The need for good “governance” is an established theme in the Asian investment universe. Fund managers demand better standards of corporate governance from the companies they invest in; asset owners demand more transparency and accountability from their managers.
While this is welcome, it is essential that Asian pension and reserve funds, which are the dominant asset owners in the region, should view governance on two levels. In addition to calling for good corporate governance of the companies in which it invests, a public pension fund - as a fiduciary, accountable to its members - must itself operate with demonstrably high standards.
Poor governance jeopardises investment returns. At the extremes, this leads to corruption and theft, such as the Shanghai scandal which made headlines throughout 2006 and 2007: officials and business people were accused of stealing 3.45 billion yuan from the city’s pension fund.
More routinely, poor governance results in inefficiency, poor decision making, higher costs and inadequate risk management.
Moreover, as pension funds seek to become “active” investors by exercising their rights as shareholders, poor internal governance greatly weakens their credibility in pushing for change.
The risk increases that companies or individuals will avoid making pension contributions to an institution which has lost public confidence.
Accountability
So, each government pension fund needs appropriate control mechanisms, and direct accountability. It can, however, be complex to establish a clear focus of liability for a public fund; because of the large and sometimes diverse number of stakeholders involved - government departments, regulators, unions - as well as the beneficiaries.
A state pension fund is in some ways an instrument of the government which is directly involved in setting it up, and may also provide its funding. For example, the New Zealand Superannuation Fund receives capital contributions of over NZ$2 billion per year from the country’s government; in China, the government last year ordered all state-owned companies which had listed since 2005
Poor governance jeopardises investment returns. It results in inefficiency, poor decision making, higher costs and inadequate risk management.
Nevertheless, safeguards are needed to ensure sufficient independence from political interference. In particular, the selection of trustees (or governors) needs special care, as they hold the main fiduciary responsibility for fund governance, including development of investment strategy, monitoring and oversight.
Identification and recruitment of qualified trustees is critical. But public fund boards are often filled with government appointees who are not finance professionals.
In South Korea, Japan and elsewhere, the fund’s governing body is part of the government. In China, the National Council for Social Security Fund is a ministerial-level agency directly under the State Council, with civil servant-level salaries and staffing arrangements.
However, the Board of the Guardians of New Zealand Superannuation was established as an independent legal entity specifically to address this issue. It is exclusively responsible for the management of the fund.
Some public pension funds in Asia are clearly expected to share the responsibility for promoting national development or economic policy objectives, especially capital market improvement.
For example, the mission statement of the Employee Provident Fund in Malaysia explicitly includes obligations to “the nation”. India’s Pension Fund Regulatory and Development Authority intends to use the New Pension Scheme to develop the country’s nascent debt capital markets. Similarly, it is expected that the Thai Government Pension Fund should play a role in strengthening financial markets.
There may be no conflicts between meeting fiduciary obligations and pursuing these national objectives - a well-functioning capital market would be desirable. However, problems may arise if fund trustees are thought to be subject to direct or indirect government influence to make particular investment decisions. There may be a perceived conflict with their responsibility to maximise fund return to beneficiaries.
In many emerging markets, regulators impose quantitative portfolio restrictions. They often force a fund to hold highly liquid but low-yielding assets; they may restrict its ability to invest overseas.
These rules are put in place to reduce investment risk. But limits on tactical asset allocation and diversification may also weaken the performance of a portfolio.
In some countries, the pension fund must buy lots of government debt. This may in effect redefine the fund’s function as providing a reserve to finance government budgets.
Buy government bonds, or else…
South Korean and Japanese pension funds were used like government development agencies (as was the case in the US earlier) for funding public works until reforms a decade ago
Asian pension funds have also been leading investors in privatisations of government assets - arousing concern about the possible conflict of interest between the government’s policy of asset redistribution and its role as the underlying sponsor of the fund.
Public funds have sometimes played prominent roles during periods when regulators have been aggressive in supporting domestic companies facing foreign takeover bids or shareholder activism.
For example, in 2006, the National Pension Fund in South Korea was involved in a high-profile proxy fight with foreign shareholders over seats on the board of KT&G, the former state tobacco monopoly. The fund strongly supported KT&G management - and that of other firms in similar battles - even though a change at board level might arguably have raised the value of the company
Transparency is crucial
While maintaining this complex series of relationships with government, on the one hand, and fund beneficiaries, on the other, trustees must seek to retain public confidence in their autonomy and the quality of their decision making.
When discussing governance, we always come back to the need for transparency - this is a crucial aspect of fund legitimacy. Comprehensive disclosure of fund policies and operations underpins the pension fund’s authority, and gives it the credibility to push for the same from the wider market.
Alexandra Tracy is the chairman of the Association for Sustainable & Responsible Investment in Asia (ASrIA)
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