Is China's recent pension proposal viable?

(Ecns.cn) – Maintenance and appreciation of the value of pension funds has been a sticky problem for China in recent years, especially as a rapidly aging population is forcing the government to address pension-fund deficits in some regions of the country.

On December 20, 2011, the National Council for Social Security Fund injected 10 billion yuan ($1.58 billion) into the country's stock market, reported the Shanghai Securities News.

Meanwhile, after some Chinese officials pushed for a system that would allow governments at different levels to invest pension funds in the domestic stock market, at the International Social Security Forum held by the Chinese Academy of Social Sciences (CASS) on the same day, it was revealed that different views on the issue were converging and might reach an agreement soon, according to Chen Liang, an official in charge of social security fund supervision with the Ministry of Human Resources and Social Security (MHRSS).

At such a positive signal, Chinese shares surged more than two percent that day, after trading near 33-month lows in earlier sessions.

However, the possibility that pension funds might be invested aroused a chorus of worried voices. Brewing for many years, this is obviously a strategy that would public raise concern, especially from those in their sunset years.

Using a trust model

A portion of local pension funds should be allocated for investment in equities, according to Dai Xianglong, chairman of the National Council for Social Security Fund, who made the comment at the International Social Security Forum. His words echo a call made by Guo Shuqing, the new chairman of the China Securities Regulatory Commission, to invest pension funds in the domestic stock market.

Currently MHRSS is planning to establish an investment management system for social security in line with the country's economic development, which bases a system of supplementary pensions on a fund managed through trusteeship, according to the finance magazine Caijing.

It says the system described in the plan will cover a sum of 2 trillion yuan ($316.6 billion), comprised of money socked away in social security funds, including those of pension, medical care, unemployment, maternity and employment injury. But the first infusion of money will come solely from the private accounts making up the pension fund.

If this plan comes into play the operating entity will probably be a newly founded one under the State Council, and then a professional management team will be organized for future investments, and be supervised by MHRSS, according to Caijing.

The system will be operating under a trust model, and local governments can realize their investment in pension funds through recognized trusts. In this way, local governments can buy stocks, and China's largely unmanaged pension funds will thus capture higher earnings, said Dai Xianglong.

Dai noted that the investment returns for China's huge pension funds fall into the red when inflation is taken into account, as they can only be deposited in banks for interest earnings in accordance with existing regulations. The proceeds from this investment are therefore far less than the fund's investment gains of 9% and the 14% average annual profit rate of corporate funds, said Dai.

Scrambling a piece of the pie

Though the plan has still to be put into practice and many market watchers are concerned that it will take at least three years before new capital makes its way into the stock market, asset managers have already prepared to do battle for a slice of this action.

Insiders reveal that MHRSS is likely to issue more than one operating license at a time, to cope with the pent-up pressures of inflation promptly. All qualified institutions may compete equally to participate in this market-oriented operation of China's pension fund system.

Some money-management empires are understandably trying any means to link up with different departments of MHRSS and are investigating the policy thoroughly. With their enthusiasm and responsible attitude, they are even accessing opportunities to join in reviews of the plan in this early stage, according to Caijing.

An unnamed fund manager said quite a number of public funds are contributing their thoughts in writing to in-house magazines of MHRSS, through which make recommendations to the related departments involved in policy-making.

Some institutions have even set up new departments specially designed to serve their interests with respect to the unfolding plan. For example, UBS Investment has set up a new department headed by Sheng Bin, the company's deputy managing director, to prepare for the marketization of China's pension funds.

Betting on risks

In order to better address what looks like it will be a long-term gap between spending and revenue in relation to pension funds, MHRSS is now preparing to move forward with this plan, despite many scholars being opposed to betting people's pension funds on risky financial markets.

The most troublesome issue is the lack of consolidation among the country's various pension funds. Regions that are already have pension-fund deficits are normally willing to hand over the power to manage local pension funds, while governments with huge account surpluses hesitate to do so.

According to Caijing, there are only four provincial-level governments that have effectively achieved the consolidation and unified management of local pension funds and they include Beijing, Shanghai, Tianjin and Shaanxi. So it is still a challenge to gather these dispersed pension funds at the provincial level and place qualified investment organizations in charge of managing them.

Securing these massive portions of the pension fund system is an additional concern, though analysts say that the Chinese stock market has dropped to a 10-year low and pension fund investment activity would make up for the capital losses on the stock market and rally a bullish phase. But after all, the move is to improve profits but avoid losses, and no one can promise higher earnings with any certainty.

Hua Jianmin, vice chairman of the Standing Committee of China's National People's Congress has suggested that the government should first aim to rectify shortcomings in the Chinese stock market by eliminating its chronic flaws and increasing the overall chances of making good, healthy profits.