LegCo Subcommittee on MPF System
Information Note
Approved Pooled Investment Vehicles
Purpose
This paper describes the proposed requirements regarding the use of approved pooled investment vehicles by MPF schemes -
- unit trusts and mutual funds (paragraph 2 below);
- insurance policies (paragraphs 3 to 9 below); and
- investment guarantees and reserving requirements (paragraphs 10 to 12 below).
Proposal
Unit Trusts and Mutual Funds
2. We propose that all unit trusts and mutual funds used by MPF schemes should belong to the class that has been -
- authorized by the Securities and Futures Commission (SFC) under the Code on Unit Trusts and Mutual Funds pursuant to the Securities Ordinance;
- approved by the SFC as to their compliance with MPF investment restrictions and guidelines except in the case of authorized money market/cash management funds; and
- managed by an investment manager meeting MPF requirements.
Insurance Policies
New classes of insurance business
3. We propose that insurance policies used by MPF schemes should belong to the class that is -
- issued by authorized insurers in Hong Kong; and
- regulated under new classes of insurance business created under the Insurance Companies Ordinance with separate statutory funds and subject to MPF investment restrictions and guidelines.
Transparency in charges
4. We propose that all charges, including establishment fees, front/back end loads, annual fees, surrender charges/penalties of MPF insurance products should be fully transparent. The investment management fees should be expressed as a percentage of the accumulated account balances, new contributions, a flat fee or a combination of these elements.
Insurance policies that do not provide investment guarantees
5. We propose that insurance policies that do not provide investment guarantees should be unitised, with unit values fully linked to the actual investment performance and operate as internal "unit trusts" subject to requirements applicable to unit trusts.
Insurance policies that provide investment guarantees
6. We propose that where an investment guarantee is provided and the actual investment earnings flow through to account holders -
- the policy should be unitised and subject to rules applicable to unit trusts; and
- the insurer should be allowed to make an explicit charge to cover the cost of the investment guarantee.
7. Where the actual investment earnings do not automatically flow through to account holders, there should be a full disclosure of the salient features of the investment guarantees. It should include a clear description of how the investment return is determined and the extent of discretion of the insurer.
Product Approval and Investment Management Supervision by SFC
8. We propose that conduct of investment management of the statutory funds for MPF classes of insurance business be subject to the full requirements, supervision and sanctions of the SFC. This means that the insurer should either be a registered investment adviser with the SFC or appoint an SFC registered investment adviser to manage the investments of its MPF statutory funds.
9. We propose that all retirement schemes policies used by MPF Schemes should belong to the class that has been authorized by the SFC under the Code on Investment Linked Assurance Schemes and Pooled Retirement Funds pursuant to the Protection of Investors Ordinance.
Investment Guarantees and Reserving Requirements
Guarantor of Investment Guarantees
10. We propose to confine guarantors of investment guarantees to -
- authorized institutions within the meaning of the Banking Ordinance; and
- authorized insurers having the appropriate authorization to carry on MPF business with investment guarantees under the Insurance Companies Ordinance.
Adequacy of Reserves
11. We further propose that the guarantors should maintain adequate reserves at a level of an international standard to ensure the security of accrued benefits of scheme members. The reserving or capital adequacy requirements should be supervised by the regulatory authorities in Hong Kong under the respective regulatory framework for banks and insurers.
Third Party Guarantors
12. We propose that an institution not being an authorized institution within the meaning of the Banking Ordinance or an authorized insurer within the meaning of the Insurance Companies Ordinance may only offer an investment product with investment guarantees if such guarantees are unconditionally given by an authorized institution or authorized insurer as defined in paragraph 10 above.
Justification
Unit Trusts and Mutual Funds
13. We envisage that unit trusts and mutual funds are likely to be widely used in MPF schemes as collective investment vehicles for both employer sponsored schemes and master trust schemes. To ensure adherence to MPF investment restrictions and guidelines and to facilitate trustees monitoring of compliance, the MPF Advisory Board recommended that unit trusts and mutual funds should be approved by an authority in accordance with MPF investment restrictions and guidelines.
14. There are special requirements for authorizing money market/cash management funds under SFCs Code on Unit Trusts and Mutual Funds. These funds can only invest in short-term deposits and debt securities with average portfolio maturity not exceeding 90 days and subject to diversification rules. Details of subscriptions into the fund and its investments must be filed with the SFC 7 days after each month end. In view of these additional safeguards, we are of the view that separate approval under MPF restrictions and guidelines would not be necessary.
15. Since SFC has the expertise in investment supervision, we propose that the approval of unit trusts and mutual funds with respect to the MPF investment restrictions and guidelines be taken up by the SFC in addition to the current role of authorizing unit trusts and mutual funds.
16. Trustee may engage an MPF qualified investment manager to maintain a segregated investment portfolio or use pooled investment vehicles. The proposal of paragraph 2(c) is to ensure that the investment manager of the unit trust or mutual fund is of the same standard as those managing segregated portfolios.
Insurance Policies
New classes of insurance business
17. The proposals in paragraph 3 above will achieve the following purposes -
- by restricting MPF insurance products to those issued by authorized insurers in Hong Kong, there will be effective regulation of the products;
- by establishing new classes of business with statutory funds under the Insurance Companies Ordinance will protect such funds from other business risks of the insurer, improve transparency of operation and facilitate compliance by insurers with MPF requirements. Similar requirements are already applicable to the ORSO scheme business of insurers under Classes G and H.
Transparency in charges
18. In the realm of provident fund business, insurers are competing against professional investment managers, commercial banks and professional trust companies for a share of the market. It is important to provide a "level playing field" that encourages healthy competitions contributing to higher quality of services and cost efficiency in the MPF System.
19. To achieve this objective, there should be a high degree of transparency in the operation of MPF schemes by service providers, including the disclosure of all charges whether for scheme administration or investment management. This will assist employers and scheme members to select the best services at the lowest cost.
Insurance policies that do not provide investment guarantees
20. One of the key principles of the MPF Ordinance is that all income or profits/losses arising from investment should flow through to the accounts of scheme members. The proposed distribution of investment income and realized/unrealized capital gains/losses by way of unitisation is in compliance with this requirement. It is a highly transparent process and provides equitable treatment for all account holders.
Insurance policies that provide investment guarantees
21. Products with actual investment earnings that flow through to account holders are in essence no different from other investment management products. The proposals in paragraph 6 bring these products in line with other investment management products whilst recognising the insurers need to charge for the guarantee.
22. The proposals in paragraph 7 enhance the transparency of operation and fee charging of the policies. A clear description of the guarantee, how the investment return is determined and the insurers discretion in its determination provide account holders an understanding of the relationship between the guarantee, the actual investment returns and the declared returns which may be at the absolute discretion of the insurer.
Product Approval and Investment Management Supervision by SFC
23. The proposal in paragraph 8 above is to ensure that the investment activities for MPF statutory funds are managed by qualified investment professionals and are subject to supervision and sanctions of the SFC so that the interests of scheme members are properly protected.
24. Insurers have been marketing retirement schemes policies as investment vehicles and administration arrangements for retirement schemes. At present, as one of the conditions for authorization of (ORSO) retirement schemes business by the Insurance Authority, insurers are required to submit the advertisements, invitations and documents of retirement schemes policies to the SFC for authorization under the Code on Investment Linked Assurance and Pooled Retirement Funds under the Protection of Investors Ordinance (PIO). The prevailing practice should be followed and retirement schemes policies marketed by insurers to MPF schemes should continue to be approved by the SFC under the PIO to protect the interest of investors.
Investment Guarantees and Reserving Requirements
Guarantor of Investment Guarantees
25. The proposal in paragraph 10 above will enable the risks inherent in investment guarantees to be monitored effectively, since the permitted institutions are subject to prudential supervision by regulatory authorities in Hong Kong.
26. The proposed arrangement is also in line with existing business arrangements -
- the provision of investment guarantees falls within the normal banking business of deposit taking. As a simple example, a time deposit is a form of investment guarantee products.
- investment guarantee is also a common feature of many retirement scheme policies issued by insurers in Hong Kong.
- pooled retirement funds sponsored by investment management companies rarely provide investment guarantees. Where they do, the SFC would require the guarantee to be backed up by a qualified banking institution.
Adequacy of Reserves
27. In the past, the provision of investment guarantees by insurers in Australia, Canada, South Africa, the United Kingdom and United States had caused great difficulties and even bankruptcies of major insurers. In the light of such experience, regulators in these countries have introduced stringent reserving requirements trying to achieve a high probability of solvency, typically set at the level of 99%.
28. Similarly, banks with excessively high exposure to high risk investments or poor quality loans have experienced difficulties to honour commitments to their depositors when market conditions deteriorate. Banking regulators, including the Hong Kong Monetary Authority, therefore require a high level of safety for banks by monitoring their assets against their liabilities closely.
29. The proposals in paragraph 11 above seek to apply similar international standards for reserves on investment guarantees for MPF products, with a view to protecting the interest of scheme members. A stringent reserving requirement does not automatically translate into high level of reserves. If a guarantor matches its assets closely with the guaranteed liabilities or by investing prudently into less risky investments, the reserves required will be relatively small. A much higher reserve is required only when there is a significant mismatching position or where the liabilities are backed up by highly risky investments.
Third Party Guarantors
30. The proposal in paragraph 12 above is in line with existing practice and offers a level playing field -
- an investment guaranteed pooled retirement fund sponsored by an investment management company may obtain SFC authorization if the guarantee is backed up an authorized banking institution.
- service providers that are not authorized banking institutions or authorized insurers could also offer investment guaranteed products.
Mandatory Provident Fund Office
Financial Services Branch
24 November 1996
[Ref.: Paper/MPF/SC-8]
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