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Review of Hong Kong’s MPF system: Recommendations for key reforms

PwC1

Welcome note

2020 will herald the twentieth anniversary of the launch of Hong Kong’s Mandatory Provident Fund (“MPF”) system. By international reckoning, in the context of a pension scheme, 40 years denotes the journey to maturity. Therefore, Hong Kong’s MPF system is approaching its half life to developing into a mature pension scheme.

Accordingly, we have taken this opportunity to undertake a review of the MPF system as it currently exists. We highlight that the second pillar of Hong Kong’s MPF has many strengths: its objective is clearly defined, coverage is complete, there is a high level of transparency, the scheme is flexible, contributions have immediate vesting, independent governance exists, and there is an appropriate level of regulation.

We also identify potential issues within the existing framework, and provide ideas for possible workable solutions – some already being adapted overseas – in order to ensure the MPF remains fit for purpose now and into the future. The guidance and diverse view-points shared here reflects the engagement PwC has had with multiple stakeholders in the MPF space.

The objective of this initiative is to promote discussion and debate among MPF stakeholders. The engagement builds on the relationships that PwC has in the MPF industry among trustees, asset managers, regulators, members, employers, and policy makers. It pairs industry collaboration with our own analysis and opinions.

I, and the Asset and Wealth Management team at PwC Hong Kong, thank the stakeholders who generously shared their insights on this sensitive and very important topic. We hope this piece provides clarity on the roadmap ahead to ensure the system remains sustainable and fit for purpose.

Marie-Anne Kong

Asset and Wealth Management Practice Leader

Review of Hong Kong’s MPF system: Recommendations for key reforms 2

Executive summary

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Policy makers across the world are starting to take action to help alleviate what could prove to be the largest socio-economic issue of the times; how to pay for the retirement of their citizens.

Hong Kong’s privately managed MPF system was conceived to “provide a vehicle for the working population to save for retirement and is an important part of the total savings pool for retirement needs in Hong Kong, contributing to the financial sustainability of Hong Kong’s broader retirement protection system1. ” The MPF system covers 73% of the employed population.However, many critics would argue that its shortcomings are not letting it meet its objectives.

Policy makers have begun to take steps to address some of the identified issues. An enhanced pension system is necessary to ensure that the adjustments not only lead to avoidance of risk in projected shortfalls, but result in a profitably managed fund that can fulfil its financial obligations to members. In order for members to have confidence in the pension system, more progress needs to be made. For its own good, the policy makers of Hong Kong must ensure that political sensitivities don’t stop it from aiming high.

Main shortcomings Recommendations

Large number of paper-based transactions and fragmented database leading to high administrative costs

Centralised database to increase cost efficiencies by standardizing, streamlining, and automating manual processes

One size fits all approach that may have been intended to benefit the lower income groups at the expense of the higher income groups

Segmentation by income level and tailoring to different market and income segments

High Fund Expense Ratio (FER) and low returns mean that members are not motivated to invest further and cannot have meaningful retirement protection

Use of technology such as blockchain or other digital solutions to increase cost efficiency and greater access to investment options.

Low levels of engagement of members with MPF leading to inadequate savings pool for retirement

Incentives to encourage additional savings into MPF accounts and improve engagement.

1. http://www.mpfa.org.hk/eng/mpfa/welcome/chairman/index.jsp

In order to strengthen the pension system while seeking better yields for its member base, PwC – in consultation with industry stakeholders – has conducted a review of the MPFs shortcomings, and proposed potential enhancements to the MPF. Here we share some collective guidance for undertaking necessary reforms of Hong Kong’s MPF system. Please note this is not an exhaustive list of all issues, merely the main shortcomings and associated recommendations, from our perspective:

Policy makers across the world are starting to take action to help alleviate what could prove to be the largest socio-economic issue of the times; how to pay for the retirement of their citizens.

A World Economic Forum report states that in 2015 the world pension gap stood at USD70 trillion and is expected to reach USD400 trillion by 2050, growing at an average annual rate of 5%. Of the existing shortfall, over 75% is attributed to under-funded government provided pension schemes.

Introduction

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Review of Hong Kong’s MPF system: Recommendations for key reforms 4

Several factors are contributing to this expanding pension gap, including:

To their credit, many policy makers are taking steps to either address these issues directly or are examining ways to respond to the looming pension crisis. These include:

2. According to World Development Indicators of the World Bank, by 2050, the share of the elderly population in China is projected to be 27%, in Japan 36%, in Germany 32%, in France 26%, in UK 24%, in US 22% and in India 13%.

3. DB pension schemes are employer sponsored retirement funds where both employees and employers make contributions. Although the employer bears the investment and longevity risk. Source: PwC

• Changing employment habits and employment prospects for younger generations. There is a high percentage of workers in the informal sector and freelance economy which leaves them with limited access to retirement savings accounts;

• A growing middle-class which, in addition to increased living standards, will have increased demand and expectations for higher levels of retirement income;

• An overall ageing of the population – particularly among developed economies2, which will lead to increased dependency ratios and strains on pension schemes;

• A move away from final salary defined benefit3 (“DB”) pension schemes, where members receive a fixed pay-out funded from a central pot over the course of their retirement, to defined contribution (“DC”) schemes, where workers pay a portion of their earnings into a privately managed investment scheme; and

Changing indexation of pension benefits, i.e. Britain’s “triple-lock” of increasing pensions by the higher of; the CPI, average earnings increases, or 2.5%, to less generous uprating mechanisms

• A prolonged low-interest rate environment which has made the funding of private and public pension systems more challenging as the need for higher returns cannot supersede the need for stable investments.

Raising the age at which workers can retire and begin drawing their pensions in ordinary circumstances. The average retirement age among OECD countries was 64 in 2014 and this is expected to increase to 65.5 by 2060

Increasing taxation – to fund pension schemes – and contribution rates, especially in DB schemes, in order to help offset the increasing liabilities of such schemes

Tightening early retirement provisions

Increasing incentives to work longer

Increasing coverage of voluntary private pension schemes

Incentives for new members to join voluntary pension schemes

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Hong Kong is not immune to the global trends buffeting the pension landscape. It has a rapidly ageing population with people aged 65 and above accounting for 15% of the population in 2014. This proportion is estimated to increase to 36% by 20644. The overall dependency ratio5

is projected to rise continuously from 371 in 2014, to 831 in 2064.

These trends, both local and global, will impact the resource allocation in the pension system and therefore it is imperative that adjustments are made to the pension system so that it is fit for purpose now and into the future.

HK’s pension system consists of two main retirement protection schemes. The Mandatory Provident Fund (“MPF”) is designed by the policy makers as a scheme to protect the retired and aged populations. The MPF started in 2000 and is privately managed. Occupational Retirement Schemes (“ORSO”) are retirement schemes set up voluntarily by employers to provide retirement benefits for their employees. While ORSO and MPF are both retirement protection schemes set up for employees in Hong Kong, they operate differently6.

The shortcomings of the MPF system have been the subject of recent public policy discussions in Hong Kong, therefore this review is quite timely to provide guidance on selective issues.

The objective of this review is to assess the state of Hong Kong’s privately managed pension system, focus on the MPFs shortcomings, and propose potential enhancements to the identified issues existing in the MPF.

To accomplish these objectives, we have engaged and consulted with industry stakeholders who have generously shared their insights. Here we share some collective guidance for undertaking necessary reforms of Hong Kong’s MPF system.

4. Hong Kong Population Projections 2015 - 2064, Census and Statistics Department: http://www.censtatd.gov.hk/press_release/pressReleaseDetail.jsp?charsetID=1&pressRID=3799

5. Overall Dependency ratio: The number of persons aged 15 and under and 65 and over per 1 000 persons aged 15-64.

6. http://www.mpfa.org.hk/eng/orso/overview/index.jsp

Review of Hong Kong’s MPF system: Recommendations for key reforms 6

Objective/Purpose of a pension systemA pension system is intended to ensure that retired workers do not outlive their financial resources. In any mature economy, having a credible and sustainable pension system is vital for its retired workers to maintain their standard of living.

The World Bank outlines five pillars which comprises the ideal pension system. These are:

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A non-contributory “zero pillar” to deal explicitly with poverty alleviation and to provide all elderly with a minimal level of protection. This ensures that people with low lifetime incomes are provided with basic protection in old age, including those who only participate marginally in the formal economy;

A mandatory “second pillar” that is typically a defined contribution plan with a wide set of design options including active or passive investment management, choice parameters for selecting investments and investment managers, and options for the withdrawal phase. DC plans establish a clear linkage between contributions, investment performance and benefits; support enforceable property rights; and may be supportive of financial market development;

A mandatory “first pillar” with contributions linked to earnings with the objective of replacing some portion of lifetime pre-retirement income. First pillars address, among others, the risks of individual myopia, low earnings, and inappropriate planning horizons due to the uncertainty of life expectancies, and the lack or risks of financial markets. They are typically financed on a pay-as-you-go basis and thus are, in particular, subject to demographic and political risks;

A voluntary “third-pillar” taking many forms (e.g. individual savings for retirement, disability or death; employer sponsored; defined benefit or defined contribution) but is essentially flexible and discretionary in nature; and

A non-financial “fourth pillar” which includes access to informal support (such as family support), other formal social programs (such as health care and/or housing), and other individual financial and non-financial assets (such as home ownership and reverse mortgages where available).

PENSION

0

1

2

3

4

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Sufficient payments

AttributesTaxation systems

Individual choice Balance

trade-offs Improve efficiency through information disclosure

Greater coverage

Security of investment

Low costs &high efficiency

Diversification

High adequacy of pension benefits to ensure that payments received by members on their retirement are sufficient to live off. This can be created through higher contribution rates to DC schemes

Taxation to encourage savings adequacy of pension benefits. Taxation needs to be balanced between contributions, income earned, and when withdrawing from pension schemes

Low costs and high administrative efficiency for DC schemes to ensure that returns members receive are not eroded

Better information and services to limit myopic behaviour and improve individual choice

Administrative efficiency to balance trade-off between increased flexibility and choice for workers and minimising fees

Good information disclosure and data collection to improve efficiency of pension system and assist in valuing the scheme benefits

Diversification / choice of investment products – a healthy range of products is necessary to provide flexibility to members’ over the course of their lives and as their retirement horizons change. Caution should be exercised that too many choices don’t overwhelm members

Security of investment – investments held in schemes need to be secure and protected to give members faith that pension schemes are there to benefit them and that the entities holding their money have proper incentives to act in members’ best interests

Having compulsory enrolment with limited opt-out provisions increases the penetration of pension systems which in turn provides greater coverage across a population. Auto-enrolment of new employees into a scheme and enhanced automation – having members automatically enrol can have a huge impact on take-up of pension systems

While there is no template for creating a perfect pension system, several attributes are recognised globally as contributing towards a robust pension system. The OECD believes that these attributes include:

Pension system in Hong Kong and its shortcomings

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Hong Kong’s old age/retirement protection system currently has the following 4 of the 5 pillars deemed necessary by the World Bank:

PENSION

Old Age Allowance – this acts as Hong Kong’s pillar zero, it is available to people over the age of 70 who meet residency requirements and is funded directly from Hong Kong’s central budget. This can be supplemented by the Old Age Living Allowance for those aged between 65-69 who meet residency and asset / monthly income limits.

MPF – acting as Hong Kong’s pillar two; this is a mandatory, occupational, DC retirement scheme. Established in 2000, it was brought in specifically to deal with issues relating to the growing elderly population and to enable workers and self-employed people who were outside the scope of ORSO schemes to have a retirement savings vehicle.

Private savings – being a relatively wealthy financial centre, there are a plethora of financial products available in Hong Kong to aid people in their general and retirement-specific savings goals.

While pillar 1 is missing, the second pillar, does fulfill several of the ideal traits found in a pension system. These include but are not limited to:

• Its purpose is clearly defined as being an occupational DC scheme

• Coverage extends across employees and self-employed members

• Contributions are made by both employers and employees

• Investments are secure and a compensation fund exists to reimburse members in extreme cases

Social help – given the non-financial nature of this pillar it is much more subjective to measure. The Hong Kong government does provide state housing and healthcare services and there is a strong culture of familial care and community within Hong Kong.

0

2

4

3

Review of Hong Kong’s MPF system: Recommendations for key reforms 8

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Despite the positive aspects of the MPF system, there are several shortcomings identified in PwC’s collaboration with industry players. These include:

• Fragmented member database. There are circa 3 million contributing members to the MPF with over 9 million MPF accounts. Coverage stands at 100% among employees and employers, and 68% among self-employed workers. Following the introduction of the Employee Choice Arrangement (“ECA”) in November 2012, and with full portability expected in the long-run7, members are required to register with individual service providers. The current requirement for registration with individual providers is inefficient.

• A one size fits all approach. To paraphrase the words of an industry leader, the MPF system is squarely aimed at workers in lower paid, high-turnover style roles. In other words, the MPF system has benefitted the lower income groups as there is only mandatory employer contribution and no employee contribution – this only takes effect once an employee’s monthly wages reach HKD7,100.

The higher income workers on the other hand, are disadvantaged by the MPF system. This is primarily because, for the higher income group, the contribution cap is too limiting and doesn’t lend itself to investment solutions that can build a substantial portfolio. Consequently, for middle- and higher income earners, the scheme does not play the integral role in retirement planning that it does with the MPF’s target member base8.

One of the implications of this one size fits all approach is that the lower income group, who may be less financially-literate, have too many investment options which may not be suitable for them. On the other hand, the higher income group does not have an incentive to be engaged with the MPF system as it doesn’t cater to them due to the monthly contribution cap of HKD1,500 being too limiting.

We recognise that the members are able to top up their accounts but there are no tax incentives to do this.

7. MPFA Press Release 22 December 2015

8. The MPFA has committed to a review of the minimum and maximum thresholds every four years, the last review was in 2014 and the next one is scheduled for 2018.

Review of Hong Kong’s MPF system: Recommendations for key reforms 10

One of the drivers of this one size fits all approach could be that it decreases the complexity and workload for administrators. However, a larger share of that administrative cost is being spent on the lower income group (with higher turnover) than on the higher income group. The cost of this imbalance needs to be weighed.

The benefits of increasing scheme flexibility to accommodate higher income earners would ensure that all population segments have an incentive to be engaged with the MPF system. To the credit of the MPF, recognising the emerging realities of increasing numbers of self-employed and casual members, development of full portability in the future, is underway. What this means is that reforms are being considered to give employees the freedom to transfer their contributions to a provider of their choice.

• High FER. A consistent, if not the main, grievance that MPF members have with the scheme is the high fees. A number of drivers contribute to this unfavourable ratio: high volume of paper / cheque-based transactions9, inefficient administration processes add complexity and system costs, low industry cooperation and inability to spread infrastructure costs across the system, high volume of transactions due to large number of SMEs and self-employed people raise costs. Layering of investments also raises costs.

To the credit of the policy makers, in order to address the existing high administrative costs due to voluminous paper-based transactions, discussions are underway to develop the electronic MPF (“eMPF”). The aim of the electronic infrastructure is to standardise, streamline and automate MPF scheme administration to enhance cost efficiencies10.

Data from 2012 – when the average FER was recorded at 174 basis points (bps) – indicates the following FER split: investment management – 59bps, administration expenses – 75bps, sponsor charges, trustee profit, member rebates, and other – 40bps. In essence, investment management comprised only 34% of the FER and the remainder was split between administrative and miscellaneous expenses.

The Default Investment Strategy (“DIS”)11 introduced in April 2017 represents a major reform of the MPF System and it aims to address scheme members’ concerns about the high fee levels of MPF funds through a fee cap, amongst other complaints.

• Low returns A concurrent concern of the average MPF member is the low returns. The 16-year annualised return of all MPF funds is 2.8% – compared to an annualised 5% return for the Hang Seng Index over the same period – while the average FER currently sits at 1.56%. Although the FER has come down since the MPF’s inception, fees are not at a comparable level to many of the ORSO schemes or with international standards. To make progress around the challenge of low returns, the DIS aims to provide reasonable risk adjusted returns to scheme members as they approach retirement. More progress needs to be made to increase returns so that members can have meaningful retirement protection and this would go a long way to increase public confidence in the MPF.

9. Of the 30 million annual administrative transactions processed, 65% are paper-based

10. http://www.info.gov.hk/gia/general/201706/02/P2017060100867.htm

11. http://www.mpfa.org.hk/engm/main/DIS/index.jsp

Figure 1: Comparison of fees across different pension systems

Figure 2: Comparison of pension returns and inflation rates

2012 2017

1.21%Australia

0.6%Chile

1.74%1.56%Hong Kong

1.32%Mexico

0.83%USA

6.48%Australia return rate (2000-2016)

2.78%Australia inflation rate (2000-2016)

7.59%

1.91%

Canada return rate (2000-2016)

Canada inflation rate (2000-2016)

2.80%Hong Kong return rate (2000-2016)

1.80%Hong Kong inflation rate (2000-2016)

6.78%New Zealand return rate (2007-2016)

1.90%New Zealand inflation rate (2007-2016)

Source: PwC, MPFASource: PwC, Morningstar, Canada Pension

Plan, SuperGuide, Money Facts

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• Limited options for members post-retirement. Until the announcement of the Public Annuity Scheme in 2017, MPF members would receive a lump-sum amount on retirement, a sum which would easily be the largest amount many members had ever received and were unprepared to manage responsibly over the course of their retirement.

Part of this lack of readiness is due to inadequate financial literacy and part is due to a dearth of post-retirement investment products. Increasing both, in addition to introducing the Public Annuity Scheme will be a step in the right direction, in terms of enabling lower income workers, who generally lack financial literacy, to better manage their MPF pay-out in retirement.

• Strengthening governance. A number of commentators have highlighted that there is an overlap of roles between trustees and sponsors or between managers of funds and promoters of funds. An appreciation of roles and their overlaps is necessary to understand which governance framework would be appropriate to adopt to mitigate potential conflicts of interest. The MPFA has acknowledged that there is an opportunity to introduce stronger independence measures and is seeking to implement a range of initiatives across the MPF system to promote good governance.

Policy makers have taken steps to address some of the identified issues. For example, in November 2012 the MPFA launched the ECA which enables MPF members to move accrued benefits from their MPF schemes to an MPF account of their choosing. This was intended to give MPF members greater control and autonomy. An extension of this is the ‘one member, one account’ long-term initiative which will hopefully reduce complexity and administrative costs.

• Enhancing service quality and user experience – establishing KPIs to measure customer satisfaction and service efficiency, complaint handling and scheme process automation.

And three areas of concern were recognised:

• Trustee boards lacking a high-degree of independence from sponsor groups

• Lack of proper processes and criteria for product selection, monitoring, and termination

• A rules-based compliance culture, unable to address fiduciary risks

The MPFA reiterated that trustees must act in the best interests of scheme members and their culture must change to what delivers the best value for money for scheme members.

To ensure that this ideal is prescribed to, the MPFA has a supervisory plan in place for MPF trustees over the period 2017-2019.

The supervisory plan is expected to focus on:

• Ensuring trustees have a sound risk culture, strong governance, accountability by senior management, and an increased emphasis on putting members’ interests first.

• Value for money initiatives including better fund performance, increased process automation, and enhanced cost-efficiency.

• Promoting data quality standards, engaging outside auditors to test internal control measures and effectiveness, and undertaking cybersecurity self-assessments and developing remediation plans.

The introduction of the DIS on 1 April 2017 is designed to help alleviate difficulties in fund selection, provide better retirement protection, reduce fees, and provide increased competition among MPF providers.

The policy makers have suggested to gradually increase the contribution rate from 10% to a minimum total of 15% in the long-term.

The MPFA has also been examining the governance practices of entities within the MPF industry and is increasingly aware of international standards regarding the governance of pensions, particularly around having robust governance structures, management accountability, competence, expertise, and a strong risk culture.

From 2014-2016, the regulator conducted two campaigns. One focusing on the Board of Directors (“BoDs”) of MPF trustees in order to promote better governance and risk culture. The other was thematic inspections on selected trustees and an industry-wide survey on data management and record keeping.

Four key areas were identified from the governance visits:

• Value for money – driving better fund performance and efficient organisation and administration of schemes.

• Trustee governance structure and policies – board and organisation structure, accountability, and documentation of policies.

• Risk management, internal controls, and data quality assurance – establishing an effective risk management framework, ongoing supervision of service providers by trustees, managing conflicts of interest, and ensuring data quality and standards.

Proposed solutions to enhance the MPF system

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Establish a centralised member database to reduce cost and improve efficiency - New technologies such as Blockchain enable the construction of a centralised database containing records of all MPF members on a single platform which can track transactions and can be shared across multiple service providers, including members and policy makers. As each transaction is registered in the Blockchain ledger and validated for its authenticity, a blockchain utility would make the transfer of funds from one provider to another easier, cheaper, and more

12. Note that these enhancements are not mutually exclusive.

As stated, the MPF contains several strong points which help it fulfil its role as Hong Kong’s second pillar. However, the shortcomings that have been identified will – if not addressed – threaten to derail the MPF project to such an extent that it may outlive its usefulness and not be fit for purpose in the near future.

In order to avoid such an outcome, PwC proposes the following enhancements to the system12:

RECOMMENDATION 1

12Review of Hong Kong’s MPF system: Recommendations for key reforms

reliable than the current paper-based and headcount-intensive MPF administration system. Blockchain technology can also be used to streamline the on-boarding process via a Know Your Client (“KYC”) utility which would provide MPF providers with faster and more efficient on-boarding, lower cost of operations, and greater customer satisfaction.

A centralised member database could also be linked across other areas of government in Hong Kong, namely: the Inland Revenue Department and the Immigration Department of the Government of the Hong Kong Special Administrative Region, to achieve greater synergy and efficiency.

Performance tracking

Member account balances

Performance tracking Fund rankings

Updates and correspondence

Communications between provider and member

Updates / press releases by policy makers

News articles and reporting on MPF

Members

Lower IncomeSingle/limited

investment options

Centralised Database

Policy Makers MPF ProvidersFeatures

Higher IncomeMore investment options

and promote self managementof MPF contributions

Investor education Financial planning tools

Budget calculator Investment product content

Money personality quiz Net worth calculators

Debt calculators

Investment allocationAllocate contributions across MPF products

Post Retirement Budgeting tools Post-retirement products

PwC

Additionally, the created synergy and efficiency would be especially welcome in the broader financial services sector, especially with regards to its KYC and AML components. Creating a centralised database would enable clients of financial service providers to be on-boarded with much less friction.

India has demonstrated the creation and delivery of such a database with the creation of their Aadhaar national biometric identification system across a population in excess of one billion so the implementation in Hong Kong with vastly less people and existing systems in place should be achievable.

Segmentation by income levels – This would entail splitting the system into subsets for lower and higher income earners with differing levels of contribution rates, income thresholds, limits on contributions (if any), product selection, and choice of providers.

Tailoring to different market segments would enable the MPF system to continue in its objective of ensuring lower income workers in Hong Kong enjoy sufficient retirement savings while higher income earners engage in the system as they would be able to have suitable levels of contributions and an increased range of product choices.

Solution for lower income earners

For lower income earners, a solution could involve centralising their MPF contributions into a single scheme. The scheme would be centrally managed by way of a diversified portfolio determined centrally with no specific needs for choice of investments provided to employees given the lower level of contributions. The scheme

could be tendered out to independent asset managers to promote healthy competition among asset managers, lower overall costs to members, and higher returns.

In essence, to reduce administrative costs, a simple solution for lower income earners would be to centralise the records and investments.

Reference can also be made to the features of micro-finance services. Micro-finance services include micro-insurance and micro-savings. The latter is of particular interest in this case as it represents individuals saving small amounts of money with the objective of building a larger savings fund.

There are already several micro-savings offerings available to consumers, some commercial examples being Acorns13, Digit14, and – closer to home – Tianhong’s Yu‘ebao Money Market Fund. The Yu‘ebao fund started off collecting the small amounts contained in consumers’ Alipay accounts and investing them – even today, investors can make an investment of as little as RMB 0.1. As of 30 June 2017, the Yu‘ebao fund had AUM of RMB 1.432 trillion and is the world’s largest money market fund.

There is great potential for micro-savings to transform the pensions system. Two main challenges would need to be considered in Hong Kong’s case:

• Whether a micro-pensions system could improve overall investment performance by reducing the costs incurred; and

• Defining those to whom it would apply and specifying how pension contributions would be obtained and invested.

To create the economies of scale that would make such a scheme viable, it is likely that a single provider would manage the scheme. Any changes to the way contributions are defined and made would require careful calibration to ensure that the right level of savings is being targeted.

13. The original concept was to round-up transactions on chosen bank cards to the nearest dollar. These small amounts were then accumulated within a consumer’s portfolio, which in turn was automatically invested in a pre-selected ETF. The service has since evolved and now also accepts recurring and one-off transactions. The charge for this account is currently $1 per month for balances below $5,000 and 0.25% per year for balances above $5,000.

14. This service works by moving money from a checking account into a savings account. In doing so it looks at the consumer’s spending habit and provides a “no overdraft guarantee”. The fee for this service is currently $2.99 per month irrespective of fund size.

15. As per the 2011 census income distribution excluding domestic helpers

3,200HKD

% of aggregatecontributions

12%

10%

8%

6%

4%

2%

0%

2,8002,4002,0001,6001,200

800400

0 HKD 7,100 

700 

10% 10%

6%

3%

3,000 3,000 3,000

 HKD 30,000   HKD 50,000   HKD 100,000 

Figure 3: Declining effective contribution rates for those earning above HKD 30,000

Monthly Contributions Effective Aggregate Contribution Rate (RHS)

Source: PwC

RECOMMENDATION 2

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Review of Hong Kong’s MPF system: Recommendations for key reforms 14

Using technology to enhance members’ experience

Technology is changing a wide range of features across society and finance is no exception. ‘Fintech’ is a common buzzword in the financial press and a wide range of financial institutions are developing innovative ways to incorporate technological changes into their entire operations; from front-office and client interactions, to back-office processing.

The increased implementation and adoption of technology into the investment process seems inexorable; private banks are making increased use of robo-advisory to support client interactions, crypto-currencies like Bitcoin and Eretheum are emerging as assets in their own right, the emergence of the blockchain can provide increased security and certainty across transactions, and the proliferation of mobile devices and high-speed internet are increasing avenues for distribution of an increasing range of financial products.

China provides an example of the extent that technology can be adapted into the financial space with technologically-savvy individuals across the investor spectrum conducting much of their investment transactions online, along with receiving much of their market information and analytics delivered across a multi-channel spectrum.

Using Tencent’s WeChat / 微信 as an example: investors are able to use this platform to invest in a range of funds with money being transferred directly from their linked bank-account through the distribution network.

Hong Kong is ideally positioned to reap the benefits of this technological shift with a mobile penetration rate of 95% as of June 2016, and 40% of subscribers using high-speed 4G networks – a number expected to reach 71% by 2020.

A “digital by default” model

Consumers now expect to be able to interact with and transact the services they need in real time; often via their mobile devices. The eMPF should embrace this expectation and move towards a “digital by default” model, whereby members, employers, etc... would interact with their provider purely through a digital channel. This would:

• Enhance the overall member experience and help members engage more with their MPF provider;

• Create greater transparency as the member / employer / trustee will have greater insight into how their provider is performing;

• Reduce the administrative burden and thus lower operating costs, which should be passed through to the member in a reduction of fees;

• Enable providers to “nudge” the member at appropriate times e.g. for them to consider their investment choices from time to time;

• Allow members to transact in real time e.g. investment switches, obtain fund values, draw benefits, etc...

If a single central database were created, it would allow members to have a full understanding of their retirement provision from a single source.

RECOMMENDATION 3Solution for higher income earners

For higher income earners, it is widely recognised that accumulated MPF contributions are far from sufficient to provide a decent pension. This is mainly due to the contribution cap currently imposed. While there are discussions globally as to whether a 10% contribution rate is sufficient, this argument in the context of Hong Kong is very misleading as the effective contribution rate for 16.4% of the working population15 is currently far lower than 10% due to the contribution cap – for example, someone on a monthly salary of HKD 40,000 contributing HKD 1,500 per-month is contributing 3.75% of their income (for a total contribution rate of 7.5% with their employer’s contribution), and someone earning HKD 100,000 per-month would have an effective aggregate contribution rate of 3%.

In the context of Hong Kong, for the affected population, the effective contribution rate needs to be raised to a more adequate level. More flexibility by way of investments can also be provided to this group of income earners.

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Incentives to encourage additional savings into MPF accounts and improve engagement – Having incentives, such as increasing the taxation exemption limit, would likely see more voluntary contributions. This outcome would not only help in better securing an appropriate pension for relevant earners, but will also help earners take a more active interest in their pension planning and savings.

During PwC’s consultation, there were broad support for taxation incentives for them to make voluntary contributions in order to make the MPF system meaningful for them and their retirement plans, provided the issue of low returns and high FER are fixed.

OTHERS• Reduce layering within the

MPF system – Currently, the MPF is structured so that one fund is layered into another. This normally takes the form of a constituent (feeder) fund investing into one or more Approved Pooled Investment Funds (“APIFs”) (underlying investment funds), which may then allocate assets among other APIFs; all of which adds to the cost of governance and administration. Reducing the layering of the system would assist in lowering costs throughout the system.

RECOMMENDATION 4 • Broader range of post-retirement options for members – Until 2017 when the policy makers announced the Public Annuity Scheme (“PAS”) – whereby the elderly can invest between HKD 50,000 – HKD 1million and receive an annuity in perpetuity – MPF members would simply receive their accrued MPF in a lump sum. This led to examples of the recently-retired falling victim to investing in highly-risky products sold through financial intermediaries who were incentivised by sale of certain products.

Having a greater range of post-retirement options such as low-risk high-liquidity, greater selection of annuities, or staggered capital draw-down products, would ensure assets accumulated over a members’ working life could continue to generate returns in a more stable environment.

Industry players have stated their support of the PAS but note that on its own it may not be sufficient to deal with the triple-threat people face in their retirement, namely; living longer than expected, higher inflation than planned, and lower investment returns over their retirement. While the PAS is a good start, more efforts may be required to build an effective solution.

• Revisiting product options and investment universe available to members – As of June 2017, there were 485 approved constituent funds in the MPF system and each scheme had an average of 13 funds in it. Funds were spread across the following types:

This leads to some members being paralysed by an abundance of choice and many choose not to make a decision and end up in a scheme which may not be in their best interests. Limiting the range of funds on offer, especially to the less financially-literate members, will offset this issue and lead to better long-term financial decisions being made.

158

45

36

23

Mixed assets funds

Equity funds

Bond funds

MPF conservative funds

Guaranteed funds

MMFs and others funds 9

214

Figure 4: Mix of 485 constituent funds

Source: PwC, MPFA

Review of Hong Kong’s MPF system: Recommendations for key reforms 16

International Pension Developments

• Industry consolidation to promote economies of scale – There are currently 18 MPF trustees, 36 MPF schemes, and 410 principal intermediaries – those responsible for selling, marketing, or giving advice on MPF schemes.

• Data from 2012 indicates that the top five trustees held 77% of MPF AUM, 80% of employees’ accounts, and 74% of employers’ accounts. Such a high concentration of AUM among a select few trustees indicates that MPF industry is ripe for consolidation. Such a move would enable remaining players to achieve greater economies of scale which should lower costs and improve returns to members

• New Zealand’s KiwiSaver scheme gives members the option of contributing 3%, 4%, or 8% of their gross income, giving members flexibility to adjust their contributions based on their financial circumstances. To address issues of financial literacy, several government initiatives have been adopted to promote knowledge on fund types, fee structures, and returns across the different stages of a members’ life.

Many of these proposed changes have been adapted or recognised by other jurisdictions for their second pillar schemes, and we offer below relevant examples which can be referred to for showing the way forward. Specifically,

• The Australian Superannuation contribution rate is currently at 9.5% and is being raised to 12% by 2025, specifically to increase the adequacy of the pension system. Australia also has a solid selection of post-retirement financial products available to members, including a variety of annuity products, and is examining additional product options to be made available to people once they retire.

• Within Chile’s pension system, the second pillar undertakes a biennial tender for new members. Under this arrangement, any Pension Fund Administrator (“AFP”) is able to tender for the accounts of all new members over a period of two years and the AFP with the lowest tender – based on fees charged – wins the bidding process. Existing members are able to move their accounts over to the incoming AFP if they desire.

• India has pioneered the worlds’ largest biometric database through (Aadhaar) the Unique Identification Numbers programme allocated to citizens and administered by the Unique Identification Authority of India. While the initial focus for this programme may have been to reduce benefit fraud, hopes are high among the finance industry that it will lead to universal bank account coverage among India’s 18+ population as it removes the need for additional verification – a letter from a village elder for instance. Such a programme in the context of the MPF could dramatically reduce KYC compliance and on boarding costs.

• Nigeria is adapting a raft of changes to its pension system since the implementation of the Pension Reform Act in 2014. These include:

– Raising contributions from both employers and employees to a combined minimum total of 18%;

– Increasing the investment scope of pension products by allowing investment in foreign funds;

– Providing tax exemptions for investment income to increase voluntary contributions; and

– Undertaking a pilot of micro-pensions to increase coverage and address underlying pension needs.

17 PwC

Conclusion

The shortcomings of Hong Kong’s MPF system are projected to lead to a shortfall in payments to beneficiaries. We cannot stay the course. In order for the MPF system to be able to fulfil its financial obligations to its members, enhancements need to be made – to not only lead to avoidance of risk in projected shortfalls but to transform itself into a profitably managed fund that is fit for purpose.

The main challenges of the MPF can be attributed to: (a) its design (one size fits all approach that doesn’t take into account Hong Kong’s demographics, limited contribution levels, overly complex investment funds, etc...) (b) its method of delivery (fragmented member database, largely paper based, high administrative burden, inefficient operating model) and (c) very low value for money (high fees and low returns) where MPF is not delivering a decent ROI to beneficiaries, therefore not fulfilling its purpose.

The recommendations discussed here are not exhaustive and therefore not of sufficient complexity to allow a comprehensive strategy to be formulated. This review is an initial step in prompting debate among MPF stakeholders, discussing and considering various perspectives as it has long been recognised as being instrumental to inform and improve the policy process.

In the future, a rigorous, risk/outcome based technical assessment has to be undertaken to either resolve the challenges or to manage them. We hope this analysis may serve as a basis for discourse about impacts, effectiveness, and efficiency of a reformed MPF system so that the members may be the ultimate beneficiaries.

Albert LoPartner, Financial Services Consultancy

+852 2289 1925albert.kh.lo@hk.pwc.com

Marie-Anne KongPartner, Asset and Wealth Management Practice Leader

+852 2289 2707marie-anne.kong@hk.pwc.com

Peter Sparshott Partner, Pensions Management Consultancy

+44 (0) 20 7212 4165peter.x.sparshott@uk.pwc.com

Contacts

Acknowledgement

Special thanks to Conal JW McMahon and Sanjukta Mukherjee for their contributions to the review.

This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.

© 2017 PricewaterhouseCoopers Limited. All rights reserved. PwC refers to the Hong Kong member firm, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details. HK-20170620-3-C1