data/interim/cr-2015-239/document.md

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August 2015



**IMF Country Report No. 15/239**
# **HUNGARY**
## **TECHNICAL ASSISTANCE REPORT—OPERATIONAL** **ASPECTS OF ESTABLISHING AN ASSET MANAGEMENT** **COMPANY**


This Technical Assistance report on Hungary was prepared by a staff team of the
Monetary and Capital Markets Department of the International Monetary Fund. It is based on
the information available at the time it was completed in July 2015. The views expressed in
this document are those of the staff team and do not necessarily reflect the views of the
government of Hungary or the Executive Board of the IMF.


Copies of this report are available to the public from


International Monetary Fund  Publication Services

PO Box 92780  Washington, D.C. 20090
Telephone: (202) 623-7430  Fax: (202) 623-7201
E-mail: [publications@imf.org](mailto:publications@imf.org) Web: [http://www.imf.org](http://www.imf.org/)

Price: $18.00 per printed copy

##### **International Monetary Fund** **Washington, D.C.**


© 2015 International Monetary Fund

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### **INTERNATIONAL MONETARY FUND**

#### Monetary and Capital Markets Department

### **HUNGARY**

**TECHNICAL ASSISTANCE REPORT**

#### **OPERATIONAL ASPECTS OF ESTABLISHING**

**AN ASSET MANAGEMENT COMPANY**

##### **Atilla Arda (MCM, Mission Chief) and Arne Berggren (Short-Term Expert)** **July 2015**



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The contents of this aide memoire constitute technical advice
provided by the staff of the International Monetary Fund (IMF)
to the authorities of Hungary (the “TA recipient”) in response to
their request for technical assistance. This aide memoire (in
whole or in part) or summaries thereof may be disclosed by the
IMF to IMF Executive Directors and members of their staff, as
well as to other agencies or instrumentalities of the TA recipient,
and upon their request, to World Bank staff and other technical
assistance providers and donors with legitimate interest, unless
the TA recipient specifically objects to such disclosure (see
Operational Guidelines for the Dissemination of Technical
Assistance Information—


http://www.imf.org/external/np/pp/eng/2013/061013.pdf).
Publication or disclosure of this aide memoire (in whole or in
part) or summaries thereof to parties outside the IMF other than
agencies or instrumentalities of the TA recipient, World Bank
staff, other technical assistance providers and donors with
legitimate interest shall require the explicit consent of the TA
recipient and the IMF’s Monetary and Capital Markets
Department.

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Contents Page


I. Introduction ............................................................................................................................8
II. Strategy..................................................................................................................................9
III. Governance ........................................................................................................................10

Tables
1. Key Recommendations June 2015 Mission ...........................................................................5
2. Summary of Progress January 2015 Recommendations ........................................................6

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**PREFACE**


At the request of the Magyar Nemzeti Bank (MNB), a technical assistance (TA) mission
from the Monetary and Capital Markets Department (MCM) of the International Monetary
Fund (IMF) visited Budapest during June 2–4, 2015 to assist the MNB in further developing
an operational framework for a recently created asset management company (AMC), the
Magyar Reorganizációs és Követeléskezelő (MARK). [1] This mission followed one that was
fielded during January 14–16, 2015

In carrying out its work, the mission met with Dr. Ádám Balog, MNB Deputy Governor;
Dr. Csaba Kandrács, Chief Executive Officer of MARK; Mr. Márton Nagy and
Mr. Dániel Palotai, both Executive Directors at the MNB; Mr. Gergely Fábián, Director at
the MNB; and other MARK and MNB managers and staff.

The mission’s main findings and recommendations were presented at a concluding meeting
with Mr. Márton Nagy, Mr. Gergely Fábián, and officials of MARK, and were further
elaborated in an aide-mémoire. Following further review at the MNB, MARK, and IMF
headquarters, this finalized technical assistance report will be sent to the MNB and MARK.

The mission would like to express its gratitude to Mr. Gergely Fábián, Dr. Csaba Kandrács,
and staffs of the MNB and MARK for their hospitality and for the fruitful discussions that
underpin the mission’s work, which greatly facilitated the work.


1 The mission comprised Messrs. Atilla Arda (MCM, mission chief) and Arne Berggren (short-term expert).

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5


**Table 1. Hungary: Key Recommendations June 2015 Mission**


**Topic/Recommendation** **Priority** **Timeframe**



Attract one or two international professional equity partners to
bring MARK closer to the preferred private ownership model.



High Near-term



Finance MARK’s operations with bonds issued by MARK. High Start of operations



Ensure case-by-case valuations reflecting the characteristics of
the assets without relying too much on average values on certain
parameters.

Ensure that work processes create value for individual assets and
improve the liquidity of its portfolio, including through clear ‘deal
flows.’

Restrict the powers of MARK’s owner(s) (i) to formulate the
mission statement and set the long-term objectives; and (ii) to
appoint the Supervisory Board and the Board of Directors.

Establish MARK’s Board of Directors as its primary decisionmaking body to set policies and procedures, determine MARK’s
risk appetite, and appoint and hold accountable its executives (in
particular, the Chief Executive Officer).

Appoint to MARK’s Board of Directors exclusively independent
members (that is, members unrelated to MARK’s owners) with
backgrounds relevant to MARK’s business (including real estate
and distressed debt management) and the Board’s responsibilities
(audit, oversight, and risk management); alternatively, ensure that
a majority of the Board members is independent and
knowledgeable.

Establish an Audit (& Compliance) Committee and a
Remuneration Committee, and possibly also a Corporate
Governance/Nomination Committee and an Investment/Credit
Committee at the Board of Directors level.

Establish reporting lines to the Boards for the Audit Committee and
the compliance function; and reporting lines to the Audit
Committee for Internal Audit.

Include in MARK’s by-laws, limited, objective grounds for dismissal
for all members of the Supervisory Board and the Board of
Directors, and the Chief Executive Officer.

Establish a remuneration and compensation package that attracts
qualified staff and rewards closing deals (that is, successful
divestments).

Ensure that liability and legal representation insurances for MARK
officials and staff in case of actions in good faith are adequate as
to substance (that is, liability and legal representation) and the
financial coverage (relative to possible liability claims and cost of
legal representation).



High Start of operations


High Start of operations


High Immediate


High Immediate


High Immediate


High Start of operations


High Start of operations


High Near-term


High Start of operations


High Immediate

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6


**Table 2. Hungary: Summary of Progress January 2015 Recommendations**



**Topic/ Recommendation**

**January 2015**


Develop a clear mission statement focused
on:


- MNB’s broad policy objective;


- MARK-specific mandate to buy assets of
specified nature with sole objective of
maximizing value;


- Mission to restructure and divest assets
within maximum of 10 years;


- Initial ownership and funding from MNB,
not precluding private investment in
future;


- Aim to achieve a market-referenced longterm rate of return for the shareholder;
and


- MARK will operate entirely on commercial
principles, meeting the highest
international standards of business
conduct and integrity.


MNB to fully delegate asset management
functions and operational decisions to MARK.


Ensure that no obstacles exist to sale of
shares or private funding of MARK.


Establish a governance structure enabling
MARK to meet its objectives and manage
distressed assets without interference in
business decisions.


Reconsider the composition of MARK’s
Supervisory Board and Board of Directors to
include a majority of well-qualified Directors
without roles in MNB.


Separate the roles of Chairman of the Board
of Directors and Chief Executive Officer,
making the Chairman a non-Executive
Director.


Consider refinancing with market-based
funding or share sales in MARK.



**Priority** **Timeframe** **Progress**
**June 2015**


High Near-term Agreed and ongoing



High By start of
operations


Medium By start of

operations


Medium Once positive

cash flows
established



High Immediate/start
of operations



Agreed and ongoing



High Near-term Agreed, to be
implemented


High Near-term Agreed and ongoing



Under consideration


Under consideration


Agreed, to be
implemented

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7


**Hungary: Summary of Progress January 2015 Recommendations** (concluded)



**Topic/ Recommendation**

**January 2015**


Adjust the maturity structure and
currency composition of MARK
liabilities to mirror expected cash
flows.


Ensure adequate equity funding to
absorb valuation adjustment and
operating losses in initial years of
operation.


Sale of assets to MARK should be
voluntary on the part of the banks.


MARK to offer prices consistent with
an expectation of making a reasonable
rate of return for its shareholder.


Develop criteria for internal valuation
of real estate.


Undertake an asset-by-asset valuation
exercise in the first months of
operations, and prepare a starting
balance sheet reflecting these.


Put in place procedures enabling
regular updating of valuations as new
market information becomes available.


Consider seeking exceptional powers
enabling MARK to circumvent delays
in legal framework.


Develop remuneration policies for staff
consistent with commercial focus and
finite life of operations.



**Priority** **Timeframe** **Progress**
**June 2015**



High After internal
evaluation of
acquired
assets



Agreed, to be
implemented



High Near-term Agreed, to be
implemented



High Continuous
(policy is in
place)


High Near-term
(policy under
development)



Agreed and
implemented


Agreed, to be
implemented



High Near-term Agreed and
ongoing



High Start of
operations



Agreed and
ongoing



High Medium-term Agreed and
ongoing


Low Near-term Disagreed


High Medium-term Agreed and
ongoing



Consider legal protections for staff. High Before
operations
start



Agreed, to be
implemented

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8


**I.  INTRODUCTION**


1. **In November 2014, the Magyar Nemzeti Bank (MNB) established the**
**Magyar Reorganizációs és Követeléskezelő (MARK), an asset management company**
**(AMC).** This was done to help restore monetary transmission, credit growth, and economic
recovery. MARK is expected to remove the overhang of commercial real estate
nonperforming loans (NPLs) from banks’ balance sheets—freeing up capital and
management time, and restoring the banks’ capacity to make new loans. These NPLs stood at
27 percent at end-2014. The MNB considers banks solvent and generally well provisioned. It
cites (a) reluctance to sell foreclosed collateral at low prices into a not effectively operating
commercial real estate market and (b) inefficient foreclosure and insolvency processes, as the
principal reasons why NPLs are not written off. MARK will buy commercial real estate loans
and foreclosed collateral from the banks on the basis of voluntary sales.


2. **The MNB has established MARK on a sound foundation: banks’ participation is**
**voluntary, market prices determine valuations, and MARK’s lifetime is 10 years.** It has
a target of HUF 300 billion purchase value (US$1.2 billion, 1.3 percent of GDP) compared to
a potential portfolio estimated to have a book value of HUF 800 billion. Purchasable loans
must be secured by real estate and be underperforming (e.g., nonperforming loans) and
minimum size limits on individual transactions apply. The latter implies relatively few loans
(<500) are expected to account for the bulk of transactions. Discussions between the MNB
and European regional institutions on the role and functions of MARK are ongoing.


3. **This provides a good basis for MARK to shape a sales pitch based on strategy**
**and governance that will further improve MARK’s credibility, marketability, and**
**profitability.** This will require a clear strategy aimed at value creation and a governance
structure that is consistent with best international practices. MARK’s strategy comprises a
clear mandate, an ambitious return on equity (ROE), a sound funding structure, a valuation
methodology based on market prices, and work processes that create value for individual
assets and improve the liquidity of MARK’s portfolio. Its governance structure should limit
MNB’s role and provide MARK’s directors and executives with a high degree of operational
autonomy. Attracting from the outset one or two international professional investors would
strengthen MARK’s credibility and support both its strategy and governance structure.


**4.** **This aide-mémoire should be read in conjunction with the report of the**
**January 2015 mission.** [2] This aide-mémoire is therefore brief, focuses on the authorities’
progress in implementing the recommendations of the January mission, and elaborates on
those recommendations in light of the progress made so far.


2 https://www.imf.org/external/pubs/ft/scr/2015/cr1599.pdf

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9


**II.  STRATEGY**


5. **MARK has a clear, well-defined mandate to focus on maximizing the value of its**
**assets.** This is supported by an ambitious return on equity and a valuation methodology
based on market prices. This will help to (i) establish clear criteria to measure the success of
MARK, its management, and staff; (ii) insulate MARK and the MNB from political and
interest groups’ pressures; (iii) minimize financial risks for the public sector; (iv) provide
clear direction for MARK’s policies on sale or retention of assets, valuation, and
restructuring, etc.; (v) provide a commercial focus and market-based incentive packages to
attract staff with the right skills; and (vi) establish MARK as a credible market player.


6. **Other key components of MARK’s strategy are as follows** :


_Return on Equity_ —The MNB expects MARK to deliver an return on equity (ROE) of
15 percent, which sets the objectives against which MARK will assess bids for its portfolio.


_Funding of MARK and its operations_


- MARK is fully owned and funded by the MNB. While this has served to proceed
quickly in establishing MARK, working toward market operations, the mission
recommended that MARK’s ownership be opened to international professional
investors to bring MARK closer to the preferred ownership model. [3]


- Instead of the MNB fully financing MARK’s operations, the mission recommended
that acquisitions be (partly) paid with bonds issued by MARK—possibly with a
government guarantee.


- Allowing equity partners and bond holders would introduce market discipline and
helpdeliver on MARK’s business strategy. A diversified ownership also would reduce
the MNB’s financial exposure and, arguably, dequalify MARK as a state-owned
company, which would increase flexibility with respect to procurement and
remuneration policies. [4]


_Valuation methodology_ —In consultation with the European Commission, MARK is
developing a methodology to set a ceiling for MARK’s bids on assets that will be offered to
it. The mission stressed that this methodology should be consistently in line with MARK’s
profitability target. This will require a case-by-case valuation reflecting the characteristics of


3 Preferably, an AMC is not set-up as a unit within a central bank or a subsidiary thereof (Ingves, et al., “Issues
in the Establishment of Asset Management Companies,” IMF PDP/04/3).


4 The authorities could also consider clarifying with Eurostat—the EU’s statistical office—whether MARK
qualifies as ‘general government.’

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10


the assets. The mission noted that reliance on average values on certain parameters—as is
under consideration—may cause unattractive assets to be overvalued and attractive assets to
be undervalued. The same risk lurks in too large a haircut on the market price.


_Work processes_ —MARK’s work processes should create value for individual assets and
improve the liquidity of its portfolio. [5] The mission recommended that a culture be established
that rewards value creation and drives toward closing deals (that is, successful divestments),
through—amongst others—clear ‘deal flows.’


**III.  GOVERNANCE**


7. **The mission reiterated the January mission’s recommendation to reconsider the**
**composition and mandate of MARK’s corporate bodies.** The mission noted that while the
MNB—as MARK’s sole shareholder—has a legitimate interest in key decisions and
appointments, the current corporate governance and decision-making structure is dominated
by the MNB and its officials, who, at the same time also must serve broader policy objectives
as central bank(ers) and exercise prudential supervision over MARK. This could undermine
MARK’s value-maximization mandate and jeopardize MNB’s autonomy and credibility.


8. **The mission recommended that MARK’s governance structure be consistent**
**with best international practices, and that the composition of its decision-making bodies**
**reflect their mandates** :


a. The _owner(s)_ should be tasked only (i) to formulate the mission statement and set the
long-term objectives; and (ii) to appoint the Supervisory Board and the Board of
Directors. Currently, MNB’s close involvement within MARK could create both
policy and personal conflicts of interests, does not support MARK’s sales pitch, and
does not convey a good image to the outside world.


b. The _Supervisory Board_ of MARK is intended to be a stand-in for and advisor to the
owner(s) without decision-making powers. Although not ideal, based on its intended
purpose, the Supervisory Board could consist of MNB representatives—currently all
MNB Executive Directors—on condition that the Board of Directors is as advised
below.


**c.** The _Board of Directors_ should set MARK’s policies and procedures, appoint and
hold accountable its executives (in particular, the CEO), and determine MARK’s risk


5 Liquidity (i.e., improve the chances to sell an asset) could be improved by a number of actions: (a) buying
assets from several banks and creating portfolios of a critical size; (b) addressing legal issues and uncertainty;
(c) taking legal action and reaching agreement with borrowers; (d) restructuring companies to make these more
viable; (e) negotiating for immediate repayments or amortizations for payments that seem impossible prior to
negotiations.

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appetite. This Board should be populated by persons with backgrounds relevant to
MARK’s business (including real estate and distressed debt management) and the
Board’s responsibilities (audit, oversight, and risk management). Ideally, the Board of
Directors should exclusively consist of independent members (that is, non-MNB
officials); alternatively, the independent members should be in the majority. [6]


9. **The mission shared the following considerations with the authorities regarding**
**other aspects of MARK’s governance structure:**


a. There should be a clear distinction between operational committees and Board
committees. The latter should include committees that are recognized by best
international practices, in particular, an Audit (& Compliance) Committee and a
Remuneration/Compensation Committee; and, possibly, also a Corporate
Governance/Nomination Committee and an Investment/Credit Committee.


b. Reporting lines to the Boards should be in place for the Audit Committee and the
compliance function; and Internal Audit should report to the Audit Committee. The
compliance function and Internal Audit would of course also report to the CEO.


c. If the authorities maintain that MNB should appoint and dismiss the CEO, the
mission recommended that the Board of Directors should have an active involvement
in the selection and dismissal of the CEO.


d. Relatedly, the mission recommended that limited, objective grounds for dismissal be
enshrined in MARK’s by-laws for all members of the Supervisory Board and the
Board of Directors, as well as the CEO.


e. The mission reiterated the January mission’s recommendation that the positions of
Chair of the Board of Directors and Chief Executive Officer (CEO) be separated. [7]


f. The remuneration and compensation package should serve two goals: attract qualified
staff, and reward closing deals. The first goal seems to be met; the second needs more
attention.


6 Currently, the Executive Board comprises three external members of the MNB’s Monetary Council. While the
members may be ‘external’ from the MNB perspective, they cannot be considered ‘independent’ for MARK’s
purposes. The mission argued that the authorities’ claim that, in Hungary, independent members are uncommon
for single-ownership corporations does not hold because, in this particular case, the parent and the subsidiary
operate with different objectives (that is, nonprofit vs. profit), and that MARK should aim to attract multiple
equity partners.


7 While a majority of independent members would diminish the need to separate the positions of CEO and Chair
of the Board of Directors, the mission maintained that these two positions be separated to ensure that the
Board’s oversight over the CEO’s executive team is not controlled or directly influenced by the CEO.

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g. Legal protection for actions in good faith should remove a distracting concern for
MARK’s leadership and staff. [8] MARK is considering liability and legal
representation insurances, which appears appropriate. The mission recommended
that the scope of this insurance should be adequate as to substance (that is, liability
and legal representation) and the financial coverage (relative to possible liability
claims).


8 The mission was informed that criminal liability for public officials would not apply to MARK’s officers and
staff, but they would be subject to civil liability without the protection that the MNB Act provides to MNB
officers and staff.