## _wp09246 ## Source details **Canonical URL:** [_wp09246](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2009/_wp09246.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2009/_wp09246.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2009/_wp09246.pdf.json) --- ### Governance standards and international context - International standards and guidance cited: ISSA (2004), IWG-SWF (2008), OECD (2006 and 2009). - Common governance objectives emphasized: - Strong governance structures with independence from government interference. - High levels of transparency and public accountability. - Historical governance failures and common poor governance features noted: - Public pension reserves undermined by explicit social/developmental investment mandates or political interference. - Practices that undermined performance: forced holdings of government paper, regulatory requirements biasing banks to buy government securities, use of non-marketable instruments with below-market yields, restrictions on foreign asset investment. - Nomination/termination procedures often allow political influence; few funds have governance committees; limited application of codes of conduct/ethics or conflict of interest rules. - In-house asset management prevalent with little external and transparent benchmarking, disclosure, or accountability. - Policy implication: - The early implementation of good governance and pension fund management standards is critical to enable pre-funding policies to achieve their objectives. ### Structure and coverage of the Chinese pension system (overview) - System features and fragmentation: - Highly fragmented due to decentralization, large population, large informal labor market, and local pilot programs; financing, administration, and parameters often defined at provincial or municipal levels. - Coverage as of 2008: - Around 40 percent of the labor force in China (775 million workers) covered by one of three government-sponsored and mandatory pension arrangements. - Coverage composition: - Basic Old Age Insurance: 28.3 percent of the labor force. - Rural pension system: 7.2 percent of the labor force. - Pension plans of state organizations and public institutions: 5.2 percent of the labor force. - Individuals not covered by these three arrangements are covered by the Minimum Life Security System (urban di bao), a non-contributory and unfunded social assistance program funded through local government budgets. - Government promotion of three-pillar system for urban workers: - Pillar I: Basic Old Age Insurance (largest pool of assets). - Pillar II: Enterprise Annuity (EA) system. - Pillar III: Complementary individual voluntary plans. - Focus of paper: three components where pre-funding takes place — Basic Old Age Insurance (Pillar I), National Social Security Fund (NSSF), and Enterprise Annuity (EA) system (Pillar II). ### Key design features and numeric parameters (Table 1 summary) - System taxonomy: Pillar I (Basic Old Age Insurance System), Pillar II (Enterprise Annuity System), Pillar III (Complementary Individual Plans). - Basic Old Age Insurance System (Pillar I) - Main features: - Based on State Council Document 38 of 2005. - Mandatory; defined benefit with pooling at city or provincial level. - Funding: Unfunded. - Contributions: - 20 percent (between 17 percent and 30 percent, depending on the city) of payroll. - 100 percent responsibility of employer. - Benefits: - Minimum 15 years of contributions to qualify. - 1 percent accrual rate 1/. - 35 percent based on 35 years of service. - Indexation rules not in place but in practice benefits tend to increase by 40–60 percent of local wage increases. - Enterprise Annuity System (Pillar II) - Main features: - Based on State Council Document 38 of 2005. - Mandatory; defined contributions; individual accounts. - Funding: - Fully funded in principle but “leakages” to the social pooling are both legal and de facto. - At least 13 provinces committed to full funding and prohibited “leakages” to the social pooling. - Contributions: - 8 percent of local covered wage. - 8 percent of individual wages which are subject to lower and upper bounds, i.e., 60 percent and 300 percent of local average wages. - 100 percent responsibility of employee. - Benefits: - Phased withdrawals as a function of average life expectancy in urban areas. - Longevity tail risk insured by Tier I. - Target replacement rate (table truncated in source). - Complementary Individual Plans (Pillar III) - Main features: - Based on MOLSS decrees 20 and 23. - Funding: Fully funded. - Contributions and tax incentives: - Defined at the company level.2/ - 5 percent tax deduction for employer only.3/ - Regulation: Not regulated. - Note: Footnotes and truncated table entries are present in source; some Pillar II and Pillar III benefit targets are not fully shown. ### Basic Old Age Insurance System — structure, reforms, assets - Two tiers introduced in 1997 (State Council Document 26): - Tier I: mandatory, defined benefit, pooling at different government levels, unfunded, pay-as-you-go. - Tier II: mandatory, defined contribution, individual accounts. - Issues and reforms: - Many local governments borrowed monies from Tier II to fund current Tier I pension expenditures. - Reforms to strengthen fund management: centralizing management toward provincial level by end of 2006; separating management of Tier I and Tier II; increasing funding in individual accounts; Tier II remains partially unfunded with no explicit recognition of past liabilities (“legacy costs”). - At least 13 provinces committed to fully fund Tier II and prohibited “leakages” of Tier II to Tier I. - Central government typically covers 75 percent of the flow of contributions based on locally relevant definition of covered wage up to a maximum of 3.75 percent of the locally relevant definition of covered wage for some provinces; no central subsidies for wealthy provinces such as Shanghai, Zhejiang and Jiangsu. - By 2008, a total of 17 provinces have achieved centralized asset management at the provincial level; government aims to complete centralization at provincial level for whole nation by end of 2009. - Pension asset totals (official figures for 2008): - Y 993.1 billion in total assets at the national level. - Approximately Y 120 billion accumulated in individual accounts in the thirteen provinces committed to full funding. - Of these, Y 33 billion in 2008 were managed by NSSF. - The other Y 960.4 billion was managed at the provincial, city or county level. ### The National Social Security Fund (NSSF) — mandate, governance, and sources of funds - Mandate and role: - Established in 2000 as a national long-term strategic reserve fund to meet future pension obligations of the Basic Old Age Insurance system. - Dual role: demographic buffer to absorb peak of demographic transition around 2030; fund of last resort for pension expenditures in the Basic Old Age Insurance system. - NSSF reports that expenditures are not foreseen for the next 15–20 years until 2025–30. - No reliable projections exist for Chinese pension system liabilities — implies fund management driven by maximizing returns without incurring undue risk rather than matching expected liability cash flows. - Institutional structure and fund governance: - National Council (board) with chairman, three vice chairmen, and 17 directors — total 21 members. - Three committees: Investment Committee, Risk Management Committee, Expert Appraisal Committee. - Nine permanent NSSF management departments. - All 21 members appointed by and reporting to the State Council; appointments for a 3-year period and renewable; appointments are not staggered and no fit and proper tests apply. - Responsibilities of the National Council (per MOF and MOLSS Decree 12 of 2001) include administration of assets, formulation/implementation of investment policy, selection/performance evaluation of fund managers and custodians, preparation of periodic financial statements, public disclosure of financial condition, distribution of funds according to joint directives of MOF and MOHRSS, and other duties assigned by State Council. - Sources of funds: - Central government budget allocations. - Proceeds from lottery licenses. - Investment income. - SOE contributions: state-owned enterprises must contribute 10 percent of their IPO proceeds to the NSSF at time of public offerings (policy originally applied to domestic and international offerings, suspended for domestic offerings in June 2002). Since June 2009, new regulation requires state owned enterprises which sold shares after 2005 structural reform, or plan to in future, to transfer shares in amount equivalent to 10 percent of their IPOs to the NSSF. Applies to 131 state-controlled companies listed on domestic exchanges. - Lock-up period of three years during which NSSF cannot sell received shares; IPO shares do not give voting rights. - Table 2 reported series (Total net flows Y billon): 20.0, 60.5, 43.7, 8.3, 38.6, 40.7, 71.0, 156.9 (by year sequence in table). - Table 2 reported Total assets Y billion series: 20.0, 80.5, 124.2, 132.5, 171.1, 211.8, 282.8, 439.7 (by year sequence in table). ### NSSF — investment policy framework, allocation limits, outsourcing, and custodians - Governing rules: - Interim Measures on the Administration of the Investment of the NSSF (MOLSS and MOF Decree No. 12 of December 2001). - Interim Provisions Concerning the Administration of Overseas Investment (National Council of the NSSF, March 2006). - Investment universe (domestic and foreign) includes cash, bank deposits, treasury bonds, mutual funds, equities, corporate bonds (domestic) and foreign bonds, equities, mutual funds, derivatives (foreign). - Strategic asset allocation limits (selected, verbatim): - Domestic: Cash and deposits ≥ 10 percent; o/w in any given bank ≤ 50 percent. Government bonds and cash and deposits ≥ 50 percent. Corporate bonds ≤ 10 percent; minimum rating ≥ A; o/w in any individual issuer ≤ 5 percent. Mutual funds and equities ≤ 40 percent; o/w in any individual fund/issuer ≤ 5 percent. Total domestic assets outsourced per year to any single manager ≤ 20 percent. Central government enterprises ≤ 20 percent; o/w in any given program ≤ 20 percent. Trust investments: o/w in any given program ≤ 20 percent. Trust investments with bank guarantee ≤ 5 percent (of NSSF total asset). - Foreign: Corporate bonds minimum rating ≥ BBB; o/w in any individual issuer ≤ 10 percent. Mutual funds and equities: o/w in any individual fund/issuer ≤ 10 percent. CDs: minimum rating ≥ AAA. Total foreign assets per manager ≤ 50 percent. - Notes: - Strategy does not contain a rate-of-return target. - Domestic and foreign assets treated as separate pools for investment risk management. - Outsourcing and custodians: - Share of assets outsourced increased from 24 percent to 47 percent in period 2003–2007. - Custodians selected include Bank of Communications (2002), Bank of China (2002), Industrial and Commercial Bank of China (2007), North American Trust Bank (2006), Citi Bank. - Custodians’ responsibilities include safekeeping, settlement, monitoring managers, maintenance of records for at least 15 years; NSSF owns Y 30 billion of shares of some local custodians (independence concerns). ### NSSF — actual allocation, concentration, implementation, and performance - Actual internal portfolio trends (selected): - Bank deposits share of internally managed assets decreased from 65 percent to 44 percent in 2001–2007. - Fixed income assets (government debt held to maturity) decreased from 34 percent to 18 percent in 2001–2007. - Increase in equities, trust investments, and indexed products from zero in 2001 to around 37 percent of internally managed assets in 2007. - NSSF held about Y 65 billion in equities by end-2008, of which Y 30 billion is invested in three largest banks: China Bank of Communications, Bank of China, China Industrial and Commercial Bank. - Performance (Table 11 highlights, Y billion unless noted): - Gross operating income: 2000: 0.02; 2001: 0.97; 2002: 2.10; 2003: 3.41; 2004: 4.66; 2005: 5.56; 2006: 20.04; 2007: 113.20; 2008: (33.76). - Net income: 2000: 0.02; 2001: 0.97; 2002: 2.10; 2003: 3.41; 2004: 4.59; 2005: 5.29; 2006: 19.58; 2007: 112.92; 2008: (39.37). - Net income after provisions: 2000: 0.02; 2001: 0.77; 2002: 1.68; 2003: 2.73; 2004: 3.67; 2005: 4.23; 2006: 15.66; 2007: 89.16; 2008: (39.37). - Gross income/average assets (%): 2001: 0.17; 2002: 1.92; 2003: 2.05; 2004: 2.65; 2005: 3.07; 2006: 2.90; 2007: 8.10; 2007 (alternative row): 31.34; 2008: (5.95). - Net income/average assets (%): 2001: 0.17; 2002: 1.92; 2003: 2.05; 2004: 2.65; 2005: 3.02; 2006: 2.76; 2007: 7.92; 2007 (alternative row): 31.26; 2008: (6.96). - Key observations: - Nominal gross returns low in initial years; between 2001 and 2005 nominal realized gross returns averaged 2.5 percent of average assets (text statement). - Rebalancing into riskier assets and increased use of external managers improved yields in 2006 and 2007; 2007 nominal yields around 31 percent of average assets. - The fund experienced a loss of Y 34 billion in 2008; 2008 shows large negative values reflecting losses/revaluations. - Social Security Fund risk reserve capped at 20 percent of net value of NSSF assets and used to offset investment losses; Individual Account Fund risk reserve capped at 20 percent of the Individual Account Fund value. - Operational costs and disclosure: - Until 2007, operating expenses averaged 11 basis points of average assets. - 2008 financial statements report total expenses of Y 5.7 billion, or 1 percent of average assets; excluding financial losses, operating expenses were Y 1.6 billion, or 0.30 percent of average assets. - 2008 annual report omits some disclosures (e.g., split in-house vs external performance), and new accounting standards complicate comparisons. ### Enterprise Annuity (EA) system — structure, scale, investment rules, and performance - System phases and growth: - Phase 1 (1990s–2004): Encouragement of complementary pension insurance schemes; group insurance DB products were important. - Phase 2 (2004 onwards): MOHRSS Decrees No 20 and No 23 consolidated EA market and strengthened regulation; legacy schemes needed redesign to be entitled to tax relief benefits. - End of first phase (2004): 22,463 firms, ~7 million workers, accumulated assets ~Y 50 billion, or 0.3 percent of GDP. - 2008: ~33,000 firms; coverage 10.4 million workers; assets reached Y 191.1 billion in 2008, or 0.6 percent of GDP. - EA performance (2006–2008, percent): - Nominal return 1/: 2006: 9.6; 2007: 24.5; 2008: -1.8; Average: 10.8. - Inflation: 2006: 1.5; 2007: 4.8; 2008: 5.9; Average: 4.1. - Real return 1/: 2006: 8.1; 2007: 19.7; 2008: -7.7; Average: 6.7. - Investment rules and risk profile: - Permitted investments (selected, verbatim): - High liquidity money market instruments with a minimum of 20 percent of net assets. - Term deposits, contractual deposits, government/financial/corporate bonds, convertible bonds and securities funds not exceeding 50 percent of net assets; government bonds cannot represent less than 20 percent of net assets. - Investment in equities, investment-linked insurance products and equity funds limited to a maximum of 30 percent of net assets; investment in equities cannot exceed 20 percent of net assets. - Prohibited investments: hedge funds, property, infrastructure, private equity and foreign markets. - Observations: Conservative quantitative limits helped shield EA funds from 2008 downturn; MOHRSS is revising Decree 23 with consultation draft including gradual liberalization of quantitative limits. - Governance framework and market structure: - Trust model with “pension council” and “corporate trustee” variants; pension council tripartite board with at least one-third employee representatives. - Decree 23 envisages four players: corporate trustee (ultimate fiduciary), custodian, account administrator, asset management company. - Licensing: 58 licenses total (11 trustees, 16 account keepers, 10 custodians, 21 asset managers) as of 2007; only domestic Chinese firms or joint-ventures licensed so far. - Minimum capital requirements (verbatim highlights): - Corporate trustees: registered capital no less than Y 100 million and maintaining no less than Y 150 million net assets at any time. - Account administrators: minimum capital Y 50 million. - Custodians: required to register at least Y 5 billion in net assets. - Fund managers (comprehensive securities companies): registered capital and net assets should be at least Y 1 billion at all times. - Weaknesses and supervisory issues: - Trustee often weakest player in practice; sponsor typically chooses all four players; trustee fees capped at 0.2 percent of net assets and market average typically < 0.1 percent. - External audit provisions weak; asset managers and account administrators not required to be audited externally regularly. - Whistle blowing provisions weak in scope and follow-up. - MOHRSS supervisory capacity limited (only 3–4 staff directly working on EA issues nationally). - Tax and market incentives: - Tax relief for EA plans raised from 4 percent to 5 percent in June 2009 (State Taxation Administration and Ministry of Finance decision). ### System-wide observations, risks, and recommendations (implicit and explicit) - System fragmentation and disclosure: - Separate regulatory and supervisory frameworks for Basic Old Age Insurance, NSSF, and EA; disclosure varies across components. - As of end-2008 official figures report: - Combined social pooling and individual accounts: Y 993.1 billion (4.2 percent of GDP). - NSSF accumulated assets amounting to Y 562 billion (at market price), or 2 percent of GDP at end of 2008. In-house managed assets around 50 percent of total assets (data up to 2007). - EA system: accumulated around Y 191.1 billion, or 0.6 percent of GDP. - Key governance and operational risks and recommendations: - Strengthen and publish detailed investment rules, selection criteria, and processes for venture capital, private equity, external asset managers, and custodians before broadening asset allocation. - Clarify and tighten provisions on minimum qualifications and independence requirements for custodians. - Consider appointing a global custodian to exploit economies of scale and improve transparency and system compatibility. - Contain fixed operating costs (wages, custodian fees) as NSSF moves toward more aggressive external management. - Strengthen internal and external audit provisions and establish a consistent whistle blowing framework for relevant parties to leverage MOHRSS supervisory function. - Reinforce independence and fit-and-proper appointment processes for board members and stagger appointments; publish codes of ethics and conflict of interest rules. - Gradual liberalization of EA investment limits while improving supervisory capacity and moving toward a “prudent person” approach. - Improve disclosure standards and public accountability to guard against political interference, especially as NSSF increases activism and exposure to alternative assets. ### Key statistics and timeframes (verbatim) - 24.2 percent based on 15 years contributions. - Tax relief for EA plans raised from 4 percent to 5 percent in June 2009. - MOLSS renamed MOHRSS in 2008. - At least 13 provinces committed to fully fund Tier II. - By 2008: 17 provinces achieved centralized asset management at provincial level; government aims to complete centralization by end of 2009. - Pension assets 2008: Y 993.1 billion total assets at national level. - Approximately Y 120 billion accumulated in individual accounts in thirteen provinces; Y 33 billion in 2008 managed by NSSF; Y 960.4 billion managed at provincial, city or county level. - NSSF reports expenditures not foreseen for next 15–20 years until 2025–30. - NSSF National Council size: 21 members (chairman, three vice chairmen, 17 directors). - NSSF IPO policy applies to 131 state-controlled companies. - Table 2 Total net flows Y billon series: 20.0, 60.5, 43.7, 8.3, 38.6, 40.7, 71.0, 156.9. - Table 2 Total assets Y billion series: 20.0, 80.5, 124.2, 132.5, 171.1, 211.8, 282.8, 439.7. - NSSF total assets at end-2008 reported as Y 562 billion (at market price) in later excerpts. - NSSF held about Y 65 billion in equities by end-2008; Y 30 billion invested in three largest banks. - NSSF experienced a loss of Y 34 billion in 2008. - EA assets under management reached Y 191.1 billion in 2008, or 0.6 percent of GDP. - EA nominal returns: 2006: 9.6 percent; 2007: 24.5 percent; 2008: -1.8 percent. EA real returns: 2006: 8.1 percent; 2007: 19.7 percent; 2008: -7.7 percent. - Operating expenses reported for NSSF 2008: total expenses Y 5.7 billion (1 percent of average assets); excluding financial losses, operating expenses Y 1.6 billion (0.30 percent of average assets). - NSSF pre-IPO participations: Y 10 billion in Bank of Communications (June 2004); Y 10 billion in Bank of China; Y 10 billion in Industrial and Commercial Bank of China; allocated around Y 30 billion into BoC, ICBC, and BoCom and Y 10 billion in Beijing-Shanghai high-speed railway company; State Council approved investment in China Development Bank estimated about Y 50 billion. *Source: Excerpt from "1. Key Design Features of the Chinese Pension System" (IMF working paper).* ### 1. Key Design Features of the Chinese Pension System ...........................................................8 ### 1. Key Design Features of the Chinese Pension System ### Governance standards and international context - Internationally accepted standards and guidance cited: ISSA (2004), IWG-SWF (2008), OECD (2006 and 2009). - Common governance objectives emphasized by these standards: - Strong governance structures with independence from government interference. - High levels of transparency and public accountability. - Historical governance failures internationally noted as relevant context: - Public pension reserves often managed poorly because of explicit social/developmental investment mandates or political interference in investment decisions. - Practices that have undermined performance include forced holdings of government paper, regulatory requirements that biased banks to buy government securities, use of non-marketable instruments with below-market yields, and restrictions on foreign asset investment. - Common poor governance features described: - Nomination/termination procedures for governing members often allow political influence; variation in size, composition, and qualification of governing bodies. - Few funds have governance committees to recommend governance policy and monitor codes of conduct or conflict of interest rules. - Standards such as codes of conduct/ethics or conflict of interest rules apply only to a handful of funds. - In-house asset management is prevalent with little external and transparent benchmarking, disclosure, or accountability. - Policy implication stated in the text: - The early implementation of good governance and pension fund management standards is critical to enable pre-funding policies to achieve their objectives. ### Structure and coverage of the Chinese pension system (overview) - The pension system is highly fragmented due to decentralization, large population, a large informal labor market, and local pilot programs; financing, administration, and parameters are often defined at the provincial or municipal levels. - As of 2008: - Around 40 percent of the labor force in China (775 million workers) was covered by one of three government sponsored and mandatory pension arrangements. - Coverage composition of the labor force: - Basic Old Age Insurance: 28.3 percent of the labor force. - Rural pension system: 7.2 percent of the labor force. - Pension plans of state organizations and public institutions: 5.2 percent of the labor force. - Individuals not covered by these three arrangements are covered by the Minimum Life Security System (urban di bao), a non-contributory and unfunded social assistance program funded through local government budgets and based on locally formulated minimum life security standards. - The government has been promoting a three-pillar system for urban workers; the components where partial funding occurs are: - Pillar I: Basic Old Age Insurance system (largest pool of assets in the pension system). - Pillar II: Enterprise Annuity (EA) system. - Pillar III: Complementary individual voluntary plans. - The paper focuses on three components where pre-funding takes place: Basic Old Age Insurance system, National Social Security Fund (NSSF, a demographic buffer), and the Enterprise Annuity (EA) system. ### Key design features and numeric parameters (Table 1 summary) - System taxonomy used: Pillar I (Basic Old Age Insurance System), Pillar II (Enterprise Annuity System), Pillar III (Complementary Individual Plans). - Basic Old Age Insurance System (Pillar I) - Main features: - Based on State Council Document 38 of 2005. - Mandatory. - Defined benefit with pooling at the city or provincial level. - Funding: - Unfunded. - Contributions: - 20 percent (between 17 percent and 30 percent, depending on the city) of payroll. - 100 percent responsibility of employer. - Benefits: - Minimum 15 years of contributions to qualify. - 1 percent accrual rate 1/. - 35 percent based on 35 years of service. - Indexation rules not in place but in practice benefits tend to increase by 40–60 percent of local wage increases. - Enterprise Annuity System (Pillar II) - Main features: - Based on State Council Document 38 of 2005. - Mandatory. - Defined contributions. - Individual accounts. - Funding: - Fully funded in principle but “leakages” to the social pooling are both legal and de facto. - At least 13 provinces committed to full funding and prohibited “leakages” to the social pooling. - Heterogeneous funding levels and target rates. - Contributions: - 8 percent of local covered wage. - 8 percent of individual wages which are subject to lower and upper bounds, i.e., 60 percent and 300 percent of local average wages. - 100 percent responsibility of employee. - Benefits: - Phased withdrawals as a function of average life expectancy in urban areas. - Longevity tail risk insured by Tier I. - Target replacement rate of (table is truncated at this point in the source). - Complementary Individual Plans (Pillar III) - Main features: - Based on MOLSS decrees 20 and 23. - Funding: - Fully funded. - Contributions and tax incentives: - Defined at the company level.2/ - 5 percent tax deduction for employer only.3/ - Regulation: - Not regulated. - Footnotes and truncated table entries are present in the source; some Pillar II and Pillar III benefit targets and details are not fully shown in the provided excerpt. ### Components emphasized for governance and fund management assessment - The paper assesses governance and pension fund management standards in: - The Basic Old Age Insurance system (Pillar I). - The National Social Security Fund (NSSF) (demographic buffer established to increase the pool of prefunded assets). - The Enterprise Annuity (EA) system (Pillar II). - Figures and appendices in the chapter (listed in the source) include: - Figure 1. Coverage of the Chinese Pension System (pie chart percentages reproduced above). - Additional figures and appendices covering NSSF governance, assets of demographic buffers, NSSF asset allocations and mandates, outsourcing trends, investment performance, EA system market evolution, and regulatory requirements (titles listed in the source). *Source: Excerpt from "1. Key Design Features of the Chinese Pension System" (IMF working paper). This overlay uses only the content provided in the source excerpt.* ### 24.2 percent based on 15 ### _wp09246 - 24.2 percent based on 15 ### Pension product description (opening notes) - 24.2 percent based on 15 years contributions - Defined contributions. - Taxed - Payment method: lump-sum or phased withdrawal. - Not regulated. - Source: Adapted from Banco Bilbao Vizcaya Argentaria (BBVA) (2008 and 2009), Ebbers et al. (2008), Hu et al. (2007), Klynveld Peat Marwick Goerdeler (KPMG) (2008), Salditt et al. (2008), and Whitehouse (2006) and MOHRSS. - Note on tax relief: The Chinese Ministry of Finance and State Taxation Administration decided to raise the tax relief benefit for EA plans from 4 percent to 5 percent in June 2009. ### Benefit formula and technical definitions - 1/ 1A benefit = 1 percent * number of years of contribution * pension base; Pension base = (average local salary of last year + indexed salary) ÷2; Indexed salary = last year salary of the person before retirement * average index of the person over his career; Average index of the person = (Xn/Cn-1+......+X3/C2+X2/C1+X1/C0÷N; Xn: salary of the person in year n; Cn-1: average local salary in year n-1; N: total number of years of contribution. - 2/ for those large State-Owned Enterprises (SOEs) under supervision of the State owned Assets Supervision and Administration Commission (SASAC), the level of contribution rate need approval from the latter. - 10: MOLSS was renamed MOHRSS in 2008. ### Scope and focus of the paper - The rest of this paper focuses on the first two pillars only. No tax relief is foreseen for the long-term complementary individual pension plans and, at present, Pillar III is merely a residual category for long-term savings. - 11: Notwithstanding this, the government of Shanghai province is studying the possibility of providing tax relief to life and voluntary pension products sold by insurance companies. Local bureaus of various related ministries have been involved in this study. - 12: See Appendix 1 for a summary of the key design parameters of the Basic Old Age Insurance system. ### III. The Basic Old Age Insurance System — structure and reforms - Two tiers introduced in 1997 (State Council Document 26): “Social Pooling” (Tier I) and “Individual Accounts” (Tier II). - Tier I: mandatory, defined benefit, pooling at different government levels, unfunded, pay-as-you-go. - Tier II: mandatory, defined contribution, individual accounts. - Many local governments borrowed monies from Tier II to fund current Tier I pension expenditures. - Reforms to strengthen fund management: - Centralizing management toward provincial level by end of 2006; separating management of Tier I and Tier II. - Increasing funding in individual accounts; Tier II remains partially unfunded with no explicit recognition of past liabilities (“legacy costs”). - At least 13 provinces committed to fully fund Tier II and prohibited “leakages” of Tier II to Tier I. - Investment rules and practices: - Pension funds can only be invested in bank deposits and government bonds; vast majority reported deposited in banking system. - Variation across provinces: some place most funds in current accounts (low interest), others place >75 percent in term deposits; some roll over 1-year deposits. - PBC document: commercial banks should remunerate these deposits with an interest rate equal to that of the three month deposit account. - Fund management responsibilities at province level shared between local social security bureau and local financial bureau; shift from social security offices to treasury offices in many provinces. - Bank selection and governance: - No clear standards for bank selection in most provinces; exposes process to undue political influence. - Guangdong is cited as a province with clear standards for bank selection and performance evaluation. ### Reforms and pilots achieving separation/centralization - 2000: State Council Document 42 — Liaoning Pilot fully separated Tier I and Tier II accounts to ensure full funding of future accrued rights in individual accounts (no attempt to fund past diverted rights). - 13: Hence, this reform is also known as the “Liaoning Pilot.” - 15: Legacy cost issue not satisfactorily addressed by policymakers. - 2004: Liaoning Pilot extended to Jilin and Heilongjiang via State Council Documents 35 and 36; due to weak tax base, individual accounts in these provinces credited only with a notional flow of contributions. - 2005: State Council Document 38 replaced 1997 provisions; at least thirteen provinces now committed to fully fund individual accounts and separate them from social pooling. - Funding level and speed decided at province level subject to central government approval; central subsidies vary by province. - Central government typically covers 75 percent of the flow of contributions based on locally relevant definition of covered wage up to a maximum of 3.75 percent of the locally relevant definition of covered wage for some provinces; no central subsidies for wealthy provinces such as Shanghai, Zhejiang and Jiangsu. - Provincial/local subsidies to facilitate reform: - For Shanghai, Zhejiang and Jiangsu, level depends on available fiscal resources. - For other provinces, local governments normally grant 25 percent of the funds toward the highest target level with subsidies. - These subsidies, together with individual contributions, are invested by provincial social security agencies. - Centralization of fund management: - Central government’s fiscal transfers to nine of the thirteen provinces are managed by the NSSF on behalf of the provinces for at least five years and for a guaranteed rate of return; provinces do not pay NSSF management fee (covered by MOF budget). - By 2008, a total of 17 provinces have achieved centralized asset management at the provincial level; government aims to complete centralization at provincial level for whole nation by end of 2009. - Limits to full separation: - 18: Full separation cannot be achieved to the extent that the decumulation phase between the two tiers continues to be connected; misuse of funds occurred in Shanghai due to unclear regulations and enforcement failures. ### Pension asset totals and provincial management - Pension assets (combined social pooling and individual accounts) are the largest pool of pension funds in the Chinese pension system. - Official figures for 2008: - Y 993.1 billion in total assets at the national level. - Approximately Y 120 billion accumulated in individual accounts in the thirteen provinces committed to full funding. - Of these, Y 33 billion in 2008 were managed by NSSF. - The other Y 960.4 billion was managed at the provincial, city or county level. - Data on accumulated individual accounts in provinces other than those thirteen provinces are not publicly available. ### IV. The National Social Security Fund (NSSF) — mandate and role - Established in 2000 as a national long-term strategic reserve fund to meet future pension obligations of the Basic Old Age Insurance system. - Dual role: - Demographic buffer to absorb peak of Chinese demographic transition around 2030. - Fund of last resort for pension expenditures in the Basic Old Age Insurance system. - NSSF expectations and liabilities: - Given demographics and potential coverage gains, NSSF is not expected to make any major expenditure in the medium term. - 20: NSSF reports that expenditures are not foreseen for the next 15–20 years until 2025–30. - No reliable projections exist for Chinese pension system liabilities — raises concerns about adequacy of NSSF resources and implies fund management driven by maximizing returns without incurring undue risk rather than matching expected liability cash flows. ### Benchmarking and international context - NSSF benchmarked against CPPIB (Canada), NPFG (Norway), NPRF (Ireland), and NZSF (New Zealand) — considered international best practices and aligned with ISSA, OECD, IWG-SWF principles. - International trend: countries (Japan, Korea, Sweden, Australia, Canada, France, Ireland, New Zealand, Norway) have modernized public pension funds or created new public pension reserves and relaxed investment restrictions. ### A. Institutional structure and fund governance of NSSF - NSSF organizational governance: - National Council (board) with chairman, three vice chairmen, and 17 directors — total 21 members. - Three committees: Investment Committee, Risk Management Committee, Expert Appraisal Committee. - Nine permanent NSSF management departments. - 22: According to the State Council document in 2000, the National Council should have 16 members. - Board appointments and composition: - All 21 members appointed by and reporting to the State Council. - Directors are ex-officio civil servants representing stakeholders including PBC, MOHRSS, MOF, Ministry of Civil Affairs, Trade Unions, Chinese Academy of Social Sciences, CPPCC, China Enterprise Federation, Zhi Gong Party, and various provinces (including vice governors of Liaoning, Shanxi, Sichuan). - No fit and proper tests apply to appointment of directors; appointment procedure not vetted by independent body or arm’s-length process. - Appointments are for a 3-year period and renewable; appointments are not staggered. - 24: See MOF and MOLSS (2001). MOLSS was recently renamed MOHRSS. - Responsibilities of the National Council (per MOF and MOLSS Decree 12 of 2001): - (i) administration of the assets of the NSSF; - (ii) formulation and implementation of the investment policy; - (iii) selection and performance evaluation of fund managers and custodians; - (iv) preparation of periodic financial statements and accounting reports; - (v) public disclosure of the financial condition of the NSSF, including assets, returns, and cash flows; - (vi) distribution of funds according to joint directives of MOF and MOHRSS; - (vii) execution of other duties assigned by the State Council. - 25: Ibidem. - Committee roles: - Investment Committee: approve strategic investment policy and oversee implementation. - Risk Management Committee: define investment and operational risk management policies (including internal controls) and oversee implementation. - Expert Appraisal Committee: majority external experts; involved in selection of external fund managers and custodians. - 26: Role of this committee explained in more detail in section on implementation of the strategic asset allocation. - Governance shortcomings and comparisons with benchmarks: - Board size (21) large relative to benchmark funds (New Zealand 6, Ireland 7, Canada 12); large boards tend to be less effective. - Unlike benchmarks, NSSF appointments are not staggered and lack an independent nominating process; benchmarks used nominating committees and required expertise-based appointments. - NSSF lacks a publicly disclosed code of ethics and good conduct and conflict of interest rules for senior management and directors; no explicit governance committee to monitor application of such a code. - NSSF’s institutional form more similar to Norway’s NPFG (government account managed by central bank) than to CPPIB, NPRF, or NZSF; however, unlike Norway, there is no fiscal rule preventing Chinese government use of NSSF funds at its discretion. - 27: Benchmark boards operate with independence from government in investment decisions and full public accountability; they have corporate governance and conflict of interest guidelines, audit committees, appointed auditors and global custodians, and use external advisers. - 28: Norway’s 4 percent fiscal rule limits non-oil government budget deficit to 4 percent of value of accumulated fund (expected real rate of return) to insulate fund from political interference. ### B. Sources of funds for the NSSF - Primary sources: - Central government budget allocations. - Proceeds from lottery licenses. - Investment income. - SOE contributions: state-owned enterprises must contribute 10 percent of their IPO proceeds to the NSSF at time of public offerings (policy originally applied to domestic and international offerings, suspended for domestic offerings in June 2002). Since June 2009, new regulation requires state owned enterprises which sold shares after 2005 structural reform, or plan to in future, to transfer shares in amount equivalent to 10 percent of their IPOs to the NSSF. Applies to 131 state-controlled companies listed on domestic exchanges. - Lock-up and voting constraints: lock-up period of three years during which NSSF cannot sell received shares; IPO shares do not give voting rights to avoid transforming NSSF into a manager of public companies. - 29: Lock-up and voting note; 30: Source: MOF. - Historical variation in annual transfers and changing concentration of funding sources: - The concentration decreased as share of proceeds from IPOs and lotteries increased from 20 percent in 2001 to >50 percent in 2006. - 2007: Large increase in realized and unrealized gains from equity portfolio following strong domestic equity market performance. - Table 2 (as reported in source) - Table 2. National Social Security Fund—Source of Funds - Unit 2000 2001 2002 2003 2004 2004 2006 2007 Central government Percent 100.078.269.6...44.324.6 14.16.4 SOE IPOs Percent ...20.220.14.812.220.4 57.38.0 Lotteries (and other) Percent ...5.554.215.511.3 10.45.3 Investment income 1/ Percent ...1.74.841.028.043.7 11.770.7 Individual accounts Percent .................. 6.59.7 Total net flows Y billon 20.060.543.78.338.640.7 71.0156.9 Total assets Y billion 20.080.5124.2132.5171.1211.8 282.8439.7 Sources: NSSF annual reports (cash flow statements), various years. 1/ Calculated as residual. - International differences in funding mechanisms noted: - Norway: transfers net oil revenues to NPFG. - Canada (CPPIB): receives cash flows not required for current pensions and retains investment income; also received proceeds of redeemed government bonds held before 1998. - Ireland (NPRF): funded with annual government contributions equal to 1 percent of Gross National [text truncated in source]. ### Key statistics and timeframes (extracted) - 24.2 percent based on 15 years contributions. - Tax relief for EA plans raised from 4 percent to 5 percent in June 2009. - MOLSS renamed MOHRSS in 2008. - At least 13 provinces committed to fully fund Tier II. - By 2008: 17 provinces achieved centralized asset management at provincial level; government aims complete centralization by end of 2009. - Pension assets 2008: Y 993.1 billion total assets at national level. - Approximately Y 120 billion accumulated in individual accounts in thirteen provinces; Y 33 billion in 2008 managed by NSSF; Y 960.4 billion managed at provincial, city or county level. - NSSF reports expenditures not foreseen for next 15–20 years until 2025–30. - NSSF National Council size: 21 members (chairman, three vice chairmen, 17 directors). - NSSF IPO policy applies to 131 state-controlled companies. - Table 2 reported figures include Total net flows Y billon 20.0, 60.5, 43.7, 8.3, 38.6, 40.7, 71.0, 156.9 (by year sequence in table). - Table 2 reported Total assets Y billion 20.0, 80.5, 124.2, 132.5, 171.1, 211.8, 282.8, 439.7 (by year sequence in table). *Source: _wp09246 - 24.2 percent based on 15 (IMF PDF chapter/section).* ### Appendix 2 reports more details on the use of proceeds from IPOs as a way to transfer assets to the NSSF and as a ### 2007. In particular, nominal yields in 2007 were around 31 percent of average assets. This is ### _wp09246 - 2007. In particular, nominal yields in 2007 were around 31 percent of average assets. This is ### Investment performance and portfolio composition (NSSF assets managed internally) - Nominal yields in 2007 were around 31 percent of average assets. - The large nominal yield in 2007 is mainly due to the sharp increase in equity prices in 2007 in both direct and index linked holdings. - The fund experienced a loss of Y 34 billion in 2008, which, in absolute terms, was twice as large as the interest and dividend income earned by the fund. - Reflecting overall rebalancing, in 2007: - Investment income from fixed income instruments and bank deposits represented around 24 percent of total returns generated from internal asset management. - Investment return generated from equity, index products and trust investments represented around 75 percent. - The 2008 annual report does not disclose performance of assets managed in-house. ### Income composition and specific income items (Table notes) - Gross operating income (Y billion): series shown for 2000–2008 in source (not fully disclosed for 2008 in the source). - Bond income Percent: 96.70 (2000), 60.55 (2001), 36.92 (2002), 24.17 (2003), 29.64 (2004), 21.80 (2005), 8.35 (2006), 4.10 (2007)... - o/w treasuries income Percent: 100.00, 99.55, 96.94, 96.98, 97.86, 97.67, 95.87, 97.12... - Deposit income Percent: 3.30, 39.45, 61.65, 75.83, 58.60, 60.05, 49.59, 19.77... - Index-based income Percent: ...... 1.43...... 1.14 7.01 38.53... - Stock price capital gains Percent: .................. 16.71 20.99 ... - Trust income Percent: .................. 1.51 2.17 ... - Asset securitization income Percent: ............... 0.04 0.42 0.14... - Equity asset income Percent: ............11.76 16.93 16.41 14.30 ... - Tax refund income 2/ Percent: ...............0.03 0.01 ... ... ### Operating expenses, accounting changes, and expense composition - Until 2007, operating expenses averaged 11 basis points of average assets. - Since 2008, NSSF adopted new enterprise accounting standards issued through Document 38 (February 15, 2006), causing reclassification that makes expenses hard to compare with previous years. - The 2008 financial statements report total expenses of Y 5.7 billion, or 1 percent of average assets. - These include: - Asset management fees: 15 percent of total expenses. - Custodian fees: 2 percent of total expenses. - Transaction fees (3 percent): 10 percent of total expenses. - Securities revaluation losses: 63 percent of total expenses. - Interest expenses: 9 percent of total expenses. - Excluding financial losses, operating expenses were Y 1.6 billion, or 0.30 percent of average assets. - Notably, wages and salaries of NSSF staff and other fixed costs are not included or reported and would increase overall operating expenses. ### Comparisons with other funds (operating cost context) - NSSF operating costs are already higher than those of some demographic buffers that follow more active strategic asset allocations and outsource assets: - NPFGs’ total operating costs over average assets (including NBIM) do not exceed 10 basis points. - External management costs for NPFGs rose to close to 30 basis points of average externally-managed assets in 2006. - Irish NPRF overall operating costs do not exceed 20 basis points of average assets; external asset management costs have been more than 15 basis points in recent years. - NZSF operating expenses rose to 88 basis points in 2008, up from 28 points in 2004. - Table excerpt (as reported): - China—NSSF b.p. av. assets ............... ... ... 30.7 - Norway—NGPF b.p. av. assets ...9.010.410.510.6 9.8 9.5n/a - New Zealand—NZSF b.p. av. assets ...28.347.5 71.1 96.2 87.7 - Ireland—NPRF b.p. av. assets 4.114.021.220.922.7 20.8 18.2n/a ### Key operational and custody issues - Expected trend: overall operating costs of NSSF likely to grow with increasing use of external asset managers, a shift toward more aggressive investments, and more active strategic asset allocation. - Importance of reducing fixed costs (wages of management agency and custodian fees). - NSSF tends to hire asset manager–specific custodians while a global custodian would be preferable. - Custodian roles: ensure segregation and safekeeping of assets, promote transparency, apply consistent valuation and accounting, assist in transaction settlement, collection of income, claiming tax refunds, treasury cash sweeps, fund reporting, securities lending, risk management, hedge fund servicing, administration and compliance. - Advantages of a global custodian: choice of service provider, system compatibility for performance evaluation, economies of scale. - Concerns about independence: no provisions requiring custodians to be independent of NSSF; NSSF has shares in some custodians. ### Governance, disclosure, and selection practices - Implementation of strategic asset allocation reflects the young age of the fund; selection of external asset managers and custodians done through a reasonably transparent process and stringent selection criteria in many respects. - Weaknesses and risks: - Lack of published details for amendments to the strategic asset allocation contained in MOLSS and MOF Decree No. 12 of December 2001. - Selection of specific venture capital funds lacks clearly disclosed guidelines and criteria. Examples: - NSSF invested in Zhongbi and Bohai in 2004 and 2006 with special approval of the State Council. - After more general approval in 2008, NSSF invested around Y 2 billion in another 2 companies without disclosed process or criteria. - Provisions regarding minimum qualifications for external asset managers and custodians, and the process for their selection, are only approximately defined. - Difficulty in defining minimum qualification and experience standards for staff working for custodians without further clarification. - Level of publicity and disclosure supporting selection decisions left to NSSF discretion, exposing procurement to potential undue political influence. - Disclosure standards: - Interim Measures on the Administration of the Investment of the NSSF require the National Council for the NSSF to disclose only its financial statements. - State Council issued a new government information disclosure regulation in 2007, effective May 2008. - NSSF’s recently revised website reflects effort to meet the new regulation; greater publicity and disclosure of information are expected in the future. ### Final considerations and recommendations (implicit in text) - Strengthen and publish detailed investment rules, selection criteria, and processes for venture capital, private equity, external asset managers, and custodians before broadening asset allocation. - Clarify and tighten provisions on minimum qualifications and independence requirements for custodians. - Consider appointing a global custodian to exploit economies of scale and improve transparency and system compatibility. - Contain fixed operating costs (wages, custodian fees) as NSSF moves toward more aggressive external management. ### Enterprise Annuity (EA) system — size and performance (summary) - EA system background: - Phase 1 (1990s–2004): Encouragement of complementary pension insurance schemes; group insurance DB products were important. - Phase 2 (2004 onwards): MOHRSS Decrees No 20 and No 23 consolidated EA market and strengthened regulation and supervision; legacy schemes needed redesign to be entitled to tax relief benefits. - Growth and scale: - End of first phase (2004): 22,463 firms, ~7 million workers, accumulated assets ~Y 50 billion, or 0.3 percent of GDP. - 2008: Number of firms ~33,000; coverage level 10.4 million workers. - Assets under management reached Y 191.1 billion in 2008, or 0.6 percent of GDP. - Table excerpt (Evolution of EA system market): - Enterprises: 116,274 (1991–2000), 22,463 (2001–2004), 23,000 (2005), 24,000 (2006), 32,000 (2007), 33,000 (2008) - No of participants Y 1,000,000: 5.6 (1991–2000), 7.0 (2001–2004), 9.2 (2005), 9.6 (2006), 9.3 (2007), 10.4 (2008) - Assets Y 1,000,000,000: 19.1 (1991–2000), 49.3 (2001–2004), 68.0 (2005), 91.0 (2006), 152.0 (2007), 191.1 (2008) - Assets/GDP Percent: ...0.3 0.4 0.4 0.6 0.6 - Potential for future growth is considerable given low current coverage, though high national savings rates and complex governance for corporate trustee EA plans may slow growth. - EA performance (2006–2008, Table 16): - Nominal return 1/ Percent: 9.6 (2006), 24.5 (2007), -1.8 (2008), Average 10.8 - Inflation Percent: 1.5 (2006), 4.8 (2007), 5.9 (2008), Average 4.1 - Real return 1/ Percent: 8.1 (2006), 19.7 (2007), -7.7 (2008), Average 6.7 - Operational fees 2/: N/A (MOHRSS does not publish operational fees) - Note: MOHRSS does not publish risk adjusted figures. *Source: Excerpts from NSSF and MOHRSS information and related tables as provided in the content unit.* ### 24.5 percent in 2007. Real yields are impressive: 8.1 and 19.7 percent, respectively. In contrast, ### _wp09246 - 24.5 percent in 2007. Real yields are impressive: 8.1 and 19.7 percent, respectively. In contrast, ### Performance and returns - EA nominal and real returns in 2007: 24.5 percent in 2007. Real yields are impressive: 8.1 and 19.7 percent, respectively. - EA nominal and real returns in 2008: -1.8 and -7.7 percent, respectively, mainly due to the global financial crisis that also affected China. ### OECD comparison and 2008 market downturn - Private pensions in OECD countries reported US$4 trillion losses in asset values in the first 10 months of 2008. - Pension funds in OECD countries experienced a negative return of nearly 20 percent in nominal terms (22 percent in real terms) on average since the beginning of the year. - Most of the loss accounted for by the United States: US$2.2 trillion out of the total OECD loss of US$3.3 trillion. - Absolute second largest losses: United Kingdom US$0.3 trillion, Australia US$0.2 trillion. - Including other private pension assets (e.g., IRAs), total loss increases to about US$5 trillion. - Figure 3 (January–October 2008) shows OECD weighted average rates of return with nominal and real series (visual not included here). - Source for OECD data: OECD Global Pension Statistics (data draw on official data from specified delegates and OECD estimates). ### Reasons for relatively satisfactory EA performance in China in 2008 - Attributed to conservative EA investment limits on risky assets (equities, foreign markets, housing) and conservative investment strategies by EA asset managers. - Actual asset allocation in the EA system is not disclosed by MOHRSS; requested information reported as confidential. ### Governance framework in the Enterprise Annuity (EA) system - Key regulatory framework: Decrees 20 (Interim Measures for the EA System) and 23 (Interim Measures for Management of Pension Funds). - Basic requirements for sponsors to establish an EA plan: - (i) participate in the Basic Old Age insurance system and fulfill statutory contribution; - (ii) be solvent; - (iii) have established a mechanism for collective bargaining. - Trust model followed with two differences: - Internal structure: “pension council” with trustees appointed by employers and employees. - External structure: “corporate trustee” with financial institutions acting as professional, commercial trustees. - Pension council governance: tripartite board; employee representatives should comprise at least one-third of the board; professionals allowed but not required; no fit and proper tests, appointment/dismissal criteria, code of conduct, or conflict of interest rules specified. - Decree 23 envisages four players: (i) corporate trustee (ultimate fiduciary duties), (ii) custodian (safe keeping), (iii) account administrator (member records), (iv) asset management company (investment). ### Licenses and market structure - EA licenses granted since 2004, granted twice: 2005 and 2007. - License initially granted by MOHRSS for 3 years; renewal required towards end of mandate. - Total of 58 licenses: 11 trustees, 16 account keepers, 10 custodians, 21 asset managers. - In 2007, three licenses were withdrawn by MOHRSS (one trustee and two account administrators). - Only domestic Chinese firms or joint-ventures licensed so far, despite provisions allowing foreign companies registered in China to apply. - Three financial groups have obtained all four licenses: Industrial and Commercial Bank of China (ICBC), China Merchants Bank (CMB), China International Trust and Investment Company (CITIC) Group — de facto major players. ### Minimum capital requirements (as specified in Table 17 and text) - Corporate trustees: minimum capital adequacy requirement set at Y 100 million; minimum net assets at Y 150 million at all times. - Account administrators: minimum capital requirement is Y 50 million. - Custodians: required to register at least Y 5 billion in net assets; commercial banks serving as custodians should have a dedicated trustee department. - Fund managers (comprehensive securities companies): registered capital and net assets should be at least Y 1 billion at all times. - Fund manager for professional trustees: minimum capital requirement is Y 100 million for both registered capital and all-time net assets. - Note in table: 1/ Lower limit in case of professional trustees only. ### Role of corporate trustees and market dynamics - Decrees state trustee is apex and has ultimate responsibility for overall plan performance. - In practice, trustee often the weakest player due to: - Sponsoring firm typically chooses all four players (trustee is a service provider to sponsor and bound by contractual mandate). - Custodians often largest state-owned banks with strong reputations and trust. - Administration fees for trustees capped at 0.2 percent of net assets; market competition drives average fees typically less than 0.1 percent of net assets, limiting trustee marketability. - Custodian and asset manager, or custodian and account administrator, often team up to obtain mandates and then find a trustee to complete governance structure; trustee de facto selected and controlled by sponsor and dominant players. - Authorities debate merging trustee, account administrator and asset manager functions (as in some Latin American jurisdictions) to consolidate market and strengthen corporate trustees indirectly. ### Audits, whistle blowing, and supervisory weaknesses - Decree 23 envisages whistle blowing responsibilities, especially for custodian: custodian must refuse to execute orders breaching law/rules/contract, inform investment manager, trustee, and regulator in time. - External audit provisions weaker: - External audits required only for annual financial statements prepared by trustees. - Activities of asset managers or plan administrators appear not to be audited as part of MOHRSS supervisory functions. - External auditors not required to report breaches to trustee or MOHRSS. - EA plans not required to establish an internal audit function. - When mandates of account administrators, custodians, or asset managers are terminated, financial reports must be audited and audit report submitted to trustee and filed with MOHRSS/local bureau; similar for terminated trustee mandates. - Identified weaknesses: - No clear distinction between governing responsibilities/fiduciary duties of trustees and internal audit function. - Audit provisions do not distinguish between accounting, financial and actuarial audits; unclear whether MOHRSS can establish minimum audit standards. - Trustees and custodians audited periodically; account administrators and asset managers not required to be audited externally. - Whistle blowing provisions weak in scope and follow-up process by supervisor. - Recommendation: authorities will need to strengthen internal and external audit provisions and establish a consistent whistle blowing framework for relevant parties to leverage MOHRSS supervisory function. ### Investment rules and risk profile - Permitted investments: - High liquidity money market instruments (current deposits, central bank notes, short-term bond repos) with a minimum of 20 percent of net assets. - Term deposits, contractual deposits, government/financial/corporate bonds, convertible bonds and securities funds not exceeding 50 percent of net assets. Among these, government bonds cannot represent less than 20 percent of net assets. - Investment in equities, investment-linked insurance products and equity funds limited to a maximum of 30 percent of net assets. Among these, investment in equities cannot exceed 20 percent of net assets. - Concentration limits for funds managed by a single investment manager: - Investments in any given corporate stock or single security investment fund cannot exceed the minimum of 5 percent of the issuer’s equity or 10 percent of the fund shares. - Prohibited investments: hedge funds, property, infrastructure, private equity and foreign markets. - Observations: - Current regulation is very conservative, based on holdings and concentration quantitative limits aimed mainly at controlling market risk. - No credit quantitative limits prescribed to control credit and liquidity risk. - Conservative rules helped shield EA funds from 2008 downturn. - Regulatory framework needs to be made more sophisticated and liberal over time; quantitative restrictions could be liberalized and complemented by a more prudent person approach. - Tradeoff to assess: encouraging higher long term expected performance (risk-adjusted) versus inevitable increase in administrative fees. - MOHRSS is revising Decree 23; the consultation draft includes a gradual liberalization of quantitative limits. ### Conclusions — system-wide observations and key statistics - The Chinese pension system is highly fragmented with separate regulatory and supervisory frameworks for Basic Old Age Insurance, National Social Security Fund (NSSF), and Enterprise Annuity (EA). - Disclosure: - Basic Old Age Insurance: as of end of 2008, official figures report Y 993.1 billion in total assets (4.2 percent of GDP) in combined social pooling and individual accounts at national level. Approximately Y 120 billion accumulated in individual accounts in 13 provinces working to fully fund the system, of which Y 33 billion managed by NSSF. Y 961.4 billion managed at provincial or county level. - NSSF: accumulated assets amounting to Y 562 billion (at market price), or 2 percent of GDP at end of 2008. In-house managed assets around 50 percent of total assets (only data up to 2007), concentrated in deposits and government debt, exposed to credit risk from banks, three of which serve as domestic custodians. - EA system: accumulated around Y 191.1 billion, or 0.6 percent of GDP. - Key systemic issues and policy concerns for EA system: - Weak Legal Framework: different regulatory treatment of internal versus outsourced corporate trustees may allow regulatory arbitrage. - Weak Standards for Trustees: minimum standards for internal trustees need strengthening; professional (non-representative) trustees should be required rather than optional. - Lack of Independence of Service Providers: lack of diversification in Chinese financial sector undermines independence among service providers; corporate trustee often captured by custodian. - Weak Governance Framework: external auditors not fully used as whistle blowers; asset managers and account administrators not required to be audited regularly; MOHRSS needs increased internal capacity to negotiate minimum audit standards. - Conservative Investment Rules: currently too conservative and potentially sub-optimal long term; gradual liberalization recommended as markets and regulatory capacity improve. - Broader NSSF considerations: - NSSF moving from conservative in-house investments to increased use of external managers and diversification into alternative assets and local IPOs. - With increased activism, governance must be strengthened to shield from political influence; risk management skills must be developed; operating costs expected to rise and need containment. *Source: _wp09246 (excerpt provided).* ### REFERENCES ### _wp09246 - REFERENCES ### References (selected) - Ambachtseer, Keith P., 2001, “A Framework for Public Pension Fund Management,” Paper presented at the 2001 World Bank Public Pension Fund Management conference. - BBVA, 2008, Pension trends: Latest Development of China’s Pension Market., http://serviciodeestudios.bbva.com/KETD/ketd/ing/nav/tematicas/pensiones/prcont.jsp - BBVA, 2009, Pension trends: China's current pension system at a glance. http://serviciodeestudios.bbva.com/KETD/ketd/ing/nav/tematicas/pensiones/prcont.jsp. - CN Pension, 2009, Performance of the EA market in China and its evaluation methods., http://www.cnpension.net/index_lm/2009-05-15/news1242347992d877724.html - Ebbers, H. 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World Bank Publication. - World Bank, 1994, Averting the old age crisis, Oxford University Press. - World Bank, 2007, Urban di bao in China: building on success, World Bank report. - Zheng, Bingwen, 2009, Reforming complementary enterprise pensions: overview, assessment and prospect,” in Deng, Dasong and Liu, Changping, eds., China’s Economic Reform in the Past 30 Year: Overview, Assessment and Prospect, China Social Science Publishing House. ### Appendix I. Key Design Parameters of the Basic Old Age Insurance System - Contributions: - First tier initially set in State Council Document 26 at a flat 20 percent of employee’s contributory wage and the employer is fully responsible for their payment. - Actual first-tier rates vary by province between 17 percent and 30 percent of employee’s wage and between a maximum of 300 percent of local average wage and a minimum of 60 percent of that (Salditt et al. (2008)). - Second tier initially set at 11 percent of employee’s contributory wage: employees contribute 4 percent of wages with 1 percent increments every two years after 1997 to reach the ceiling of 8 percent; employers contribute the complement to 11 percent with a corresponding decreasing schedule from 8 percent to a floor of 3 percent. - 2000 Liaoning Pilot: introduced a 10 percent rate to the social pooling for self employed individuals and abolished employer’s contributions to the individual accounts; employees contribute only to the second tier at a rate set at 8 percent of individual’s contributory wage. - 2004 Jilin and Heilongjang pilots (Documents 35 and 36): individual contributions reduced from 11 to 8 percent with the full 8 percent credited to individual accounts separate from social pooling. - Pilots in thirteen provinces generally maintain contribution levels for individual accounts at 8 percent with full responsibility of the employee and separation from social pooling. - Note: some provinces reduced contribution rates to 3 or 5 percent due to fiscal constraints, although eventually these should return to 8 percent. - Footnote: Contributory wage in chine includes most of the monetary income: i.e., basic salary, bonuses and other subsidies. - Benefits: - First tier benefits initially set by State Council Document 26 at 20 percent of previous year’s local average wage indexed to the local average cost of living. - Individual accounts annuity set as monthly “annuity” of 1/120 of accumulated account balances at retirement with no adjustments for early retirement. - Retirement age: 60 for men, 55 for women, and 50 for employees in hazardous categories. - Minimum contributory period: 15 years. - 2000 Liaoning Pilot: incentives to work longer introduced at a rate of 0.6 percent increase in overall benefits per additional contributory year in excess of the minimum qualification period of 15 years. - Document 38: target replacement rate from Tier I set at 35 percent of local average wage; target replacement rate from Tier II at around 24.2 percent of local average wage (Salditt et al. (2008)). - Note: the 35 percent target has been changed in the past ten years based on various Pilots in different provinces. - Note: Starting from January 1, 2006, the MOHRSS enhanced the pension benefit formula so that actual target replacement rates are now probably higher. No information is available on the extent to which target rates have increased in consequence of such adjustments. - Footnote: Individuals are not required to buy annuities from the private sector as commonly seen in mandatory DC pensions in Latin America and Eastern Europe. ### Appendix II. Reliance on Proceeds from IPO to Fund Pension Liabilities - NSSF pre-IPO participations and amounts: - June 2004: NSSF invested Y 10 billion (US$1.2 billion) in Bank of Communications (BoCom). - July 2005: BoCom listed in Hong Kong at a price 42 percent higher than that paid by the NSSF, generating an unrealized return of over Y 4 billion (US$0.5 billion). - Subsequent pre-IPO investments: Y 10 billion (US$1.2 billion) in the Bank of China (BoC) and Y 10 billion (US$1.2 billion) in the Industrial and Commercial Bank of China (ICBC). - Successful Hong Kong listings of BoC in June and ICBC in October 2006 produced immediate unrealized returns totaling approximately Y 30.5 billion (US$3.9 billion). - Assuming shares not sold as of end-October 2006, cumulative unrealized gains for NSSF in these three banks would approximate US$ 7 billion as of the end of October 2006. - At present, NSSF has allocated around Y 30 billion (US$3.8 billion) into BoC, ICBC, and BoCom and Y 10 billion in Beijing-Shanghai high-speed railway company. - State Council approved investments as strategic investor in China Development Bank and Agriculture Bank of China; investment in China Development Bank estimated to be about Y 50 billion. - Governance and risk observations: - IPO participation produced substantial (unrealized) profits given IPO prices tend to be significantly higher than pre-IPO prices. - NSSF is a passive investor and does not participate in day-to-day operational management; per relevant regulations it should not aim at control of the company. - Participation in IPOs may reflect an implicit political decision to help the NSSF boost its returns quickly. - Concerns linked to governance and related party transactions arise from ministerial nature of NSSF and its role in pre-IPO strategic investments. ### Appendix III. Regulatory and Supervisory Architecture for the Enterprise Annuity System - Institutional roles and capacity: - Main regulator/supervisor: MOHRSS (Ministry of Human Resources and Social Security). - Supervisory responsibility within MOHRSS: Department of Supervision of Social Insurance Fund (established in 1998), organized in three divisions: one for social insurance funds administered commercially (mainly EA assets), one for regulation and supervision of public pensions, and one for general administrative issues. - Capacity constraints: only 3–4 staff directly working on EA issues within MOHRSS (including a Deputy Director General and 2–3 staff from the EA division). - MOHRSS branches at provincial, city and county levels bring the estimated number of individuals involved in supervision of EA system and public pensions to about 100. - Only 11 of the 31 provinces have established specialized divisions for pension supervision; in other cases supervision activities are mingled with other activities. - MOHRSS budget is fully funded by the central budget; various fees charged to supervised entities are far from sufficient to cover operational costs. - Supervisory methods and systems: - MOHRSS uses both on-site and off-site supervision. On-site supervision includes routine visits, ad-hoc inspections and supervision of fund frauds; ad-hoc inspections and fraud inspections are handled on an ad-hoc basis. - Off-site surveillance involves analysis of annual reports, financial accounts and other requested data. Manuals for financial analysis of EA plans and a system of early warning ratios are believed not yet developed. - MOHRSS is thought to have developed a regulatory ladder to guide supervisory and regulatory response during early EA market development. - “Jinbao Project” (started in 2003) aims to introduce a networked system through national, provincial and city levels to improve monitoring; as of May 2009 the system was only partially implemented across the country. - Other regulators and coordination: - Other agencies involved: China Banking Regulatory Commission (CBRC), China Insurance Regulatory Commission (CIRC), and China Securities Regulatory Commission (CSRC). - Practical roles: banks mainly serve as custodian and administrator, insurance companies serve as trustees, and securities firms serve as asset managers. - Financial institutions must obtain two licenses to conduct EA business: one from one of the three specialized financial regulators and one from MOHRSS. - Coordination across agencies is not formalized but allegedly implemented in practice; MOHRSS plays a leading role in EA supervision while the three financial regulators provide assistance if necessary. - CIRC is principal regulator/supervisor of voluntary private pensions in the form of insurance products (pillar III). As of 2008 the five specialized pension insurance companies in China accounted for 10.8 percent of the Chinese EA market as account administrator. *Source: _wp09246 - REFERENCES* ### 24.8 percent as trustee and 19.7 percent of asset manager. ### _wp09246 - 24.8 percent as trustee and 19.7 percent of asset manager. ### Policy coordination and tax treatment for pensions - The State Taxation Administration (STA) and the Ministry of Finance (MOF) have responsibilities on pension policy and tax exemption, including decisions on whether to exempt some tax collections (e.g., tax on investment income). - Policy coordination among multiple regulatory and supervisory agencies appears problematic. - Example: In early 2008, the CIRC and the municipal government of Tianjin introduced a new trial scheme in Binhai giving tax relief for pension contributions for voluntary private pension products sold by insurance companies. A few months later, MOF and STA issued a joint statement calling off this trial, stating that it was against accounting rules. - In June 2009 the STA and MOF increased the tax benefit limit related to EA contributions, i.e. previously 4 percent of payroll to 5 percent attempting to encourage development of the EA market in China. - Footnote in source: "There have been some arguments, however, regarding whether this policy initiative would be enough to have any significant impact in the market." ### EA market composition and enterprise-related business by pension insurance company (Yuan Million in 2008) - Table 1 (as presented in source): - Taiping 3,4286,166 9,426 - Pingan 9,01712,402 14,613 - China life 5,3576,137 ... - Changjiang 2,15822,261 13,699 - Taikang 589398 2 - Total 20,54847,364 37,737 - As percent of the EA market (in percent)10.824.8 19.7 - Source cited in table: CIRC (2008). - Note from source: "1/. As shown in Appendix 4 Taiping is not currently EA account administrator, therefore, the figure might be related to business which was conducted via partnership with other EA account administrator(s)." - Additional note in source text: "Specialised pension insurance company was first established in China in 2004 largely in response to potential development of the EA market in the country. As of the time of writing the report there were five such companies in China." ### Licensing criteria for corporate trustees (per Decree No. 23 and EA regulations) - Corporate trustee licensing requirements (verbatim as listed in source): - Approved by state financial regulatory authority and registered in China. - Having registered capital no less than Y 100 million and maintaining no less than Y 150 million net assets at any time. - Having a sound corporate governance structure. - Staffed with required numbers of professionals qualified for pension fund management. - Equipped with proper business site, safety facilities and other necessary facilities for trust management of pension fund. - Having sound internal auditing system and risk control system. - No serious violation of law and regulation in recent 3 years. - Other conditions required by the State. - The source notes that both corporate trustee and pension council models are permitted, but regulatory and supervisory focus is on the corporate trustee model, potentially leaving room for regulatory arbitrage across the two models. ### Main functions and duties of the EA corporate trustee (verbatim list) - Choose, monitor, and change the record keeper, the trustee and the investment manager and other intermediary service provider. - Set down pension fund investment strategies. - Prepare pension fund management and accounting report. - Monitor corporate annuity fund management basing on the contract. - Collect contribution from the company and employee according to the contract and distribute benefits to beneficiaries. - Deal with enquiry of client and beneficiaries. Provide clients, beneficiaries and regulators with pension fund management report regularly. Report to them on a timely manner in case of significant event. - Keep records pertinent to pension fund management for at least 15 years. - Other duties defined in the contract and required by the State. ### Appendix IV — List of Enterprise Annuity Licenses by Type of Company in China as of May 2008 (summary from source) - Categories shown in source: Trustee (11), Custodian (10), Account Administrator (16), Asset Manager (21). - Cross-category examples (verbatim listings and structure preserved in source): - Insurance company (5) — Taiping Pension Insurance; Pingan Pension Insurance; Changjiang Pension Insurance; China Life Pension Insurance 1/; Taikang Pension Insurance - Bank (10) — China Ind. and Comm. Bank; Bank of China; China Construction Bank; China Communications Bank; China Merchants Bank; Agricultural Bank of China; China Minsheng Bank; Shanghai Pudong Development Bank; China Everbright Bank; China Ind. and Comm. Bank (repeats as presented) - Insurance companies (6) — China Life Insurance 2/; Taikang Life Insurance; Xinhua Life Insurance; China Pacific Life Insurance; Huatai Insurance; China Life Insurance - Fund Manager (15) — South Fund Management; Boshi Fund Management; Huaxia Fund Management; Harvest Fund Management; Fullgoal Fund Management; EFund Management; China Merchants Fund Manag.; Zhongcheng Trust; Haifutong Fund Management; Guotai Fund Management; ICBC CS Fund Management; Guangfa Fund Management; Taikang Fund Management; PICC Fund Management; Changjiang Pension Insurance (as presented) - Trust company (3) — CITIC Trust; Shanghai Pudong Dev. Bank; Zhongcheng Trust (as presented) - Securities company (2) — CITIC Securities; China Int. Capital Corp. - Source note: "1/ Texts in italic refer to licenses granted in 2007, while others to licenses granted in 2005." and "2/ Three licenses were taken back by the MOHRSS, which are indicated by texts with crossing lines." *Source: _wp09246 - 24.8 percent as trustee and 19.7 percent of asset manager. (PDF chapter/section).* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2009/_wp09246.pdf_