Executive summary: At the Central Economic Work Conference that concluded on December 18, Chinese leadership emphasized that it will propel the development of the third-pillar pension system. This indicates that developing a diversified pension finance system is now high on the country’s agenda. China’s financial regulator is also actively pushing forward the development of pension finance, encouraging the banking and insurance industries to provide more diversified pension products featuring long maturity, high safety and secured yield.
At a recent seminar, “Regulation and Innovation of Pension Finance in China” held by CF40, experts said the development of the third-pillar pension system in China is facing two major challenges: first, acceleration in population aging means that the establishment of the third-pillar pension system will need more than routine reform measures; second, both the design of and regulatory framework for pension products need to be further optimized.
In the future, policymakers can take three steps to propel the development of the commercial pension market. First, encourage innovation by introducing qualified products and financial institutions into the market; second, make arrangement to connect individual pension accounts to qualified financial products and investment management institutions; third, as pension products are quasi-public goods, existing regulatory framework should make appropriate adjustment.
I. The development of pension finance is in urgent need
The development of the third-pillar pension (private pensions) is urgently needed to make up for the weaknesses in China’s pension system. At present, the first pillar, i.e. state pension faces a shortage of funds. The second pillar of enterprise annuity has witnessed rapid development but the coverage remains rather limited, with only around 20 million employees of state-owned enterprises participating in the plans. Given the bottleneck in the development of state and enterprise pensions, it is of great significance to promote the development of the third-pillar private pensions. Internationally, the second- and third-pillar pensions have developed rapidly into the major sources of retirement income in the US, accounting for 90% of total pension as of the end of 2018. With a combination of both mandatory and flexible arrangements, the pension system in the US has engaged a variety of commercial banks, insurance companies and various asset management institutions.
The development of the third-pillar pension system as a supplement to the existing pension system of China, will not only serve enterprises by providing direct financing, but also meet the need of residents for retirement income.
From the perspective of economic and social development, pension funds as a type of long-term capital will play a significant role in addressing enterprises’ demand for direct financing, facilitating the development of the capital market and providing support to industrial upgrade. Some believe that pension funds are the ballast and foundation for the robust development of the economy. Take the US as an example. The large scale, long duration and risk appetite of pension funds have enabled them to provide continuous and stable capital to the capital market and helped support industrial upgrade.
From the perspective of residents, with the evolution of demographic structure and deepening of financial development, people’s demand for pension finance is continuously on the rise. The third pillar of the pension system can provide diversified asset allocation products and higher yield for residents without compromising safety of assets. It can also shift individual investors’ preference for housing and savings toward investment and financial products in their preparation for retirement.
II. Two challenges facing the development of the third-pillar pension system in China
At present, the development of the third pillar pension system in China is facing two major challenges.
At the institutional level, the establishment of the private pension system is a complicated process and can hardly be achieved through routine reforms considering the speed of population aging. Based on international experience, it often takes a long time to create a mature private pension system which involves individual pension accounts, qualified pension products approved by regulators, professional management institutions and a highly coordinated regulatory system. With the acceleration of population aging in China, demand for pensions is expected to rise further more. Therefore, development of the third-pillar pension system propelled by institutional reform can hardly catch up with the aging of population or satisfy the needs it generates.
At the product level, the design of pension products needs to be improved. First, pension products currently available are not much different from other products. Ambiguously defined, they hardly show any feature that embodies the underlying concept of old-age care except for long maturity; most importantly, redemption of pension products is not different from that of other wealth management products, which makes them less attractive for investors. Second, only a limited variety of pension products and strategies is available to investors. Third, current regulatory framework has not offered special explanations or provisions for pension products. As a result, pension products are managed under general laws and regulations such as those for asset management wealth management activities, as there is no separate policy arrangement for pension products.
III. Promote the development of pension finance in China in a gradual and practical manner
First, encourage innovation by introducing qualified products and professional financial institutions into the market and allow them to carry out pilot programs.
On one hand, regulators should clearly define the features of pension products. Experts at the webinar said that pension products need to be standardized in terms of naming, risk ratings and warning, information disclosure, and minimum initial investment, among others. Regulators believe it’s important to clarify the definitions and features of pension products to distinguish them from wealth management products. This will also help build better understanding with regard to whether certain regulations, such as the new asset management regulation, need to be amended for pension products.
On the other hand, encourage more financial institutions to provide pension services. In the past, insurance companies were the major player in the pension business, now banks’ wealth management subsidiaries and asset management firms are showing increasing wiliness to participate. The goal to give full play to the market in pension product design, rather than leaving this task to administrative departments.
Second, establish an effective mechanism to link individual pension accounts to qualified pension products and service providers. For pension finance to prosper, China needs to promote both the development of the private pension accounts (system reform) and that of commercial pension products (market development), and this has been the focus of discussion at the webinar. International experience shows that to build a mature commercial pension system, efforts are needed on both fronts. Therefore, personal account establishment and pension product design run parallel to rather than against each other, and they will soundly integrate as a whole.
Finally, proper adjustments should be made to the current regulatory framework considering the special nature of pension products as quasi-public goods. Some hold that pension products are at both commercial goods and quasi-public goods. As commercial goods, they need to be regulated under applicable laws such as the new asset management regulation; as quasi-public goods, they need special policy arrangements to facilitate their development. After clarifying the definition of pension products, regulators could consider rolling out special, targeted provisions for pension products, including expanding the investment scope of pension products, relaxing evaluation rules, and providing liquidity support. In the meantime, to meet the people’s need for retirement income, requirements on the safety of pension products cannot be eased.
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