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IPA: China's pensions system set to come of age

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  • IPA: China's pensions system set to come of age

CHINA - Recent policy signals give a clearer indication of the future evolution of China’s pensions system, which is set to quadruple in size over the next decade, reaching a total value of CNY28trn (€3.4trn) by 2020, according to a report published this week by Z-Ben Advisors.

A drive towards improving returns on pensions funds also means large-scale opportunities for asset managers, the report argues.

Since the downsizing of China’s state-owned enterprises in the 1990s and the dismantling of the Maoist “iron rice-bowl” welfare system, China’s pensions system has been unable to keep up with the country’s rapid economic growth.

Public pension funds (PFPs), traditionally the primary source of retirement income, have been limited in their investment options, meaning the overwhelming majority have struggled to deliver positive returns against a backdrop of steady - and occasionally high - inflation.

As China seeks to boost domestic consumption within the economy and liberalise its financial markets, profound changes lay ahead for its pensions system. According to Z-Ben, the two major trends are centralisation and privatisation.

Poor returns and management issues have deterred citizens from paying into PFPs, and many have opted out of pensions provision in the last decade. China’s emerging middle class has preferred to take out private policies, leading to rapid growth of the private sector and creating an entirely new source of opportunities for asset managers.

Restrictions imposed on the National Social Security Fund have hindered performance, while liabilities are set to increase as demographic structures change, giving policymakers a strong incentive to liberalise investment options. Among the most significant reforms in this area are moves to bring provincial pension funds under the management of the NSSF and increase active management.

Given China’s size, low participation rates have not prevented the accrual of significant pensions assets. By 2011, China’s total pensions assets had reached nearly CNY7trn, according to Z-Ben.

This comprises CNY2trn in PFP assets, CNY920m in NSSF assets and CNY4.1trn in private insurance scheme assets. There is also a small but growing EA segment.

To improve returns on these assets, Z-Ben argues the government will continue to increase the investable quotas for all types of pension funds, while also allowing greater diversification into riskier and alternative assets as they attempt to improve returns.

For financial institutions, this means a steady expansion of opportunities, the report concludes, particularly those with solid track records and pension fund management experience. There will also be greater scope for specialisation, and mandate opportunities will differ according to the type of firm.

For example, the NSSF is the only entity able to release RFPs to the public, meaning fund managers looking for EA mandates should approach custodian banks or EA trustees, the report points out.

Insurers can currently only outsource asset management functions to insurance AMCs, but, over time, external AMCs may also be allowed into this space, it speculates.

Fund managers may occasionally express frustration with the slow pace of reform. But Z-Ben argues that, despite current restrictions, there is likely to be an expansion of opportunities to a wider range of financial institutions as China’s modernisation of its pensions system continues.

This may require patience, but, given the rapid rise in liabilities that China’s demographic structure will create in the near future, even the most recalcitrant political elements will be forced to accept liberalisation and greater risk exposure for pensions fund - because the consequences of inaction will be even harder to stomach.

The new edition of IPC contains a special section on the development of individual retirement accounts in China.

IPC’s team of writers analyse the policy development and the practical implementation problems being addressed. They also compare the experience of retirement accounts in other parts of the world.

To receive a copy, please register here.

This article first appeared in IPE sister publication Investment & Pensions Asia.

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