Asia’s state pension funds: en route to better governance

Funds in China, Korea and Thailand break ground on voting and corporate accountability, but there are still areas to develop.

As evidence mounts that good management of ESG issues can enhance portfolio value, some Asian pension funds are beginning to give more emphasis to RI methods and to pressure companies in which they invest to demonstrate improved standards of corporate governance. It is still relatively rare to see the government-linked pension and provident funds in Asia exercising their proxy voting rights, but several large state funds, including Korea’s National Pension Corporation (NPC Korea) and the National Social Security Fund in China, are now developing corporate governance guidelines and/or proxy voting policies. Thailand’s Government Pension Fund (GPF Thailand) has already compiled a corporate governance rating system for Thai companies inspired by the OECD Principles for Corporate Governance.
However, a pension fund needs to view governance on two levels: firstly, as a responsible investor that takes account of investee companies’ corporate governance practices; and secondly, for the fund itself, as a fiduciary accountable to its beneficiaries.
In order to ensure organisational credibility, the administration and operation of public pension funds themselves must be conducted with demonstrably high standards of transparency and governance.Public confidence in the pension system is critical to encouraging public participation, especially where the fund is dependent at least partly on voluntary payments from workers for its inflows – many Asian countries are currently aiming to introduce an element of voluntary contribution into their pension systems. At the extremes, poor oversight can encourage corruption and theft, which in turn adds to under-funding problems in some countries. Generally, inadequate governance may cause confusion, poor decision-making and inefficiencies, which drive up administrative costs and jeopardise investment returns. As Asian pension funds seek to become active investors, poor internal governance also weakens their credibility when they raise corporate governance questions with investee companies.
One of the basic principles of governance is the separation of the governing from the executive function. To establish accountability, there must be a clear focus of liability on a governing body or person, who is in turn accountable to the beneficiaries; and the relationships between trustees, plan sponsor, regulator and government must be clearly established. The governance structure should include an appropriate division of operational and oversight responsibilities, and appropriate control, communication and incentive
mechanisms that encourage good decision-making, proper and timely execution, transparency and regular review and assessment.
Fund trustees are typically responsible for monitoring the pension scheme’s employees and external agents in their execution of the fund’s strategy. Identification and selection of trustees is, therefore, a vital part of fund governance, although many public fund boards in Asia (and elsewhere) include political appointees whose qualifications may be limited. Good governance demands a clear succession planning structure to deal with the appointment and removal of trustees.It also requires that trustees meet regularly, with adequate time for consideration of the complex matters facing the fund. Transparency is a crucial aspect of fund legitimacy. Trustees should regularly disclose information both to beneficiaries and supervisory authorities, covering their decision-making procedures, fund policies and investment returns. In Asia, the public pension funds tend not to disclose as much data as some funds in developed markets, but many now publish a website.
State pension schemes have historically been allowed relatively little independence from government sponsors and regulators, but in order to retain public confidence in the quality of their decision-making, the trustees must be viewed as autonomous and independent from political pressure. In emerging markets, a complex relationship may exist between public sector pension schemes and government agencies, which have established the funds and tend to have an ongoing role in their operations. Pension schemes are often directly linked with government ministries: Malaysia’s Employee ProvidentFund answers to the Ministry of Finance, for example, and Thailand’s Social Security Organisation is controlled by the Ministry of Labour and Welfare.
In some emerging markets, moreover, in addition to generating a long-term return on investments, the pension fund is expected to have a responsibility to support national development objectives. This may be positive – GPF Thailand explicitly describes its role in the development of the Thai economy, with one of its primary objectives being to promote good investment practices.
However, investments in government securities, domestic companies or projects which are interpreted as being motivated less by investment return potential than by political or developmental goals (financing government budgetary requirements or propping up a failing industry, perhaps) can damage the pension fund’s credibility and legitimacy.
Investment in privatisations can cause possible conflict of interest between the government’s policy of asset redistribution and its role as the underlying sponsor of the pension fund. At the same time, if the pension fund’s stake in the privatised company is substantial, the goal of the exercise may be effectively undermined – control of the asset merely passes from one arm of government to another.
Some state pension funds, such as NPC Korea in 2006, have also been criticised for appearing to use their voting rights to support local company management against foreign take-over bids and shareholder activism, rather than pushing for maximum value to shareholders.
Domestic capital market development is a government

priority throughout the region. Investment of even a relatively small proportion of pension fund assets would have a significant impact on the market capitalisation of some Asian emerging market stock exchanges and the creation of a strong institutional investor base would help to improve the efficiency of those markets. With these aims partly in mind, many countries constrain the ability of the state pension funds to invest in foreign securities. Such policies have negative implications in that they restrict the fund’s flexibility to diversify across global markets or to manage its exposure to the performance of the domestic economy.Where the local capital markets are small or illiquid, there is also a danger that the pension fund’s inevitable position as a dominant investor will severely undermine its ability to outperform. Some more mature funds, therefore, have gradually achieved more independence: for example, GPF Thailand began investing abroad in 2005 and recently announced its intention to allocate 25% of its portfolio to overseas assets.
As Asian pension funds mature, and as beneficiaries start to become more aware of their rights, demands for clearer accountability, autonomy and transparency of decision-making are likely to become louder.