LegCo Paper No. CB(1)567/96-97
(These minutes have been seen by the Administration)
Ref : CB1/HS/1/96

Subcommittee on Mandatory Provident Fund System

Minutes of Meeting held on Friday, 29 November 1996 at 10:45 a.m. in Conference Room A of the Legislative Council Building

Members present :

Members absent :

Public officers attending :

Mrs Pamela TAN: Director

Mandatory Provident Fund Office

Mr Raymond TAM: Assistant Director

Regulatory Standards

Mr Francois Roy: Senior Manager

Service Providers

Mr Jeremy Gadbury: Senior Manager Investment
Mr John Allen: Deputy Crown Solicitor
Legal Department

Clerk in attendance :

Miss Polly YEUNG

Chief Assistant Secretary (1)3

Staff in attendance :

Miss Pauline NG: Assistant Secretary General 1
Ms Connie SZETO: Senior Assistant Secretary (1)5

I Meeting with the Administration

Trustees - Professional indemnity insurance

Level of indemnity

Jurisdiction of Hong Kong courts

Suppliers of PI insurance

Investment - Investment restrictions and guidelines

II Any other business

I Meeting with the Administration

1. Members deliberated on the following subject areas outlined in the information papers provided by the Administration.

Trustees - Professional indemnity insurance

(LegCo Paper No. CB(1)345/96-97(05))

Level of indemnity

2. Members raised the following concerns on the proposed professional indemnity (PI) insurance to be taken out by the trustee to cover losses in scheme assets-

As the PI required was capped at $500 million for MPF assets exceeding $10 billion and in anticipation of the future growth in MPF funds (estimated to produce contributions of some $30 billion to $40 billion per year), the proposed level of indemnity would not be commensurate with the large size of the funds. Hence, a percentage of the fund assets instead of a monetary maximum should be used as the PI requirement.
It would be advisable to allow scheme members to take out additional insurance to better cover possible scheme losses.
The proposed maximum deductible of $100,000 was considered too low in relation to the value of fund managed by a trustee. If the deductible amount was set too low, it might have the disadvantage of resulting in a higher premium cost.
The Government should re-consider the proposal to act as the final guarantor for the MPF system in view of the low level of protection offered by the PI insurance.

3. Responding to members' concerns, the Director of Mandatory Provident Fund Office (D of MPFO) and the Assistant Director, Regulatory Standards (ADRS) made the following points-

The proposed minimum levels of PI insurance were set to strike a balance between ensuring adequate protection for scheme members against losses and keeping premium costs reasonable. The Administration had reservations on raising the levels for reasons that premium costs might increase disproportionately with higher PI levels and that the insurers might not have sufficient capacity to underwrite the amounts. Nevertheless, the Administration would consult the insurance industry on the latter's capacity if a higher level of PI was to be stipulated.

The Administration envisaged that the future MPF market would be characterised by a considerable number of service providers of different scales although initially, the majority of MPF schemes would be managed by relatively large service providers.

MPFO

Besides the PI insurance, other safeguards including trustee's capital commitment and performance guarantees in the case of individual trustees, as well as the Compensation Fund were also available to compensate scheme members for losses.
The subsidiary legislation would only prescribe the minimum level of PI insurance required. Scheme members could make arrangement with the trustee to take out extra insurance if they considered it necessary.

The maximum deductible of $100,000 was applicable to claims on the PI insurance policy and was not the deductible amount in indemnifying losses for individual scheme members. The Administration would further study the possibility of raising the amount as suggested by some members and whether this could lower the premium costs.

MPFO

When enacting the principal ordinance, the Administration had decided against acting as the final guarantor for the MPF system as this would have the adverse effect of service providers undertaking unduly high-risk investments in the belief that the Government would bail them out in case of difficulties. This would not contribute to the healthy development and effective regulation of the system.

4. In reply to an enquiry on whether the future Mandatory Provident Fund Schemes Authority (MPFSA) could direct a trustee to take out a higher level of PI insurance, the Deputy Crown Solicitor (DCS) advised that the requirement for trustees to take out PI insurance was provided for in the rule-making power of the MPFSA. The Authority could amend the rules if necessary but it was not empowered to issue ad-hoc direction to individual trustees.

5. On the protection for scheme members against losses of scheme assets, some members requested the Administration to provide an information paper summarizing the various channels available to scheme members for indemnifying their losses, as well as their priority of claims, if any, over the assets of the trust company which became insolvent.

6. In response, ADRS agreed to provide an information paper as requested. As regards protection of scheme assets in case of insolvency of the trustee, the DCS advised that if the trust company went into liquidation, its creditors would have no claim on the scheme assets which were held under trust and separated from the assets of the company.	MPFO
7. Concerning the Deputy Chairman's request for information on premium costs for different levels of PI insurance, the D of MPFO explained that the premium charged on a trustee would vary according to factors like the trustee's reputation, financial soundness and past claim records. Nevertheless, the Administration would contact the insurance industry for such information, if available.	MPFO
8. As regards information on the levels of PI for retirement schemes in overseas countries, ADRS advised that there was no statutory PI level for retirement schemes in other countries and the Administration had only made reference to the levels adopted by private schemes in the USA and UK. While there would be difficulty in procuring the required information, he would try to obtain comparable information in other countries on the amount of PI required for different levels of scheme assets.	MPFO

Jurisdiction of Hong Kong courts

9. ADRS explained that in order to provide greater protection to MPF schemes, the Administration had proposed that the PI insurance policy should be subject to the jurisdiction of Hong Kong courts. On whether the insurance policy would also be subject to Hong Kong laws, the DCS advised that this subject would have to be further examined. Nevertheless, in the event that assets of a foreign insurance company were unavailable for execution in Hong Kong, it might be necessary to take action on the reciprocal enforcement of judgment.

AGC/
MPFO

Suppliers of PI insurance

10. On the proposed credit rating of overseas PI insurers, ADRS advised that the Administration was developing the detailed proposal and would provide more information to members when available. Basically, the ratings given by international recognized credit rating agencies would form the basis of the rating system.

MPFO

Investment - Investment restrictions and guidelines

(LegCo Paper No. CB(1)401/96-97(02))

11. Members expressed the following concerns and views on the proposed restrictions and guidelines for MPF investments-

While it was proposed that investment in bonds or other debt securities issued by private corporations should meet a minimum credit rating of 'BBB', query was raised on the rationale for a much higher rating of 'AAA" for debit securities issued by the government, the central bank or an equivalent agency of a country.
Inadequate governmental control was exercised in some of the recognized stock exchanges included in Annex A of the paper. Therefore, it might not be in the interest of scheme members to allow investments in the listed shares of these markets.
Due to the high risk involved in securities lending, it might not be advisable to permit this activity in MPF investments.
More stringent control should be imposed on derivatives, especially those which involved high risks such as options.

12. The ADRS explained that the cardinal principle in imposing restrictions on MPF investments was to provide sufficient safeguards to ensure security of scheme assets while allowing flexibility for investment managers to achieve reasonable returns for scheme members. Addressing members' concerns and views, he made the following points-

Investment in government or other public bonds/debt securities which met a minimum credit rating of 'BBB' would be permitted, the same standards as private debit securities. If the bonds/debt securities which were unrated but were issued by a government, a central bank of a country or a multilateral agency which qualified for a credit rating of 'AAA', they would also be acceptable.
Investment in equities was limited to fully paid-up shares listed on the recognized stock exchanges provided in Annex A. To allow flexibility to investment managers, up to 10% of a fund's assets could be invested in listed shares in other stock markets.
The list of recognized stock exchanges was adopted from the Securities Ordinance (Cap. 333). In designating these markets, it was understood that consideration had been given to their liquidity of trading, transparency in operation and regulatory mechanism. The Occupational Retirement Schemes Ordinance also contained similar restriction on the investment of scheme funds in equities.
The stringent control on securities lending which included the provision of collateral with sufficient margin over the value of the lent security either in cash or approved bonds/debt securities could serve to reduce risks. Moreover, interests were also received for the loan, thus increasing the income of the scheme.
The Administration was aware of the need to restrict leveraged investment of a MPF fund. Permitted financial futures and options should be traded on recognized future exchanges and only be for the purposes of hedging existing positions in a portfolio and efficient portfolio management where the effective exposure is within 10% of the fund's assets with no leveraging allowed.

13. Responding to members' enquiries on foreign currency exposure and management charges for MPF investments, ADRS advised as follows-

The proposed limit of foreign currency exposure of 70% was applicable to every individual investment fund of the MPF Scheme. Hedging of the currency risk of foreign currency assets into Hong Kong dollars would be allowed for the purpose of determining compliance with the limit.
There would be rules to prevent double charging of management fees for the same scheme by investment managers. As regards payment of fees, they might be deducted directly from the investment returns of scheme members.

14. Concerning the effectiveness of the proposed restrictions and the current practice of fund investments, ADRS advised as follows-

The restrictions/guidelines were developed upon the best industry practices and the existing regulatory framework for the investment management of retirement funds and authorized unit trusts.
A great majority of the current investment portfolios of retirement schemes could already meet most of the proposed requirements.
According to the Wyatt Report, the average investment return for these funds was about 17.2% over the past 13 years.

II Any other business

15. Members agreed to hold the next two meetings on the following dates-

Monday, 9 December 1996 at 10:45 a.m.
Thursday, 19 December 1996 at 2:30 p.m.

(Post-meeting note: Notice for the meetings were issued vide LegCo Paper No. CB(1)440/96-97.)

16. To facilitate deliberation, members also agreed that on the basis of the information papers already provided, they would forward written questions, if any, in advance of the next meeting for the Administration to respond.

17. The meeting ended at 12:30 p.m.

Legislative Council Secretariat

20 December 1996

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