit of relying on the prudent person principle… is that it promotes risk awareness and enhances pension funds’ ability to adapt their asset portfolio to their risk profile, with fund members’ long-term interests as a guidepost,” the report said.

It did, however, welcome the work already underway, with the appointment in March 2023 of a working group on behalf of the Minister of Finance and Economic Affairs, whose tasks include preparing a green paper on the pension system.

“The bank hopes and expects that the statutory framework for the pension funds will be reviewed thereafter…. The Central Bank considers these proposed amendments beneficial in the context of financial stability, financial supervision, and the risks facing the pension system, as seen from the Bank’s perspective,” it stated.

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