Pension reform in China and the rest of Asia has created evergrowing pools of money, which in turn are driving the growth of the financial services sector. Toby Green reports
China's NSSF needs to increase the value of its fund to match what will be large liabilities in the future as the cradle-to-grave welfare system is gradually dismantled. That means diversifying investments away from fixed income and local Chinese equities to overseas funds through foreign fund managers. In fact, the NSSF is even considering taking a stake in one of the big private equity players to diversify its investments and chase higher returns in the shortest period possible. Of course, there is a danger that investments won't create returns, something the Chinese will have to get used to. Other countries in Asia have adopted similar reserve pension funds, such as Japan, and private plans in Taiwan and Hong Kong.
"Importantly, if these reserve funds are to succeed, they will require professional asset management and it is encouraging to see a trend towards this type of outsourcing in China, Japan, South Korea and Taiwan. "Governments will increasingly look to capital market investments managed by external asset managers to achieve the returns they need," Miksa added. Professional asset management is in demand in China. China's pension assets will increase by 23.1% between now and 2015 at a compounded annual growth rate, says Allianz. In fact, asset management is expected to grow by as much as 24% annually for the next decade, making it the fastest-growing segment in financial services in China. The sector has grown at a rate of 60% annually for the past three years, fuelled by the retirement, investment and insurance needs of the middle classes and mass affluent. "Markets such as Japan, South Korea and China have much room to provide sufficient pension systems for their ageing population. Professional asset management could extend more comprehensive pension options for these economies," said Douglas Eu, CEO, Asia Pacific, at Allianz Global Investors. "Synergy of the global experience with local expertise could be the resolution to the challenges in the region."
To date, the government has licensed more than a dozen asset managers, including several foreign joint ventures, to manage enterprise annuities. In a bid to allow more selected fund managers and financial institutions to help manage China's RMB90bn enterprise annuity pensions, China issued related rules to govern its pension funds, which will take effect from January. The Chinese government is opening the pension market to professional money managers with the hope of boosting returns as the cradle-to-grave welfare systems is dismantled. China will soon issue 20 licences to select fund managers and financial institutions. Life insurers and pension firms approved by China's insurance regulator may offer global pension insurance products while pension firms may help manage company pension plans nationally as well. According to the new rules, insurance companies must conduct thorough checks on the financial backgrounds of the clients who are purchasing policies of "significant size", and disclose the investment risk of their pension products when writing to potential clients. In addition, insurers are eligible to enjoy tax breaks for their pension business offered by the central and local governments. China's vice labour minister, Liu Yongfu said in April that China would transfer more than RMB70bn in company pension plans to fund professionals by the end of 2007.
China's fund management industry
China wants to boost its fund management industry. But the eightyear- old industry is still small in size and has been plagued by some scandals. Still, by the end of 2006, China had 58 fund management companies in operation. Among these, 24 were joint ventures with foreign firms. Some easing of regulations has been made under China's World Trade Organisation commitments. As opposed to the previous 33%, foreign firms may now hold a maximum stake of 49% in a joint venture fund management company.
The government's Qualified Domestic Institutional Investor (QDII) programme, which permits Chinese nationals to invest overseas through authorised Chinese asset managers, should also buoy the pensions sector. QDII has been slow to take off because the government restricted it to fixed income assets. But in May, the China Banking Regulatory Commission began permitting local commercial banks, through QDII, to invest in a wider range of asset classes. There is now greater interest as China Asset Management, China Southern Fund Management, Harvest Fund Management and China International Asset Management each raised up to US$4bn for their QDII funds in single day. But restrictions still apply for foreign asset managers and it will take time before the market is fully liberalised. This is partly because China wants to develop its own fund management industry. So what have some investors done to grab a slice of the pension scene in China?
HSBC is one of the best examples. It has a stake in China's Bank of Communications (Bocom) and could be launching a pension fund management joint venture next year. The joint venture could be a 50:50 split depending on regulatory approval. BoCom is believed to be in talks with the regulator and the Ministry of Labour and Social Security (MLSS) to seek advice and licences for the new business. BoCom has already obtained two licences: one for custodian qualification and the other for corporate annuity fund account management services. HSBC is able to lend its expertise to handle corporate pension accounts, but will not be involved in the public social security funds managed by the Chinese government.
It's no surprise that HSBC wants to play big in the corporate pension annuity market. Analysts have estimated enterprise annuities could surpass China's NSSF in terms of assets under management. This would provide pension providers and fund managers with juicy fees. But China wants its own companies to scale up and manage pension funds. In May 2007, the China Insurance Regulatory Commission granted local insurer Taikang permission to set up a pension insurance company in Beijing and allowed the Kangjiang Pension Insurance Company Co to set up in Shanghai. Ping An is the most active and well-known Chinese life assurance company active in the pension market. But there are still regulatory hurdles to overcome before the market truly flourishes. There are only modest tax benefits and still some opaque rules providing employees weak incentives to use the EA plans. However, it took the US 401(k) system more than two decades to reach its current US$3trn in assets. If China wants to reach that milestone it will have to address tax regulations.
Enterprise annuities (EAs) represent the new pension paradigm in China. China's elderly population will reach 440 million by 2050, with 30% of the country's population topping 60 years old. So as the large population transforms into an aged one, China will have to support more retirees than any other country. The need for a private or corporate pension system is essential to prevent this problem snowballing.
The rules surrounding EAs were established in 2004, when they were created as fully funded, voluntary defined contribution schemes set up by employers. They form the second part of China's three-pillar pension system. The first pillar is the old defined benefit state pension provided through mandatory contributions by employers and basic, defined benefit individual accounts for employees who are compelled to pay into the plan. The third pillar of the pension system includes other voluntary plans set up by employers. Around 300 schemes have been established among corporates in China. In 2006, EAs covered about nine million urban employees or 3% of total urban employees.
The EA market could really take off once the government clarifies licensing, tax unification, trust management, asset management and allocation policies. For a pension plan to appoint a licensed trustee, custodian, administrator and fund manager, it must first seek approval from the relevant regulator. So an insurer must receive approval from the China Insurance Regulatory Commission, a fund manager from the China Securities Regulatory Commission, and a banker from the China Banking Regulatory Commission. Regulators and EA early movers recognise the licensing system needs to be more user-friendly. Earlier this year, the government agreed to streamline the application and licensing process for those wanting to provide EAs and this could happen by the end of 2007.
But it is still not clear where one regulator finishes and the other starts, creating some confusion in China. Liu Yongfu, vice minister of the Ministry of Labor and Social Security, said earlier this year that licensees will be expanded and standardisation of management of pension funds could happen sometime in 2008
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