The contentious offset mechanism in the Mandatory Provident Fund (MPF) scheme could come to an end this year—a move that would prove good news for pension savers and investment managers alike, say market experts.

In Hong Kong, employees and employers both have to make regular mandatory contributions calculated at 5% of the employee's relevant income (and capped at HK$1,500 a month apiece) to an MPF scheme.

However, when dismissing redundant staff, employers can opt to withdraw money from the contributions they had paid into the employees' schemes to offset the cost of long service payments (LSP) or severance payments (SP)—the so-called offset mechanism.

Currently, more than HK$3 billion ($383.43 million) of the accrued benefits from employer MPF contributions are used each year for the offset mechanism. This reduces the total amount of MPF benefits to which employees are entitled, according to the city’s latest policy address released in October last year.

Labor unions have long been calling on the government to abolish this mechanism, while on the other side have been business groups claiming that doing so would increase the financial burden on small and medium-sized enterprises. On January 7 the Hong Kong government sided with the former, when chief secretary Matthew Cheung said the administration would put forward a proposal to eliminate the mechanism in the first half of the year.

Eliminating it should mean working individuals face less chance of seeing their retirement savings diminished in the event they are dismissed. Cancelling the mechanism should also mean more assets to manage for fund managers.

“It would be very likely that they (fund managers) will benefit,” Stewart Aldcroft, senior adviser in Citi’s markets and securities services division, told AsianInvestor. Anything that increases (or doesn’t cut back on) the level of contributions placed into MPF funds would be positive to them, he noted.

But some think that contributions for making LSP and SP payments should be managed separately from MPF contributions.

"Once the regulation has more clarity, and down the road as the amount of money [contributed from employers] builds up, there might be potentials for asset managers to help preserve and grow the capital,"  Janet Li, wealth business leader for Asia at Mercer, told AsianInvestor. She is also the vice chairman of the Hong Kong Retirement Schemes Association.

The legacy

The offset mechanism was part of the MPF scheme, which was launched in 2000, as part of a concession made by the Hong Kong government in order to convince the business sector to accept the scheme.

That has led some businesses to claim that the government should honor the promise it originally made to them. But opposition voices to the mechanism have also been growing loader. Aldcroft noted that employers are paying less wages to their employees than they would have to if no MPF system existed. They are also getting tax benefits making the contributions to the MPF scheme, he added.

“When you look at it from that perspective and ask ‘why are these employers being so negative and trying to prevent [scrapping] offsetting [LPS and SP]?’, it doesn’t look good,” he said.

Abolishing the offset mechanism is one of the priorities of the government. On January 7, Cheung said he was confident the proposal to eliminate the mechanism could be rolled out in the first half of this year, adding that the government has firm stance to scrap it.

Former chief executive Leung Chun-ying had proposed earmarking HK$7.9 billion to subsidise firm costs over a 10-year period. But Cheung said the current administration will have to invest “far more” than this amount and that it was open to extending the transition period over more than a decade.

Debate on how

A key question going forward will be how the government chooses to replace the mechanism to ensure companies can fund LSP and SP costs.

It is considering whether to require employers to make a higher contribution, local Chinese newspaper Sing Tao Daily reported on January 5, citing unnamed sources.

Under its draft proposal, employers would contribute an additional 1% of employees’ income to a specialised account for making LSP and SP. However, the proposal did not specify whether this sum would be invested into MPF funds, or at what time the money would be paid to the employees.

Companies are expected to have to set an amount equivalent to 20% of the annual income of all their staff for LSP and SP. While the government said it would subsidise firms that cannot afford to pay LSP and SP, it has no plans to establish a funding pool, according to Sing Tao Daily’s report.

While employers might have to make a 1% contribution, Aldcroft argued that employees should be empowered to decide how the money is invested and not have the company do so. He added that the money should also be managed together with the MPF contributions to avoid additional administrative costs.

Alternatively, the contributions could be invested into the MPF’s default investment strategy (DIS) plans, which have low fees and are relatively less risky, Aldcroft said.

However, Li of Mercer believes this is unlikely to happen because the government will not want to cover any gap in LSP or SP payments in the event the value of the underlying funds drop. Instead, she advocated having employers save the additional contributions until there is enough to support LSP and SP outlays.

Based upon the 20% salary coverage ratio, employers will be able to work out how much reserve they need. It could take a decade for a company to contribute enough to the cover this amount, after which it can ensure the money is invested in a manner to preserve and grow the capital and asset managers can have a role to play, said Li.

Ideal timing 

The overall MPF market recorded a 19.87% return across Hong Kong in 2017 according to Fidelity International, thanks to the global stock market rally. The Mandatory Provident Fund Authority stated that total MPF funds were worth HK$646 billion at the end of 2016, its latest figure. This means the total value at the end of last year should be HK$774.36 billion (exclusing new contributions).

Hong Kong equity funds and Asian Ex Japan equity funds topped the chart with return rates of 40.09% and 39.96%, according to Fidelity.

The year 2017 marks one of the best years for MPF’s annual performance, said KP Luk, head of Hong Kong defined contribution business at Fidelity. He declined to comment on how to replace the offset mechanism when questioned by AsianInvestor

Such positive MPF fund returns are set to further weaken arguments towards scrapping the offset mechanism, Aldcroft said. Many businesses are also making good money and the economy is growing. That makes now the best time to scrap the offset mechanism, he asserted.