October 2008 - The pressure to strengthen and improve Hong Kong’s Mandatory Provident Fund scheme comes not so much from the grass roots membership as from within the ranks of those running the scheme.  Everyone knows what the challenges are and the solutions are hotly debated. Yet progress on refinements has, up to now, been slow. Everyone knew, when the MPF began operating at the end of 2000, that it wasn’t perfect, so there is a certain sense of achievement in the fact that it has thrived and, although in need of some re-modelling, is in good shape.

The MPF covers 2 million employees in Hong Kong, and requires employers and employees to contribute 5% of the employee’s salary up to a total of HK$2,000 a month to an MPF scheme run by a recognised provider. Members are entitled to redeem their investment at age 65.  Coverage of the scheme is good, with overall enrolment levels and compliance at a high level. For employers who should be enrolled the figure is 99% and for employees it is 97.5%. And 75% of self-employed people are registered for the scheme. Darren McShane, Director of the Regulation and Policy Division at the Mandatory Provident Funds Schemes Authority (MPFA) says, “By global benchmarks, that represents a high level of compliance. The difficulty comes in getting the money in each month.”

Indeed, the amount of effort the MPFA has to expend on ensuring compliance is an issue that has the regulator reviewing its objectives. The number of non-compliant employers represents a small proportion of the money in the system, but a disproportionate amount of time and resources spent holding the non-compliers to account. Some employers, the most high profile recent case being the newspaper publisher Sing Pao, have abused the system by deducting employees’ contributions from their salary without investing the money into MPF funds. “People aren’t used to the idea of a regulator being a debt collection agency,” says McShane, “but a non-contributing employer becomes a debt to the MPFA, so the authority is forced to pursue the non-compliers. And most do eventually pay. ”

McShane expects new legislation just passed by Hong Kong’s Legislative Council  “will encourage employers to do the right thing”. The maximum penalty under the MPF ordinance, for failing to enrol employees in an MPF scheme or failing to made contributions, was HK$100,000 plus a six month jail sentence. The latest change to the ordinance means the penalty will increase to $350,000 and a three year jail term.

Pressure from the MPFA and a critical report from the Consumer Council in 2007 resulted in fund groups lowering their fees, (see IPA Q1 2008 page 3) but it still hasn’t been across the board. Most MPF fund providers have only cut fees for their capital preservation or money market type funds. The fee-cutting war has not yet expanded to the more actively managed funds, which means that 80% of the invested assets of MPF scheme members are still paying 2-3% management fees. The fund managers argue, of course, that they have to cover the cost of actively managing the funds. Some of the managers with a small share of the MPF market will indeed be struggling to make the business pay.

With the demand for lower cost products, it is perhaps surprising there are so few index funds available within MPF. “Yes, we have been asking that question ourselves,” says McShane. ” We would like to see fund promoters offering low-cost passive strategies, because we wonder whether investors are getting much alpha from their MPF funds. This will remain an issue and is bound in with the whole debate about education. Investors need to understand what they are paying for.”

McShane says the main regulatory change that will occur in this area is for an improvement in fee disclosure and measures allowing greater comparison, including a web-based fee comparison platform.

The issue of management fees is only half the story. If the overall fee is a little over 2%, a third of that will go the investment manager and close to 50% goes to the trustee. Watson Wyatt’s Philip Tso observes, “As MPF assets have now exceeded $220 billion, some economies of scale should have been achieved by the trustee administrators.”

Everyone highlights education as the single most important necessity for the development of MPF. Without it, other developments such as employee choice, increased contribution levels and portability will not fly. Education programmes are carried out by MPFA and by the fund promoters, but the feeling is that it is a struggle to capture the hearts and minds of people. The majority of MPF members consider it a necessary evil, but not something they are keen to engage with.

Product development has a role to play in helping members strike the right balance in their investing behaviour. One product trend that does seem to have gained traction is the ‘age profile’ fund. HSBC and others are developing products that segment member profiles based on time commitment, financial literacy and investment horizon. As Tso says, “One size does not fit all. The lifestyle option would be easier for less financially literate people to understand. It would also ensure the investor is exposed to the appropriate level of risk. Profiling members can personalise education, encouraging members to make informed decisions for their future,”

Greater competition will ultimately improve the choice and cost available to Hong Kong employees. And, once educated, they will be able to make their decisions based on a range of factors, not just fees. With the implementation of employee choice of provider, competition will intensify on other fronts, including overall quality of service and investment performance.