China’s pension funds need bolder reforms: HKIFA

The head of Hong Kong's fund association believes China’s financial regulator should let retail pension products invest into international assets and take steps to encourage more individual pension saving, following a fresh round of product approvals late last month.  

On December 28, the China Securities Regulatory Commission (CSRC) approved 14 pension fund of funds (FOFs) from 13 fund houses, specifically for retirement purposes.

These new approvals follow an initial batch of 14 funds in August last year, plus a second batch of 12 funds in October, meaning 40 pension FOFs are available for China’s pension savers. Another 32 funds are still pending approval from the regulator, according to CSRC and the Securities Daily media report.

While the number of FOFs is on the rise, they can only invest in onshore assets. Sally Wong, chief executive of the Hong Kong Investment Funds Association (HKIFA), believes this needs to change to ensure better returns. She is calling on the CSRC to let retirement funds invest in offshore funds.

“The regulatory framework should provide greater flexibility for the providers to develop them. In particular, there should be more room to structure diversified products, be it across geographies and across asset classes,” Wong told AsianInvestor.

FOF STRUCTURES

The draft rules released by the CSRC in March 2018 stipulated that pension fund products of asset managers must take the form of funds FOFs. Two investment strategies are allowed: target-date and target-risk.

In a target-date fund, the amount of equity in the fund gradually decreases in favour of high-quality debt as the investor approaches his or her retirement date, to reduce risk as the investment horizon shortens. In a target-risk fund, the asset manager has to ensure that the level of risk is not greater or less than the fund's target-risk exposure.

Wong noted China’s target retirement mutual funds are allowed to invest into the mutual recognition of funds scheme between China and Hong Kong, as well as using qualified domestic institutional investor (QDII) quota to invest into offshore assets. She argued that both target-date and target-risk FOFs should be allowed to invest in more offshore products, to better diversify investment risk and returns. Wong didn't offer any specific examples of offshore investment products. 

However, it’s not likely that the pension FOFs will be able to invest in offshore assets in the near future. Beijing is likely to prioritise retaining strict capital controls to prevent mass capital outflows, which will likely prevent such investment choices, said a chief investment officer of one of the asset managers who obtained the approval to roll out the pension products.

THIRD PILLAR REFORM

China’s regulator should also seek to encourage more voluntary investing into pension funds, instead of relying on the government to support retirement, Wong said.

China divides its retirement system into three pillars, as defined by World Bank guidelines. The first pillar is dominant, and consists of social security that is funded and run by the government; a less developed second pillar that is mainly made up of corporate annuity schemes; and a nascent third pillar that is comprised of personal savings and voluntary individual contributions. 

The final pillar represents a potential treasure trove for fund houses, as it can offer a key source of consistent long-term capital. And most of China’s main asset managers are gearing up for this new line of business.

HFT Investment Management, the joint venture fund house of Haitong and BNP Paribas, gained approval in the latest round. A spokesman told AsianInvestor that it plans to issue more pension target-date FOFs in the coming years, in anticipation of these products become increasingly used by individual investors to ensure their post-retirement security.

But the third pillar is currently very small, with most individuals relying on the first pillar for their retirement savings.

A KPMG report released in November 2017 estimated the country had Rmb5.5 trillion of assets in the first pillar in 2015, versus Rmb1 trillion for the second pillar and Rmb2 trillion for the third. The three pillars are estimated to grow to Rmb20.4 trillion, Rmb12.8 trillion and Rmb11.4 trillion respectively by 2025.

RACE AGAINST TIME

That is unlikely to be enough. Indeed, China is in a race against time to tackle its pension challenge. The China National Committee on Ageing (CNCA) estimated that 17.3% of China’s population was aged 60 or over at the end of 2017, but this will rise to 487 million, or nearly 35%, by 2050.

This rapidly growing number of grey-haired citizens means the government won’t be able to sustain its level of retirement payments to retirees under the first pillar. But having a relatively high contribution rate today serves to disincentivise employers and employees from looking to put money into the other pillars, Wong said. 

“Think about it, if you (employers and workers) are already contributing 28% (of a workers' wage) under the first pillar, it would really be a struggle to dish out more for other pillars,” she noted.

Under current rules, employers have to contribute 20% of an employee's wage to retirement, while workers pay 8%.

To address the imbalance, Wong argued the CSRC should introduce a process to reduce the contribution rates to the first pillar by 1% to 2% each year. That would force individuals and companies to gradually shift resources into the other two pillars. It would also offer more incentive to develop China’s third pension pillar, she added.