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Asia - success or failure?
Provident funds governance

 

By: Mukul G Asher
Insights 42, June 2002 

Many Asian countries rely on provident funds to finance retirement. Globalisation, rapid ageing, a need for fiscal consolidation and more individualistic preferences have increased the significance of provident funds, but substantive reforms in their governance are needed to realise their full potential.

Provident funds collect mandatory contributions, with the investment risk being borne by the plan member rather than by the plan sponsor. Provident fund accounts move through two main phases (Figure 1).

In an initial accumulation phase, provident fund account balances expand as pension contributions grow with compound interest. This requires that pre-retirement withdrawals be minimised and that positive real rates of interest are earned. In a second phase, the funds accumulated over the working years are used during retirement. During this phase, longevity risk (the risk that a person may outlive his or her resources) and inflation risk (the risk that the real value of fund balances decline) must be addressed.

Norm of centralisation
In both phases, investment policies and performance are of crucial importance. As provident fund contributions are in the nature of contractual long-term savings, their investment in profitable projects can increase fund balances and enhance long-term rates of economic growth. With the exception of Hong Kong, centralised investment management by the provident fund authorities has been the norm in Asia.

The pension literature draws attention to the importance of governance issues in fund investment. These concern

responsibility for trusts, i.e. balancing risk and returns in investing the funds

tractability, i.e. ensuring that all dealings of the provident fund are undertaken in a transparent manner

accountability, i.e. establishing procedures to hold provident fund management responsible for the fund outcomes.

Managing investments
In all Asian countries, investment policies and performance are in need of substantial improvement. In high income but rapidly ageing Singapore, a government investment company whose operations are by law non-transparent and non-accountable is ultimately responsible for the investment of provident fund balances. This has led to a highly regressive large tax on provident fund wealth and to low replacement rates. In others, such as Thailand, Malaysia, and Sri Lanka, international diversification of provident fund assets is lacking. As their domestic financial and capital markets have limited depth, there is an overemphasis on government securities and other government guaranteed assets in their portfolio. Lack of independence from the political authorities has complicated the investment function in Asia.

In most developing countries, performing the core administrative tasks of provident funds satisfactorily remains a major challenge. There is also a need to review periodically the relevant laws, regulations, organisational structures and procedures, and design details of various schemes of the provident funds. Some Asian countries, such as Malaysia and Singapore, have been fairly successful in undertaking core administrative tasks effectively while others, such as India, Indonesia, and Sri Lanka, need to make substantial progress in this area.

Strategies for change
Consideration should be given to setting up national regulatory agencies for the pensions sector. Such agencies, staffed by independent-minded and competent professionals, could help ensure greater professionalism and educate stakeholders on the importance of governance issues. Strategies for changing the organisational culture of provident funds are also required. Encouraging research on pension issues within each country may assist in developing more informed and locally relevant pension programmes and strategies. Complementary reforms in the financial and capital markets and in corporate and state-owned enterprise governance are also essential.

In the final analysis, there is no substitute for creating a policy environment in which provident funds can pursue good governance.

 

 


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