Hong Kong’s retirement schemes industry has achieved considerable success in a short time-span. Compliance rates for employers and employees within the Mandatory Provident Fund (MPF) system, which became operative in December 2000, have exceeded expectations of even the most optimistic of industry observers. The system now covers around 2 million employed persons in Hong Kong.
Conceived in the midst of the political wrangling of the pre-handover period, a healthy sense of scepticism has attached itself to the MPF since it was first proposed in the early 1990s. The result is a flawed but functioning system that is still struggling to sort out its teething problems.
Hong Kong has a rapidly ageing population. People aged 65 and over currently account for about 10% of the population. This is expected to rise to 13% by 2016 and 20% by 2029. The MPF is a retirement protection system for the entire working population of Hong Kong. Employers are required to enrol employees into the MPF. Mandatory contributions are calculated on the basis of 10% of an employees relevant income, with the employer and employee each paying 5%. Contributions are generally made on a monthly basis.
Before the implementation of the MPF system in December 2000, about one third of the workforce of 3.4m
people had some form of retirement provision. The Mandatory Provident Fund Schemes Ordinance provides the framework for the establishment of employment-related, privately managed MPF schemes for all employees.
The three main types of MPF Scheme are :
o A master trust scheme is a pooled scheme open to membership to the relevant employees of more than one employer, self-employed persons and persons with accrued benefits transferred from other schemes. It is especially suitable for small- and medium-sized companies.
o An employer sponsored scheme is only open to the relevant employees of a single employer and its associated companies.
o An industry scheme is a scheme specially established for employees of industries with high labour mobility, for example, the catering and construction industries. An employee who is a member of an industry scheme does not need to change scheme if they change employment within the same industry and if his or her previous and new employers are participating in the same industry scheme.
The participation rate is currently running at 94% and no one can quite believe it: “We don’t try to explain, because we can’t,” says Griffiths. The compliance rates for employees and self-employed individuals has been equally impressive, with over 90% take up for both.
“The estimates by Hewitt and GML were for 65% in the first year, and even then people said we were being too ambitious,”adds Griffiths. “I think it has something to do with Hong Kong being such a closely concentrated population, which makes communication easier. As a result, what you get is sort of a herd mentality.”
To put this in context, in Australia, it took nine years for 60% of companies to comply with mandatory pensions law. A lot of the promotional work was taken down to a district level, so there was good degree of local community involvement.

The scheme administrators were as surprised as everyone scale by the scale of the initial sign-up. There was a lot of misinformation coming from the employers, so while the trustees had good systems in place to weed out such problems, the extent of the clear-up operation was daunting. The main problem appears to have been that employers were failing to properly reconcile contributions to employees according to their relevant earnings. Each employer is responsible for maintaining a list of eligible employees and their contributions. In many cases, the cheques being forwarded to approved trustees didn’t match the employee contribution information, which resulted in huge amounts of money being put on hold before it could be invested.
The learning curve was steep, and the initial backlog took four months to clear. The problems had been foreseen at the planning stage. Indeed MPF was known by the industry to be a flawed system. Nonetheless, a decision was made to move ahead with it and refine it later, rather than try to create something perfect, which would have taken a great deal longer to bring about. In the run up to the handover in 1997, MPF had been constantly pushed back in the legislative agenda.
At the same time, the service providers while pointing out all the possible problems, were not engaged in a meaningful dialogue with the government authority, in the form of the MPF Authority. Having seen the whole process unfold as one of the architects of MPF, Anthony Griffiths, chairman of the HK Retirement Schemes Association, pays tribute to the industry for working long hours to get the MPF up and running and in sorting out the considerable early problems they faced.
The taxation of MPF schemes is fairly simply and is certainly quite generous. Employers have their MPF contributions allowed as a corporate tax deduction, while employees are allowed to claim tax relief on mandatory contributions and their benefits are not taxed at all. The rules applying to voluntary contributions and carry-overs from the ORSO schemes are less clear cut, though the rules do allow the employer a deduction of up to 15% of the employers net relevant earnings. Employees can make no further relief on voluntary contributions. There is no limit to the amount that a member may contribute to his MPF scheme. The estimate as to the amount of money that will eventually flow through the system is around HK$40bn (e5.8bn) a year.
MPF is credited as the catalyst for a greater awareness of investment generally. But for the moment, the current popularity of guaranteed funds is eclipsing all other types of product. This is largely a factor of the market conditions and the fact that a few groups had some early success with the funds, and then everyone else piled in – not very imaginative, but that is what is selling.
The MPF launched a new culture of investment, and hence expectation, for members of retirement schemes, which has far reaching implications, not least for the half million members registered under the Occupational Retirement Schemes Ordinance.
Of the HK$27bn of assets in the MPF, around HK$15bn would be transfers over from ORSO schemes, a figure Griffiths, whose association represents many ORSO members, expects to increase steadily over the next two years, with many of the existing DC schemes converting to member choice plans.
The issue of member choice is much talked about at the moment. The trend is likely to catch on with many new MPF schemes and with those that are moving over from DB to DC. The market for defined benefit schemes is expected to stagnate with the rise of DC plans and the introduction of the MPF. Even before MPF began, many DB and hybrid schemes had considered the transition to becoming DC schemes. Ironically, the present environment probably favours DB schemes, with low inflation, low staff turnover and a freeze on salary increases.
Though it’s a competitive environment for those investment houses targeting the MPF market, the advantage is that Hong Kong is a concentrated environment and so it’s not a difficult job to reach the 250,000 employers in the territory. Equally, for the MPFA, embarking on its education programme for MPF, the association was able to get its message across very effectively.
There is little scope for smaller promoters or specialists such as hedge fund managers trying to pitch for MPF business; not yet anyway. Similarly, the idea that funds should look more at a total return idea, which was put forward in the Myners recommendations for UK schemes, is premature in this context.
Griffiths comments: “We have only just got to the point where benchmarks have been accepted as a measurement of relative returns. Here, the idea of total return portfolios for MPF schemes has been talked down by the asset consultants, who consider that a mixture of active and passive is probably the best way to go for this market, especially since 100% of the sales of investment funds in the retail market in the last few months is accounted for by guaranteed products.” So although the wider market may be moving away from geographical allocation tied to a global benchmark in favour of sector allocation and total return asset mixes, it is too much to expect in the context of MPF at this early stage in its development.
How does the industry address the inclination of investors to be over-cautious with the pension investments at a time when they should be looking for growth. Griffiths says responsibility really falls to the service providers, and to a much lesser extent on the employers. The seminars put on by fund promoters have addressed the issue, explaining to young investors that they can afford to take more risk at age 25 than someone aged 55.
The MPFA and HKRSA have also stressed the need for member education, talking participants through elementary examples of risk and return and then moving on to more sophisticated ideas. Employers play their part in terms of the type of funds they make available. They are responsible for the selection of investment managers and for monitoring their performance in the interest of employees. For example, if the employer has set up a new scheme and has not run one before, it makes little sense to set up a master trust with 30 different funds that will just bewilder the scheme participant. For that you need a certain sophistication which the average Hong Kong investor does not have. Which is why the majority go for the conservative, balanced and aggressive options.
Statistics compiled by the MPFA show that the most popular fund option chosen by employees has been the balanced option, with around 50% of contributions invested in this way. Guaranteed funds account for 20% of contributions, and a further 15% for capital protected products, with pure equity funds way down the list.
Industry observers do not expect there to be much switching about within accounts at first, until the overall level of sophistication improves and there is a fair wind in the markets. In addition to the cost of establishing the scheme, the complexity of member choice means higher administration costs as well as the on-going cost of communication.
Larger schemes have yet to embrace the alternative investment options with any gusto. Outside of a few individual cases (the Hospital Authority of Hong Kong’s investment in a private equity vehicle set up by Goldman Sachs is the best known example) there hasn’t been.
An extension of this is the question of who should advise the investors? People are very aware of giving investment advice because there are heavy fines for anyone found to have given faulty advice. In fact the original wording of the MPF Ordinance would have put employers in jail for the offence. Research among 401k investors in the US has shown that employees often make poor investment decisions, such as being too conservative in the early years of their plan, buying high and selling low during turbulent market periods. The onus is falling on the financial advisers and planners.
More changes to MPF are likely, but these will be administrative refinements of more concern to the pensions industry than to scheme participants. There is one suggestion that Griffiths is keen to nip in the bud; that MPF contributions should be frozen for up to two years to help small- and medium-sized firms survive the economic downturn. Griffiths says this would be a disaster for the MPF and for Hong Kong’s reputation: “It disrupts a system that is only just finding its feet and it sets an awful precedent. The question will be asked, ‘are they going to pull the plug when times are tough?’ Our advice to the government would be, in the strongest possible terms: Don’t be tempted to do this – the short term gain would have awful consequences.”
Obviously it would have been better for MPF to have been launched into a more ebullient period for the markets. Negative returns have not helped to reinforce the benefits of the retirement scheme. But despite this, MPF has started to work and the administrative problems are being ironed out. Investor education is an ongoing challenge and fines are regularly being handed out to members who flout the rules. All in all, the Hong Kong employees’ retirement scheme is a good example of what can be achieved, against considerable odds.

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