Tackling the pensions issue is not normally high on politicians’ agendas. The accepted view is that it will not win you many votes.
| Alan Wong | ||||||
Indeed it is far more likely to lose them for you. Not for nothing has it been dubbed “the third rail on the track” – the electrified one in the middle. Touch it and you die.
So prevalent is this view that the pensions issue has still to be addressed in many countries worldwide, not least in Europe where three of the world’s leading economies, Germany, France and Italy, have each yet to come up with a serious solution.
However in Asia, politicians are grasping the nettle. Following in the footsteps of its neighbour and fierce rival Singapore, Hong Kong is taking on the retirement provision problem and it means business. “We are not going to be paper tigers,” says Alan Wong, deputy managing director of the Mandatory Provident Fund Authority, which has responsibility for implementing the new scheme. Wong is threatening non-contributors to the MPF with heavy fines and even imprisonment.
There is a reason for his draconian tone. Forcing individuals to contribute 5% of their salaries to save for their retirement, and making their employers match that contribution, entails engineering a shift in a tradition that is as old as China itself. For centuries it has been accepted that the young care for the elderly: families look after their ageing grandparents.
Now the onus is being placed on individuals to save for themselves. Furthermore they are also being told that they must keep a close eye on their savings to make sure they build up a large enough sum to keep them in their old age. This defined contribution system has been prevalent in the US and certain other countries, such as the UK, for some time. For Hong Kong it is an almost entirely new experience.
Even so, people are not being allowed to put their heads in the sand and hope the new regime goes away. On top of saturation marketing and advertising of the new system, in recent weeks a huge banner has been flying on the Kowloon side of Hong Kong harbour proclaiming the deadline for signing up to the scheme. In giant orange letters it reads simply: “MPF Dec 1”.
The perfect role model?
However it is not merely in Hong Kong that the MPF is attracting attention. The system is being carefully analyzed by other countries across Asia.
| Jeremy Gadbury | ||||||
Although it is true that Singapore beat Hong Kong to the punch in setting up a compulsory savings scheme, its system is more rigid and is far more a state-run operation. Recently there have been moves to give more freedom to individuals to use their savings as they see fit.
Hong Kong is going a significant step further by working with the private sector to secure optimal fund management performance. The prospect of running these new funds has attracted the obvious banking names such as HSBC and Standard Chartered, as well as specialist investment houses such as Jardine Fleming (the Hong Kong arm of Chase Fleming Asset Management) and Schroder Investment Management.
The success of the MPF, at least in its foundation, has attracted praise from influential bodies such as the World Bank.
“The World Bank is very interested,” says the MPFA’s Wong, who was invited to Washington earlier this year to deliver two lectures on the subject.
In return, Yvonne Sin of the World Bank’s social protection division says that Hong Kong, as the first east Asian country to introduce a fully funded second-pillar system, is leading the way in the region. “What happens in Hong Kong over the next several years in the area of old age income security reform will have enormous impact on how other Asian countries choose to approach their own reform mandates,” she says. “As other countries in the Asia Pacific region begin to embark on their own pension reform process, they will certainly look to Hong Kong’s experience for lessons learned and to help build better systems in their own countries.”
One of these interested countries is China which has also invited Wong to come and discuss establishing a new pensions system. “China is now exploring various options to reform its pensions system, which is in crisis,” he says. The ageing population and longer life expectancy are taking their toll, together with other factors. “Whether you like communists or not, they are improving China’s standards of living with things like better medical care,” says Wong.
However China’s state pension system collects about Rmb200 billion ($24 billion) each year but has to pay out the same amount. It has been calculated that it really needs to bring in 20 times that sum to have an adequately funded and solvent scheme.
Wong says it is hard to see how it can manage to raise Rmb4 trillion when the economy is growing at only 7% to 8% a year. “They are relying on a structure that was put in place in the 1950s and ’60s and is pretty antiquated,” he says. “China is looking at moving towards a contributory system and the MPF is interesting to them.”
David Humphreys, chief executive of HSBC Provident Fund Services, says Hong Kong will definitely have some influence on other countries. “You would think anyone looking to introduce a mandatory system would look at previous systems to be role models for theirs and they would cherry pick from the better parts of each system.”
Humphreys says that not every aspect of the MPF will suit other countries, but it does set a good example. “The overall concept is excellent,” he says. “I would have thought that it would be a very good starter for other countries looking to introduce their own system.”
At Schroder Investment Management, Jeremy Gadbury, director of its MPF operation, who was heavily involved in the consultation process during the scheme’s inception, says there is good reason for other countries to look at Hong Kong’s system. “I hope everyone looking to launch a provident system will look at it because it has many good points,” he says.
However he cautions that Hong Kong has strong fundamentals that China, for one, does not. “We have a developed stock market here,” he says. “We have very easy and effective methods of investing overseas, we have a virtually fixed exchange rate.”
China has the problem of a pension system that is overstretched and also limited in its investment outlets because of Chinese companies’ lack of track record. Despite that, Gadbury says the MPF still has something to offer the mainland. “China has been looking very closely at the scheme and it is very excited about it,” he says.
However there are big differences between Hong Kong and China which is only just starting, and only slowly, to liberalize financial markets. “The majority of people, it’s fair to say, are investment illiterate and they need a lot of education before they can begin to look after themselves,” says Wong. “The vast majority of the population, as much as 90%, are peasants or farmers or workers with no idea of securities or unit trusts. They could be easily swindled or cheated.”
For these reasons, China is likely to want to have more state intervention than in Hong Kong.
As the World Bank’s Sin points out, Hong Kong’s unique characteristics give it an advantage. “The organization and design of the MPF reflects Hong Kong’s vibrant free-market economy as well as the entrepreneurial character of its residents,” she says. “Its dependence on private management in a free competition environment is probably the more cost-effective approach for providing old age protection.”
However, encouragingly, China and other Asian countries like Taiwan retain a keen interest in the MPF.
“The two most closely related countries to Hong Kong are China and Taiwan,” says Michael Yuen, general manager for the MPF at Jardine Fleming. “Time and again we have visitors, and industry participants coming to talk to us.
They both need to address their pension needs but they have quite different circumstances.”
Yuen feels China will use Singapore at one end and Hong Kong at the other extreme as its yardsticks for creating its own system.
Teething troubles
The theory is one thing, practice something else entirely. Towards the end of November, with the December 1 deadline in sight, the MPFA was still only able to claim a 50% take-up by employers, with expectations of 70% by the new year.
The deadlines are a little confusing because scheme members are actually being given 60 days’ grace to make the first contributions, so February 1 is the real deadline.
Despite a last minute rush to join, the scheme is still going to fall some way short of full, or practically full, participation.
The sheer number of small companies in Hong Kong is a major problem. The MPFA has had little problem with larger employers failing to sign up. However Hong Kong has only around 5,000 companies with staff of more than 50.
The remaining 275,000 Hong Kong companies have fewer. Chasing up the stragglers in that group will take time.
HSBC’s Humphreys says that from this group there is rapid take-up to the MPF. “They are suddenly realizing that it is all actually happening and it is a much easier sales process,” he says. “They are walking in and asking where to sign.”
So despite criticism from some quarters, the MPFA garners praise from the World Bank about the way it is handling the implementation of the new system. “Since the passage of the MPF ordinance in April 1998, the MPFA, in close collaboration with the investment community, has done an admirable job in promoting and educating the public on the importance of the scheme as well as improving financial literacy,” says Sin.
Boom time for fund managers
The arrival of the MPF lends further weight to the argument that fund management is the area of financial services with the healthiest future. As more people start to save for their retirement, inevitably the pool of funds to invest grows and hence fund managers find there is more demand for their services.
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Hong Kong: The MPF will give the stock market a stable source of local funds |
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This has been another factor behind criticism of the new scheme. “Not everyone likes this system,” says Wong. “Businessmen see it as a cost increasing mechanism, while trade unionists have criticized it because they see it as only benefiting the fund managers. They see them as making money regardless of whether asset prices rise or fall.”
However Wong is unrepentant. “We believe this is the right way to go,” he says.
As for the fund managers, it is going to be some time before they see a big enough pool of money in the MPF for it to contribute significantly to overall profits.
Even HSBC, which is leading the market with a 40% share, has some reservations. Humphreys says initially it will be only a small part of overall income but the bank is putting significant resources behind it to prepare for future growth.
“We view it as a core business because it’s a fundamental part of everybody’s working life from now on,” he says.
Jardine Fleming’s Yuen is upbeat about the business potential. His firm has formed an alliance with insurer AIA to secure distribution for its products. “From our perspective it won’t take that long to turn it into a profitable business,” he says. “We don’t need to hire extra portfolio managers and the initial marketing push has not cost a huge amount of money compared to our global operation.”
Yuen estimates that HK$12 billion ($1.5 billion) will flow into the MPF in the first year. That is not a large sum to share around more than 20 potential providers. “Divided between so many service providers it’s not that much but throughout the years it will build up. It will be good business to have,” he says, pointing to the fact that the Hong Kong population will have to become familiar with unit trusts.
“They will start to learn about collective investments and if you look at other countries such as the US, Canada or the UK, once people are used to these vehicles they will start to use them for other savings,” says Yuen. “People will make other savings beyond the MPF.”
Humphreys backs up this point. “At the moment there is so little investment in unit trusts here so it is all very new to people,” he says. “Most people in Hong Kong put their money in savings accounts, property or the horse running in the 3.30 at Happy Valley.”
With not much in the way of funds to start with and with so many contenders looking to succeed in this new market, competition will be fierce. Inevitably not everyone will succeed.
“Consolidation will happen very quickly because a lot of those providers won’t get critical mass,” says Yuen. Even as big a player as Citibank decided not to go ahead with launching a product. Other players who have come fresh to the game will find it hard to usurp the powerfully dug-in domestic players such as HSBC.
“Clearly when you’re playing with organizations the size of HSBC and some of the others, when you’re competing against those you’ve got to be very confident that you can stay the pace for a number of years,” says Humphreys.
“For companies setting up at the moment there’s no income and it will be very slow for a couple of years,” he adds. “Shareholders will have to accept that and have deep pockets to withstand it.”
Yuen backs up this point. “Quite a few people are so far behind that a lot of people will decide not to carry on,” he says.
Humphreys expects roughly half the current players to drop out. However he also believes that the market, which will look different in five years’ time, will also start to attract players that are not keen to get involved at this stage. “Once the fund has built up in a few years’ time we will see new names coming in,” he says.
For its part, Schroders, which has neither HSBC’s distribution nor Jardine Fleming’s alliance with AIA, is content to bide its time. “Our view is that we’re in it for the long term and we’re quite happy with the long-term potential,” says Gadbury. “We’re looking to build a product with a very strong reputation because we think within five years people will start to move on and change providers and we think there will be greater demand for our product.”
He thinks that this shift of funds will occur partly because of the movement of labour. Hong Kong has traditionally seen a relatively high staff turnover. Once the MPF has been bedded in, when people leave their employers they will be able to leave their existing contributions where they are or, more likely, move them to their new employer’s scheme or into a private fund.
Gadbury predicts that in five years’ time there will be a growing number of people with in the region of HK$100,000 of funds to invest. “They won’t have to place those funds with any one employer so there will be a lot of competition for that business,” he says.
| Michael Yuen | ||||||
One of the key drivers in any funds gravitating to new managers, as Gadbury predicts, will be performance.
“The interesting thing about the MPF is that to start with it is being decided by the employers but as things develop the employees will have more say and will be able to bring pressure to bear if they think their bosses have made the wrong choice,” he says.
While the likes of HSBC have undoubtedly done well in securing good market share, they will come under scrutiny once the scheme is up and running, particularly if global markets struggle. Public performance tables will put fund manager’s rankings up in black and white for easy comparison. This could lead to phone lines into call centres running hot.
Gadbury explains: “If the markets perform poorly and the average fund is down 12% but you are only down by 8% you will not be able to say to the individual, ‘Haven’t we done well?’ because that won’t wash with the man on the Shau Kei Wan tram.”
It will be hard to explain relative performance. “The customer won’t want to hear about the potential for market conditions to improve, or whatever, he will simply want to know when he will get his money back,” says Gadbury. “The potential for discontent will be substantial.”
This will be magnified by the fact that for most people in the MPF, it will be their only form of savings and they will necessarily place great importance on performance.
Boost for the markets
So it will not be completely plain sailing for the financial services industry. However there is little doubt that the markets will receive a significant boost from the steady inflows of new funds.
| David Humphreys | ||||||
“The local stock market will benefit because we require 30% to be invested in Hong Kong so we have strict investment rules which will help stimulate the local stock market, says the MPFA’s Wong. “We will also stimulate the development of a debt market in Hong Kong because we expect a lot of these funds to be invested in bonds.”
Jardine Fleming’s Yuen says the nature of markets will also change. “The MPF will start a real local pool of asset management products,” he says. “Hong Kong, being a very free and active market is quite easily affected by foreign money so if foreigners come in, the market goes up and if they leave it drops. At the moment we don’t have a stable source of funds coming from Hong Kong.”
However Yuen warns against over-excitement in the short term. “The impact initially will be small,” he says. “The daily volume of transactions in the market is around HK$10 billion. Out of the MPF’s HK$12 billion in its first year, only a portion will be invested in Hong Kong equities so people may have the wrong impression about how much of a boost the MPF will give the market.”
HSBC’s Humphreys takes a more bullish stance on how much money will flow into the system in the first year. “We expect to see between HK$14 billion and HK$20 billion,” he says. “That isn’t very much compared with the daily turnover of the Hong Kong stock exchange but when it is a third of GDP it will obviously have a significant effect on the market.”
This process could be accelerated if tax benefits for voluntary contributions were brought in, adds Humphreys. “At the moment there is no real incentive to invest but if that were to change we would see a much bigger fund and the MPF would become a much more important issue.”
“There is not a suspicion of international markets but historically the Hong Kong market has done well so people have felt no great need to invest elsewhere,” says Jardine Fleming’s Yuen. “Even after the Asian crisis, Hong Kong bounced back quite quickly.”
Initially also, along with all the other educational demands of implementing the new system, financial services providers will have to persuade investors of the advantages of putting money into equities. “What we expect is that at the start most of the money will go into bank deposits and bonds because people don’t have a great understanding of how the stock market works,” says Yuen. “That’s where we have to do a lot of work. We have a big challenge to educate the investor about what we mean by benchmarks, what we mean by growth.”
Degrees of success
However for all the plaudits going to Hong Kong for biting the bullet and tackling the pensions issue, Schroder’s Gadbury offers some cautionary words.
“People are obviously pleased with the MPF but you have to look at what people’s perception of success is,” he says. “For Schroder Investment Management here it might be gaining huge market share but if you ask someone in London he might say success involves making a lot of money.”
As regards the customer, he will see the scheme as a success if his savings rise by 20% in a year, while an individual portfolio manager will think of success in terms of the size and performance of his fund.
“If you ask the MPFA, their idea of success will be if everybody joins whereas the politicians, the policymakers, will call it a success if there is no old age economic crisis,” says Gadbury.
He argues that the Chinese, and other Asian countries also tackling the retirement issue, will find it hard to get a clear picture as to the success of the MPF.
“We might see 100% take-up in the scheme, meanwhile the Hong Kong stock market may fall by 20% for three consecutive years and people who have put their savings into defined contribution funds may find their money has been halved,” says Gadbury. “In that case the MPFA may see it as going well while the man in the street trying to save money thinks it has been an absolute disaster. All these scenarios are possible.”
Despite this pessimistic view, Gadbury remains optimistic. “Hong Kong will be stronger overall for the MPF but it is going to be a big bang situation and no one can confidently predict what will happen.”
Jardine Fleming’s Yuen also feels positive about the future of the new system, with some provisos. “The spirit of the MPF is right.
Hong Kong should have some form of pensions system for the public at large,” he says. “But we also have to be aware that we need to educate the public about a whole new way of investing, which is going to be quite a challenge.”
The last word, for the moment, goes to the MPFA’s Wong. “So far it has been a success,” he says. “We have 300 staff here after just 15 months, we have attracted billions of dollars of foreign investment into the market in the form of new trustees, we have created jobs for 10,000 people.”
These numbers give him confidence. “So far so good,” says Wong. “But we still have a long way to go.” The eyes of China and the rest of Asia will follow them closely.
