China already sees the National Social Security Fund (NSSF) as its potential pensions saviour. But with enough imagination it could also be used to turbo-fuel its apparent ambitions as an environmentally conscious nation.

The world's largest carbon-emitting economy only has to look northeast across the East China Sea to see how the NSSF could potentially play a leading ESG role for its country, much like Japan's  Government Pension Investment Fund – and maybe more so.  

The role of the NSSF, which managed assets of Rmb2.96 trillion ($438 billion) at the end of 2018, is growing in importance as China tries to narrow its yawning pension funding gap.

With the number of retirees relative to the rest of the population booming, a report by the Chinese Academy of Social Sciences released in April forecasts that the number of tax-paying workers supporting each non-tax-paying pensioner in the country's main urban worker pension fund will halve to just one by 2050. The expected shortfall in this scheme from 2018 to 2050 has been estimated at Rmb56.6 trillion ($8.1 trillion) by Liang Hong, an economist for China International Capital Corp.

To begin addressing this funding gap, Beijing approved the transfer of 10% equity stakes from select state-owned enterprises into the control of the National Council for Social Security Fund, the agency responsible for NSSF's operation. All-told, 59 centrally owned SOEs are expected to shift about Rmb660 billion-worth of assets to the NSSF, according to the Ministry of Finance. For example, in March the NSSF received $4.7 billion-worth of shares in the People’s Insurance Co. of China.

This bold reform should help China’s pension champion begin to combat this retirement funding problem. But Beijing could yet be much bolder because if empowered, the NSSF could use its experience (and its role as a large minority investor in major SOEs) to push ESG principles within China’s major companies.

Doing so would fit well with Beijing’s stated desire to encourage better environmental standards and more green finance. After all, the nation has already said that all publicly listed Chinese companies need to undertake and disclose a set of environmental emission measures by 2020.

In addition, the People’s Bank of China is part of the Central Banks and Supervisors Network for Greening the Financial System to improve awareness of climate risks and green financing.

So it seems only logical for China’s national pension champion to lead these efforts from the investment side. As one of the country’s largest institutional investors and a key holder of stakes in Chinese SOEs, NSSF could push for better standards of governance and environmental practices.

EMULATING GPIF

To do so, NSSF only has to look at the example set by Japan’s GPIF.

The world’s largest pension fund, with ¥161.76 trillion ($1.48 trillion) of assets, has under chief investment officer Hiromichi Mizuno become a living embodiment of the central government’s approval of ESG. It has acted as a trailblazer for other asset owners in the country, and pressurised investee companies and external fund managers to improve their transparency, management processes, employee conditions and carbon emissions.

GPIF’s rationale for doing so is simple: Mizuno believes it is so large that its key challenges are more macroeconomic than market-based, and issues such as a climate crisis and poor governance factor highly among them. Mizuno believes ESG offers it one of the most effective means of addressing these.

NSSF could play a similar role, standing as a champion for environmental standards, effective management and good stewardship in China. That could be particularly important as a major investor in SOEs, which are often seen as inefficient, prone to corruption, polluting and increasingly obsolete.

By promising to push for improved governance and actively demanding the central government’s desire for better environmental accountability, NSSF can show Beijing is serious about tackling climate change and holding its own companies to higher standards.

Doing so would have other benefits too. Chinese equities are slowly becoming more important to international investor portfolios, thanks in part to index provider MSCI’s decision to introduce and gradually up the weighting of A-shares in its Emerging Market and Global indices. But many international investors are still reluctant to invest too heavily in the country’s companies because of concerns over poor oversight and bad respect for minority shareholder rights.

NSSF could become the embodiment of improved progress and help convince international asset owners and fund managers that there is a domestic major investor interested in the same things they are. That could encourage investor inflows into the country.

CHANGES NEEDED

For all this considerable untapped potential, obstacles exist.

For a start, under current plans the NCSSF will only receive passive stakes in SOEs; for five years it cannot sell them or use them to try and influence the companies. It’s a decision Beijing might want to revisit if it wants to compel its state firms to improve their efforts and efficiency.

Secondly, NSSF would need to build up an internal coterie of ESG expertise through which it can start handing out external investment mandates and include ESG principles when picking its fund managers or deciding on its asset allocation. But there are plenty of asset owners that would be willing to offer their experience (not least GPIF), while domestically several fund managers have demonstrated their commitment to ESG by signing up to the UN Principles for Responsible Investment (PRI).

Indeed, NSSF should aim to become a PRI signatory too. Becoming one would underline its genuine commitment to ESG and indicate to other Chinese asset owners (only Ping An Insurance Group is a signatory today) that it’s not enough just to talk a good game on climate change. As major investors in the largest carbon-emitting economy in the world, they have a lot of responsibility to help tackle this problem.

Third, it would make sense for Beijing to ease the stringent investing rules NSSF has placed upon it, to make it more effective. Currently 17 Chinese provinces, regions or municipalities have promised to transfer Rmb858 billion of their pension assets to NSSF, to take advantage of its superior investment capabilities. But they can only invest 30% of these assets in equities and it has to ensure these assets have a 95% probability of positive returns.

Easing these requirements would help NSSF invest more in equities and private assets in an ESG-compliant fashion on behalf of these funds. It would also help give China’s pension-fund champion even more sway in pushing concepts Beijing says are important to its future.