Japan revises guidelines for alternatives
27 Jul 2012
Japan's Health, Labor and Welfare Ministry released a draft revision of its guidelines for portfolio management by employee pension funds (EPF).
For alternative investments, it will require that targets and allocations be stated specifically in the basic investment strategy, and has changed the methods for qualitative assessment of consigned fund managing institutions. It plans to implement a portion of the scheme in the near future and the remainder by April 2013 at the latest.
The revision was prompted directly by the AIJ scandal. The Ministry, having received a final report from a special advisory panel, will first introduce the measures that it is able to execute on its own.
The main components added to the guidelines concern alternative investments. Such investments were uncommon when the guidelines were introduced in 1997, so the rules were clarified this time. The Ministry will require the basic investment strategy of EPF spell out the investment targets, positioning and allotment within the policy asset mix (basic portfolio), and risks specific to the alternative investments employed.
It also asks that the EPF, when choosing the managers for such investments, examines carefully whether the managing organisation itself functions properly, including its decision-making process, internal controls and review systems. It also requires a proper check of the organisation's financial standing and performance history.
In selecting actual alternative investments, EPF must obtain a clear explanation of products from the fund managers to confirm the contents. This includes four specific points: the source of returns and risk; the evidence behind the calculation of market value and reporting methods; the response to requests for disclosure; and management costs. These points should be followed for each product type.
New components were also added regarding the selection of fund managers, including alternative funds. The present standard calls for an overall assessment from both a quantitative (e.g. past performance) and qualitative (e.g. management system) perspective. The new guidelines also recommend actual interviews with each managing institution, especially with the managers who make the actual investment decisions.
The quantitative and qualitative standards were also upgraded. The former is currently based on an overall judgment from appropriate market benchmarks of investment returns. Under the new guidelines, components related to active investments aiming to beat the benchmarks must be listed separately. Such active investments must use indicators such as information ratios estimating risk/return levels.
Qualitative assessments have also previously involved simply a broad evaluation of the investment philosophy, structure and capabilities of management firms. They must now consider the logic and consistency of the management strategy, the line of responsibility and the sustainability of operations, such as the length of service of employees.
Moreover, since EPF represent a portion of public pensions, importance is placed on risk management and the establishment of ethical guidelines for employees.
There is a striking number of mandatory rules due to come into effect in April next year. Based on the recommendations of the advisory panel, funds will now be obliged to draw up a basic portfolio rather than simply making their best efforts to do so. They must lay down their strategies for any large concentrated investment in specific managing institutions and ensure that all staff connected with fund management receive training commensurate with their knowledge and experience.
Management consultants must be registered as investment advisors or brokers under the Financial Instruments and Exchange Act. Any problems will be dealt with under the law. Funds will be required to confirm whether consultants have any contractual relationships with managing institutions.
The Ministry has also altered the requirements for the structure of EPF internal asset management committees. At present, only managing directors, representative directors or corporate managers in charge of financial or personnel affairs can serve on such committees. The new rules will add academics and others experienced in finance or economics. The minutes of committee meetings must be made available to all representatives and subscribers.
Author: Nenkin Joho