Tomorrow stands to be a landmark day for China’s public pensions industry with the National Social Security Fund (NSSF) set to ink an investment mandate to manage Rmb100 billion with the Guangdong government, a senior source tells AsianInvestor.

The move is seen as a first step to badly needed reform of the country’s entrenched pensions system. It will be the first time an experienced manager such as the NSSF will be permitted to manage provincial pension assets. Investment is set to start before the end of this month.

More than 90% of public pension assets are held in bank deposits and have returned less than 2% on average over the past decade. That compares with NSSF’s 9.17% average return since 2002.

Government regulation only allows public pension funds to invest in bank deposits and government bonds. However, AsianInvestor understands that investment guidelines governing the pilot project with Guangdong allow for equity exposure up to 40% and for investment in overseas markets and alternative assets.

What remains in question is whether the Rmb100 billion will be run as a segregated account or be funnelled into the NSSF’s asset pool.

The mandate’s required rate of return will be fixed, although as trustee the NSSF will not be obliged to disclose investment strategy and results. The source declines to reveal the rate, indicating only that it will be above forecast inflation.

Zheng Bingwen, director for the Centre for International Social Security Studies at the Chinese Academy of Social Sciences, describes bringing the NSSF into the process of pension management as “the optimal solution”.

“Under the present system there is a lack of incentive for investment reform,” says Zheng, who since last year has been a member of China’s pension fund reform taskforce.

“The management of public pension funds at the municipal level involves more than 2,000 local government entities. Inevitably there is some moral hazard in the process of transferring pension money from local to government level.”

China’s basic public pension system consists of a social pension pool (20% of salary contributed by employers) and individual pension accounts (8% of salary by employees).

Zheng suggests a dedicated institution should be set up to invest provincial pension assets, and tasked with managing the social pension pool, while an organisation such as NSSF manages individual accounts.

He notes that the creation of such an institution is being discussed by a number of government ministries and agencies, including the China Securities Regulatory Commission.

At this stage, however, all he is able to confirm is only that “it is inevitable the pension investment system will be reformed” and investment portfolios diversified.

Only recently AsianInvestor spoke to Stuart Leckie, chairman of Stirling Finance and author of books on China's pensions industry, and he urged Beijing to set up a pensions regulator as well as train the next generation of social security officials in capital markets investment.

Guangdong was chosen for the rollout of this pilot scheme since it not only boasts by far the largest pool of pension assets at Rmb350 billion but also has a pro-reform government.

Only three other provinces had public pension assets in excess of Rmb100 billion at the end of 2010, namely Jiangsu (Rmb130 billion), Zhejiang and Shandong (both Rmb110 billion).

Zheng forecasts that China’s pool of public pension assets will reach Rmb15-16 trillion by 2020, behind only the US and Japan.

“The preservation of pension fund wealth is second in importance only to [the preservation of] China’s foreign reserves,” Zheng states. “What we need now is political determination and the central government needs to choose a good time to roll out the reform.”

A full interview with Zheng will be featured in the forthcoming March edition of AsianInvestor magazine.