Santiago, September 2016. Bill N°10.661-05 (the Bill), which was sent to Congress in May of 2016 allowing Chilean pension funds to invest directly in private equity and in public works concessions, in addition to improving the feeder fund regulatory framework, has been given truly fast track treatment and has now been approved by both the Chamber of Deputies and the Senate. It is currently in the final formalities before being enacted.

To date, Chilean pension funds have been precluded from investing directly in either private equity funds or in infrastructure projects such as public works concessions. They can only do so indirectly. In the case of private equity funds, Chilean pension funds must invest through private equity feeder funds which have to be registered for public offer with the local securities regulator (SVS) and managed by a locally registered asset management firm. The proposal in the Bill is that pension funds will now be able to invest directly in private equity funds without using this feeder fund structure. Likewise, the Bill provides a range of 5% to 15% within which the pension regulator is to determine the aggregate investment limit in these alternative assets.

Will this mean the end of pension fund investment in locally registered feeder funds? Not necessarily, given feeder funds can provide value, but have been criticized for their regulatory constraints. It is precisely the source of this criticism that the Bill also aims to address by introducing three structural reforms to the feeder fund regime:

  • Shareholder concentration limits are raised from 35% to 49%. The current 35% has in practice been too low given the size of pension fund commitments compared to those of other types of investors and the difficulty of having to convince at least three pension funds to invest. This higher limit is seen to be more adequate and certainly will provide more flexibility and reduce the need for general partners of the underlying private equity funds to invest in the feeder funds in order to dilute pension funds.

  • Commitments may be for more than the current 3 years term contained in the pension fund statute. It will now be up to the pension regulator to determine the maximum term for commitments. This is a welcome development given the current term does not match that of typical private equity fund commitments.

  • No more need for fully funded feeders. Indeed, this will be thanks to the fact that pension fund commitments will no longer count towards the investment limits in equities. With many pension funds being very close to their regulatory allowance to invest in equities, having commitments count toward this allowance was seen as an inefficient form of allocating their assets. This had forced pension funds to invest in fully funded feeders whereby they would pay the whole of their commitments from day one, which commitments had to be invested in other assets pending the capital calls from the underlying private equity funds. Likewise, setting up a structure of two types of feeder funds, one fully funded feeder for pension funds and another regular feeder fund for other types of investors, was cumbersome and made these investments more expensive. In other words, this reform will entail reduced transaction costs given such a dual feeder fund structure would no longer be necessary.

    • One area of doubt that remains is whether direct investment in private equity will be adequately implemented. Indeed, the Bill may be interpreted (Article 139 of the pension fund statute) in the sense that direct investment will not be allowed in foreign private equity funds where the general partner of the fund has discretion to authorize transfers of limited partnership interests. If that is the case, then direct investment may not become a reality.

    Even if there may be questions around the feasibility of direct investment in private equity, it is expected that all the other changes may improve portfolio diversification by making it easier for pension funds to have greater exposure to alternative asset classes that, while less liquid, may provide higher returns in a low interest rate environment, without necessarily increasing risk. The lower transaction costs for investing in private equity thanks to this reform might also contribute to such better returns. Some predict that this reform may mean a 4% to 5% increase in future pensions, which is welcome news amid widespread expressions of discontent against the current pension system in Chile due to the low pensions it is providing as a result of prolonged unemployment and higher life expectancy.