China's Corporate Pensions- Current State and Future Challenges Takeshi Jingu

I.

Overview of corporate pensions in China

China's social welfare system has undergone gradual reforms since the 1990s, atthe same time that the Chinese government was reforming its state owned enterprises(SOEs). This SOE reform stripped away from the SOEs, and then systemized, thevarious social welfare functions that the SOEs had been performing outside of theirmain corporate activity. In the area of social security, China began building a pension
system in 1991, an effort that included the government's promotion of corporate
pensions.1
Corporate pensions are expected to fill three roles. Their first role is to alleviate
the burden on the basic pension system created by China's rapidly aging population.2
China's population is aging at a rapid pace, and those aged 60 and older are expected
to comprise 18% of the total population by 2026. The pension system introduced in
China in the 1990s was a three-pillar arrangement based on 1) the basic pension
system, 3 enrollment in which is compulsory, 2) corporate pensions, for which
enrollment is voluntary, and 3) personal savings. When the pension system wasdesigned in the 1990s, it was envisioned as replacing 90% of enrollees' incomes, withroughly 60% coming from the basic pension system, 20% from corporate pensions,and the remaining 10% from personal savings.4
Their second role is as a company benefit and incentive mechanism, so as topromote the sustained development of corporations. A third role is to foster thedevelopment of institutional investors that invest for the long term, and thereby
promote development of the capital market.
Next, we look back at how corporate pensions have developed since the 1990s.
This process started in 1991, when policies related to corporate pensions were put
forward as part of pension reforms, as noted above. Specifically, Article 8 of theDecision by the State Council on Reform of the Enterprise Employee Old Age Pension
12
3
4

Since then, China's social security system has primarily developed in urban areas. The
system for urban areas is different than that for rural areas.
The three roles are as explained by the National Development and Reform Commission(2007).
Made up of personal accounts and a "social pool." For details, see Nomura Institute of
Capital Markets Research (2007)
He, Ping (2007).

China's Corporate Pensions - Current State and Future Challenges - 37

System provides that "supplemental corporate pension insurance shall be establishedby corporations for their employees, using their own economic resources..., while thegovernment shall promote, and provide policy guidance regarding the implementationof supplemental pension insurance by corporations." It was this requirement thatlaunched the introduction of corporate supplemental pension insurance, i.e. corporate
pensions, which have been positioned as the second pillar of the pension system.
The Notice of the State Council on Deepening of Reform of the Enterprise
Employee Old Age Pension System, issued in 1995, held that corporations, aftercollecting basic pension insurance premiums in accordance with regulations, canestablish supplemental pension insurance under the State Council's policy directives,
based on the business conditions at said company.
Likewise in 1995, the Ministry of Labor and Social Security (MLSS) issued the
Notice Regarding Printing and Distribution of the 'Opinion on the Establishment of
an Enterprise Supplementary Old Age Pension System', which provided a basic
framework for establishing supplemental pension insurance, including basic terms,
decision-making procedures, financing, management methods, benefits, theinstitutions to be involved, and fund management. The notice also made it clear that
corporate supplemental pension insurance is to be based on the defined contribution(DC) format.5 Furthermore, it stated that the institutions that would administer the
corporate pensions established pursuant to the Opinion would be the social security
agencies of regional governments, industry-specific organizations and corporations,and commercial insurance companies. In fact, there appear to have been a large
number of corporate pensions that were managed by social security agencies andindustry-specific organizations. Initially, industry organizations also used to manage
the basic pension insurance for each industry, but basic pension insurance wassubsequently transferred to the social security agencies of local governments, leaving
the industry organizations to specialize in corporate pensions.
Although the corporate pension system was established as noted above, as of theend of 2000 only 5.6 million people were participating in a corporate pension, a mere
5.4% of the number of people enrolled in the basic pension system. Corporate pension
plans were primarily established in the wealthy coastal regions and in the wealthierindustries, including electric power, oil, petrochemicals, air transportation (civil),telecommunications, and railroads.6
One of the reasons that corporate pensions were not more widely implemented isthat although they were proposed as the second pillar of the system early on,
corporations never viewed corporate pensions as mandatory, seeing them instead assomething to be implemented voluntarily when they could afford to do so. Secondly,
in many regions and industries there have been no specific laws implementing
corporate pensions, nor have any tax incentives been established, while administrative
rules vary widely depending on the region and the industry, with no existing
individual accounts in some cases. Pension accounting rules are also lacking in
5
6

National Development and Reform Commission (2006)
He, Ping (2007)

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consistency. Thirdly, it had already become apparent in 2000 that the basic pension
system was underfunded, making it necessary to divert funds meant to be saved in thebasic pension system's individual accounts in order to pay for the benefits of retirees.
In some regions, the social security agencies even had to divert funds from corporate
pensions in order to pay basic pension system benefits. This fomented concerns overthe idea of the regional social security agencies handling corporate pensions. Even in
the case of corporate pensions managed by large corporations, there were problems
with the co-mingling of a corporation's other assets with corporate pension assets. A
fourth problem was the lack of expertise in fund management and related areas.7
In response to these issues, considerable progress has been made on the legislative
front since 2000, when the State Council announced its Trial Plan to Improve the
Urban Social Security System. It was under this proposal that corporate supplemental
pension insurance plans were renamed corporate pensions. Companies that meet therequirements are able to establish corporate pensions, which are defined contributionplans with individual accounts to which both the corporation and the employees
contribute. The proposal also made it clear that corporate contributions up to 4% of
total wages could be deducted from the corporation's taxable income. Liaoning was
one of the provinces chosen to try the program out on a trial basis.
In 2001, three requirements were stipulated for a company to establish a corporate
pension: the company must (1) participate in the basic pension system, and pay
premiums on time, (2) have stable production/business, and relatively strong
corporate earnings; and (3) have a sound system for internal controls.8
In 2004, the MLSS announced the Trial Measures for Enterprise Annuities, while
the Trial Measures for the Management of Enterprise Annuities Fund was announced
jointly by the MLSS, the China Banking Regulatory Commission (CBRC), the China
Securities Regulatory Commission (CSRC), and the China Insurance Regulatory
Commission (CIRC). Both laws required that pensions be managed by qualified
trustees (asset managers), record keepers, custodians, and investment managementcompanies, and filled out the framework for a trust-based corporate pension system.
The administration of corporate pensions, previously handled by the social security
agencies of regional governments, must be transferred to these qualified institutions,as explained in more detail below. Following publication of the two laws, moredetailed rules and procedures were established through notes and other means.

78This paragraph references Otsuka and Japan Center for Economic Research (2002) andHu (2006)
National Development and Reform Commission (2007)

China's Corporate Pensions - Current State and Future Challenges - 39

II. Corporate pension framework
1. Basic framework
We look here at the current framework for China's corporate pension rules, basedon the two pension laws implemented in 2004: Trial Measures for Enterprise
Annuities (Order No. 20 of the Ministry of Labor and Social Security) and Trial
Measures for the Management of Enterprise Annuities Fund (Order No. 23 of the
Ministry of Labor and Social Security).
As noted above, corporate pensions in China are established voluntarily bycorporations and employees (officers and workers) as supplemental pensions,predicated on participation in China's basic pension system. Article 2 of Order No. 20of the MLSS on Trial Measures for Enterprise Annuities (20-2) states that a company
can establish a corporate pension, provided that it (1) participates in, and pays
premiums for, the basic pension system, (2) has the ability to bear the economic cost,and (3) has a mechanism for collective bargaining (20-3). Requirement (3) isnecessitated by 20-4, which states that corporate pensions shall be established upon
consultation between the company and the union or employee representative.
A corporate pension proposal must include (1) the employees eligible to participate,(2) the method of funding, the methods for (3) administering individual accounts, (4)administering the funds, and (5) calculating and making payments, (6) the conditions
for payments, (7) the approach for administration and oversight, (8) conditions for
suspending contributions, and (9) other items that must decided by both the company
and employees (20-5). Compliance with these requirements is checked closely whenestablishing a corporate pension.
In addition, corporate pensions must be of the defined contribution type, offer
management of individual accounts (20-10), and allot investment returns to thoseindividual accounts. Individual accounts must be transferable to the new employer
when changing jobs (20-13), i.e., must have "portability."On the contribution side, corporations and employees must make joint
contributions (20-6), the company's contribution cannot exceed 1/12 of an employee's
total wages of the previous fiscal year, and the total contribution by company andemployee together cannot exceed 1/6 of an employee's total wages of the previous
fiscal year (20-8). Benefits are to be paid after retirement, either in a lump sum or in
installments (20-12).

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2. Institutions that administer and manage corporate pension assets
The administration and management of corporate pensions, in light of the pension
management issues noted above, is organized so as to provide a clear division ofduties among the trustees, record keepers, custodians, and investment managementcompanies, providing for a system of mutual checks and balances.
Companies that establish a corporate pension must first designate a trustee toentrust with managing the corporate pension fund. The company and the trustee are ina trustor/trustee relationship. The trustee is either the corporate pension fund council
established by the company or the corporate trust institution that satisfies state
regulations (20-15). The corporate pension council consists of corporate andemployee representatives (at least one third of the council). The trustee can outsource
the pension's record keeping to a qualified corporate pension record keeper,
investment management to a qualified investment management company, andcustodianship to a qualified commercial bank or specialized custodial institution(custodian) (20-19). The relationship between the trustee and the record keeper,
investment management company, and custodian is an outsourcing relationship(Figure 1).

Figure 1: Contractual arrangement of corporate pensions

Recordkeepingagreement

Record keeper

TrustorCorporation
Employees

Trusteeadministrationagreement

Trustee

Custodial
agreement

CustodianTrustagreement
Investment
managementagreement

Source:Investment
managementcompany

Nomura Institute of Capital Markets Research, based on Yang and Zou (2006a)

We look next at the specific duties of the trustee, record keeper, investment
management company, and custodian.
The trustee is responsible for (1) selecting, supervising, and changing the record
keeper, custodian, investment management company, and the intermediary service
providers (investment advisors, accounting firms, and law firms); (2) setting the

China's Corporate Pensions - Current State and Future Challenges - 41

fund's core investment strategy9 ; (3) preparing administrative reports and financial
accounting reports; (4) collecting contributions from the employer and employees per
agreement and distributing pension benefits to beneficiaries (persons qualified toreceive pension benefits); (5) submitting to examinations by trustors (the corporationand employees) and beneficiaries, submitting fund management reports to trustors,
beneficiaries, and regulatory authorities, and, in the event of a serious event,submitting reports to trustors, beneficiaries, and regulatory authorities as necessary(Article 13 of Order No. 23 of the MLSS on Trial Measures for the Management ofEnterprise Annuities Fund (23-13)). The requirements to qualify as a trustee include
having registered capital of at least Rmb100 million and net assets of at least Rmb150
million (23-12). In addition, the trustee's management fee must be no more than 0.2%of the net assets of the corporate pension fund being managed by the trustee (23-53).
The record keeper is responsible for (1) opening accounts for the corporation andindividuals; (2) keeping a record of employer and employee contributions and ofinvestment returns; (3) reconciling data on contributions and changes in corporate
pension accounts with the custodian; (4) calculating corporate pension benefits; and(5) periodically submitting reports on fund account administration to the trustee andregulatory authorities (23-21).The requirements to qualify as a record keeper include
registered capital of at least Rmb50 million (23-20). In addition, the recordkeeping fee
shall be no more than Rmb5 per account per month (23-54).
The custodian is responsible for (1) securely storing corporate pension fundproperty; (2) opening a cash account and securities account for the fund property
under the name of the corporate pension fund; (3) opening separate accounts for theproperty of other corporate pension funds under its custody; (4) distributing fundproperty to the investment management company on instructions from the trustee; (5)liquidating and settling as appropriate on instructions from the investment
management company; (6) calculating and estimating fund accounts; (7) reconcilingrelated data with the record keeper and the investment management company andsupervising investments made by the investment management company; (8)periodically submitting fund custodian reports and financial accounting reports to thetrustee; and (9) periodically submitting fund custodian reports to the regulatory
authorities (23-27). The requirements to qualify as a custodian include having net
assets of at least Rmb5 billion (23-26). In addition, the custodian's management fee
must be no more than 0.2% of the net assets of the pension fund in custody (23-55).
The investment management company is responsible for (1) investing the corporate
pension fund property; (2) reconciling the fund's account calculations and estimateswith the custodian; (3) establishing reserves for the fund's investment management
risk; and (4) periodically submitting investment management reports to the trustee andthe regulatory authorities (23-35).

9

The investment manager actually invests according to the investment strategy establishedby the trustee. Employees are not allowed to directly choose investment products.

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The requirements to qualify as an investment management company are, forsecurities firms, at least Rmb1 billion in both registered capital and net assets, and forfund management companies, trust & investment companies, insurance asset
management companies, and other specialized investment institutions, at least
Rmb100 million in both registered capital and net assets (23-34). In addition, the same
institution (or institutions with cross-held equity or shares) cannot serve as both aninvestment management company and custodian (23-45). The management fee
received by the investment management company must be no more than 0.2% of the
net assets of the corporate pension fund being managed (23-56).
The system is thus designed to ensure mutual checks and balances among thetrustee, record keeper, investment management company, and custodian (Figure 2).

Figure 2: Relationships among corporate pension players

TrustorReport on contributions,investments, and benefits
and on administrative
statusContributions

Oversight
institution

Information and inquiry
services

Oversight

Record keeping
reports

RecordkeeperTrustee
Notification of
investments ofcorporate
pension funds

Reportinvestments,
management,
and tradingdata

Investment
managementcompany

Source:Information oncontributions

Oversight

Various custodial reports,
including contributions,benefits, and transfers
Contribution
information andbenefit notices

CustodianOversight of investments and reconciliation of
trading data

Nomura Institute of Capital Markets Research, based on Yang and Zou (2006a)

In August 2005, the MLSS announced a list of institutions qualified to administrate
and manage corporate pensions. The first list included 29 institutions and 37
qualifications. A second list, announced in November 2007, included 18 institutions
and 24 qualifications (Figure 3).

China's Corporate Pensions - Current State and Future Challenges - 43

Figure 3: Institutions that administer and manage corporate pension assets
Custodian
Industrial & Commercial
Bank of China

Banks

Trustees
Industrial & Commercial
Bank of China

Recordkeeper

Investment managementcompany

Industrial & Commercial
Bank of China

China Construction Bank

China Construction Bank

China Construction Bank

China Merchants Bank

China Merchants Bank

China Merchants Bank

Bank of Communications

Bank of Communications

China Everbright Bank

China Everbright Bank

Bank of China

Bank of China

China CITIC Bank
Shanghai Pudong
Development Bank

Shanghai Pudong
Development Bank

Agricultural Bank of China
China Minsheng Banking

China Minsheng Banking

Insurancecompanies

China Life Insurance
China Life Pension

China Life AssetManagement

China Life Pension
Taikang Life Insurance

Taikang Pension &Insurance

Taikang Pension &Insurance

Taikang Asset Management

Ping An Annuity Insurance Ping An Annuity Insurance Ping An Annuity Insurance
China Pacific Life Insurance
Taiping Pension

Taiping Pension
PICC Asset Management
Huatai Asset Management

Changjiang Pension
Insurance

Changjiang Pension
Insurance

Changjiang Pension
Insurance

Xinhua Life Insurance
Trustees

CITIC Trust & Investment

CITIC Trust & Investment

Fortune Trust

Fortune Trust

China Credit Trust
Shanghai International
Trust Co.
Fund
managementcompanies

China Southern FundManagement
Bosera Funds
China AMC
Harvest Fund Management
Fullgoal Fund Management
E Fund Management
Yinhua Fund Management
China Merchants FundManagement
Fortis Haitong Investment
Management
Guotai Fund Management
ICBC Credit Suisse AssetManagement
GF Fund Management

Securities
firms

Note:
Source:44

CITIC Securities
China International Capital

Shaded areas denote companies on second list (see main text).
Nomura Institute of Capital Markets Research, based on various news reports

Nomura Capital Market Review Vol.11 No.2

There are some financial institutions on this list receiving three qualifications(including for group members). Future lists may include new combinations in addition
to the 2+2 (one company serves as both trustee and investment management company,
and another bank serves as both custodian and record keeper) seen on the first list,
such as a 3+1, in which all of the functions except for custodian are handled by thesame financial group, or likewise, all of the functions except for investment
management are handled by the same financial group. As we note below, a key area towatch will be whether the system of mutual checks and balances functions even undera 3+1 arrangement or when the same institution serves as both trustee and investment
management company.

3. Investment of corporate pensions
We look here at the investment of funds by the investment management company.
To begin with, corporate pensions must limit their investments to bank deposits,
government bonds, and other highly liquid financial products, which include shortterm bond repos, bank debentures and corporate bonds with an investment grade or
better, convertible bonds, investment-type insurance products, mutual funds, andequities (23-46). The maximum investment in each of these products is as follows,with percentages calculated based on market values.
(1) Investments in money market funds and liquid products such as bank demand
deposits, central bank bills, and short-term repos shall not drop below 20% of thecorporate pension fund's net assets.
(2) Investments in bank time deposits, "negotiated" deposits, government bonds,
bank debentures, corporate bonds and other fixed-rate products, as well as convertible
bonds and bond funds, shall be no more than 50% of the fund's net assets, while
investments in government bonds alone shall not drop below 20% of net assets.10(3) Investments in equities, investment-type insurance products, and equity funds
shall be no more than 30% of the fund's net assets, while investments in equities alone
shall be no more than 20% of net assets (23-47 for all of the above).11
When a corporate pension managed by a single investment manager invests in a
stock issued by a single corporation or in a mutual fund, the amount of thatinvestment shall not exceed a total share of 5% of said stock or said mutual fund, norshall exceed 10% of total pension fund assets managed by the investment manager(23-49).
Corporate pension funds are prohibited from being used for margin trading,lending, or collateral (23-51). Also prohibited are the comingling of the investment
manager's property with the corporate pension's property, unequal treatment of other10
11

Since 31 January 2007, corporate pensions have been allowed to participate in theinterbank bond market.
Because the basic pension system is limited to investing in bank time deposits andgovernment bonds, corporate pensions actually have greater latitude in investing theirfunds.

China's Corporate Pensions - Current State and Future Challenges - 45

corporate pension funds managed by the investment manager, and the diversion of
corporate pension property (23-40).

4. Tax rules
We look next at the tax treatment of corporate pensions at each level: making
contributions, generating investment returns, and receiving benefits.
As already noted, the State Council's Trial Plan to Improve the Urban Social
Security System in 2000 authorizes a tax deduction for corporate pension contributions
up to 4% of wages. This only applies, however, to Liaoning and other provinces
where the Trial Plan is being applied on a trial basis. Only a small number ofcompanies have actually used this program. 12 In other regions, deductions wereapparently allowed up to a certain percentage of total wages, depending on conditionsin that region, based on the Ministry of Labor and Social Security's 1995 Opinion on
the Establishment of an Enterprise Supplementary Old Age Pension System.13 Later,
based on a 2003 Note from the Ministry of Finance, corporations in other regions
were also allowed in principle to deduct up to 4% of their contributions; at this point,
however, the incentive tax rates differ by region (Figure 4).
Figure 4: Tax deductions in each region

Wuxi

Maximum
deduction
12.5%

Sichuan(% of total wages)
Maximum
deduction
4%

Hubei

12.5%

Shaanxi

4%

Shanxi

8.3%

Shandong

4%

Chongqing6%

Qinghai

4%

Tibet

4-6%

Ningxia4%

Zhejiang

5%

Liaoning

4%

Province (City)

Note:
Source:12

Province (City)

Yunnan

5%

Jilin

4%

Shenzhen

5%

Hunan

4%

Shanghai

5%

Heilongjiang

4%

Guizhou

5%

Hebei

4%

Fujian5%

Guangzhou

4%

Anhui

5%

Gansu

4%

Xinjiang

4%

Beijing

4%

Tianjin4%

For corporate income taxes, denotes the maximum employer contribution that canbe deducted from taxable income (see main text).
Nomura Institute of Capital Markets Research, based on page 88 of "Zhongguo
Qiye Nianjin Guifan yu Fazhan (China Enterprise Pension Regulation andDevelopment)," published by China Industry and Commerce Associated Press,
2007

13

Hu (2006)
Hu (2006), Yang and Zou (2006b)

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There was no mention of employee contributions in the Trial Plan, nor have othernotes included any tax incentives.
There are no tax breaks on the investment returns of corporate pensions, andbecause corporate pension benefits do not receive any special treatment underindividual income tax rules, individuals must pay income tax on the benefits that theyreceive.
Using the letters E for exempt and T for taxed for each stage -- contribution,
investment returns, and benefits -- China's corporate pension taxation is currently ETTon the corporate side and TTT on the individual's side.14

5. Oversight
The main governmental agencies charged with the oversight of corporate pensions
are the MLSS, the CSRC, the CIRC, and the CBRC. The MLSS is responsible forsetting policy on the administration of corporate pensions, while administrative unitsof the MLSS handle the supervision and administration of corporate pension fundmanagement (23-9). In addition, the CSRC, the CIRC, and the CBRC supervise andadminister financial institutions involved in corporate pensions, based on the industry
segments they are responsible for. For example, if a financial institution wants to bequalified as a trustee or investment manager, it must receive approval from therelevant regulatory body prior to applying with the MLSS. Because various categories
of financial institutions are involved with corporate pensions, governmental
administration is shared in accordance with the industry segment.

III. Trends and issues since publication of the two laws in 2004
1. Transferring corporate pensions established under the old system to the new
systemAs of the end of 2006, 24,000 corporations had established a pension, 9.64 million
employees were paying into these pensions, and total fund assets stood at Rmb91
billion. By the end of 2007, these assets appear to have grown to over Rmb130
billion.15
As also evident from the events leading up to the development of corporate
pensions, two pension tracks exist side by side, those established prior to publicationof the two laws in 2004, and those established after. Of the total corporate pension

14

15

Under the basic pension system, both the employer contribution and the employee
contribution are deductible. In addition, the individual pays no income taxes on benefits
received.
MLSS, Department of Fund Supervision. China Securities Journal, dated 23 November
2007.

China's Corporate Pensions - Current State and Future Challenges - 47

assets of Rmb91 billion at the end of 2006, only Rmb20 billion is managed by funds
established under the two 2004 laws.16
In response, the MLSS announced its Opinion on the Takeover of Pre-existing
Enterprise Pensions in April 2007. This opinion provided for the transfer of corporate
pensions that had been managed by social security agencies, industry organizations,and individual corporations to the institutions noted above that are qualified to
manage corporate pensions. Prior to the transfer, portfolios were rebalanced to meetthe investment criteria of the two laws, and if there was any nonperforming asset it
was disposed of after clarifying responsibility. 17 In principle, the deadline for thistransfer was the end of 2007, although the deadline was extended until the end of2008 for those SOEs run by the central government (CSOEs) that could show theMLSS that they would have difficulty meeting the 2007 deadline.
This decision provoked competition among the financial institutions in each region
to win contracts on corporate pensions established under the old system. A number ofthese transitions occurred in 2007, one of which was the corporate pension run by thecity of Wuxi in Jiangsu province. Its over Rmb700 billion in assets and over 6,000
plan participants were turned over to Taiping Pension as trustee and investment
management company, to the Industrial & Commercial Bank of China as record
keeper, and to the Bank of China as custodian. In addition, Changjiang Pension
Insurance became trustee for the over Rmb15 billion corporate pension of ShanghaiCity's Corporate Pension Management Center, while both Taiping Pension and Ping
An Annuity Insurance are now trustees of over Rmb34 billion in assets for Jilin
province.
The first CSOE to transfer its corporate pension was Dongfeng Motor in August
2007, with the Dongfeng Motor Corporation Enterprise Pension Trustees the trustee,
the Industrial & Commercial Bank of China as custodian, the China Merchants Bank
as recordkeeper, and three investment management companies: China Life AssetManagement, Bosera Funds, and Harvest Fund Management.
Following release of the Opinion on the Takeover of Pre-existing EnterprisePensions, the State-Owned Assets Supervision and Administration Commission(SASAC) announced its Notice Regarding Trial Implementation by Central
Government Enterprises of Enterprise Pension Systems in September 2007. This
Notice prohibited the establishment of a corporate pension by CSOEs reporting a loss
on their consolidated financial statements or CSOEs that do not maintain or increase
the value of state-owned capital. The initial trial for corporate pensions required that
employee contributions be at least 25% of corporate contributions, and this amount
was gradually raised to 100%. Pre-existing corporate pensions must be modified andstandardized, and proposals for a new corporate pension drafted, as soon as possible,
and auditing paperwork must be submitted to the SASC no later than June 2008. As

16
17

MLSS, Department of Old Age Pensions. China Securities Journal, dated 10 September
2007.
The big scandal that erupted at Shanghai Labour and Social Security Bureau in 2006 also
included the unlawful investment of funds misappropriated from corporate pensions.

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noted above, under extenuating circumstances this deadline can extended until the endof 2008.
CSOEs are expected to provide a role model for the expansion and standardizationof corporate pensions. In reality, however, with the exception of companies in
profitable, monopolistic industries like electric power, petrochemicals, crude oil, andtelecommunications, the CSOEs do not necessarily have a very strong commitment toestablishing corporate pensions, owing to cost considerations and the lack oftransparency regarding tax treatment. We think that the Opinions of the State Council
on the Pilot Implementation of the State Capital Operating Budget announced in
September 2007, which requires CSOEs to distribute profits to the Ministry of
Finance, will also raise the cost consciousness of CSOEs.
Meanwhile, an initial group of three financial institutions, the Bank of China,
China Everbright Bank, and PICC Property and Casualty, were authorized on 7
February 2007 to establish corporate pensions under the new system based on the two
2004 laws. The three are China's flagship state-owned commercial bank, joint stockcommercial bank, and nonlife insurance company, respectively. Lenovo, the company
that acquired IBM's PC business, received approval to establish a corporate pension in
July 2006, and a number of other companies have established corporate pensions
since then.

2. Competition among financial institutions is heating up
In February 2008, the CIRC published the operating data of annuity insurers for the
first time ever, showing total assets held in trust by all of China's annuity insurancecompanies of Rmb8.4 billion, and total assets managed for investment of Rmb7.97
billion. The leading annuity insurer was Ping An Annuity Insurance, with Rmb4.98
billion in assets held in trust, and Rmb5.05 billion as investment manager. One reason
for Ping An's lead is that it has captured over an 80% share of Shanghai City's
corporate pension market, which quintupled in size in one year. 18 When Liaoning
province began experimenting with the transition from the old system to corporate
pensions in 2004, second-ranked Taiping Pension took over the pensions forcompanies affiliated with the province, and this gave it an early start in developing its
corporate pension business.
A second list of financial institutions approved to handle corporate pensions wasannounced in November 2007 (Figure 3), and with the addition of banks as approved
trustees there is now a three-way competition in the trustee segment among banks,
insurers, and trust banks. Insurance companies and fund management companies now
compete for business in the investment management segment.19

18
19

Jfdaily.com, dated 16 February 2007.
Of the 36 companies signing agreements with investment management companies in2006, 27 selected fund management companies. Ba (2007).

China's Corporate Pensions - Current State and Future Challenges - 49

IV. Future challenges and risks
1. Growing size of corporate pensions
Although the number of participants in corporate pension plans, 9.64 million at theend of 2006, has grown over the past few years, it is still miniscule compared with the187.66 million enrolled in the basic pension system (including 46.35 million retirees),and corporate pensions still have a long way to go before they can be called thesecond pillar of China's pension infrastructure.
Various challenges remain in achieving growth in corporate pensions. To begin
with, corporate pensions remain fairly unknown. Both corporations and employees
lack basic knowledge of the significance of corporate pensions, how they areorganized, and what their benefits are. Although the authorities have positioned
corporate pensions as the second pillar of China's pension system, corporate
management does not appear to feel compelled to implement the plans. An MLSS
survey found that only about 40% of corporate management were aware that
corporate pensions existed, and of those, only about 30% truly understood corporate
pensions. One in three managers thinks that companies have no responsibility forcorporate pensions.20
In a survey of pension-qualified fund management companies, a majority answeredthat the current difficulty in developing the corporate pension market is owing to alack of awareness among corporations, and that a strengthening of promotional andeducational efforts is needed. This lack of awareness was thus identified as the biggest
issue standing in the way of developing corporate pensions.21
A second problem is the lack of tax incentives. As noted above, only the employer
contribution is tax deductible, and even this varies across regions. These regional
differences may further complicate the challenge of setting up a corporate pension
plan, and of ensuring that plan's portability, for those companies that operate
nationwide.
In addition, because the employee's contribution is not tax deductible, there is no
tax incentive for individuals to contribute. Thus the market is waiting for thegovernment to announce a nationally uniform set of tax incentives for corporate
pensions that apply at every level: employer and employee contributions, investment
returns, and benefit payments.
Officials at China's State Administration of Taxation (SAT) have announced theirthinking on the direction of tax incentives,22 as follows. Corporate contributions topensions should be deductible from taxable corporate income, but certain restrictions
would be added to prevent the use of these deductions for tax evasion. For individual
income taxes, (1) employee contributions can be deducted from taxable income; (2)although employer contributions are added to individual accounts, they are not20
22

Based on a survey by the MLSS. National Development and Reform Commission (2007).
Based on a survey by Ping An Securities. Ba (2007).
Proposal by the Chief of the Tax Law Department, SAT. Securities Times, dated 10
September 2007.

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recognized as current income for the individual and thus not taxed; (3) investment
returns, while also added to individual accounts, would also be tax-free for an
extended period; (4) Withdrawals made by retired employees from their individual
pension accounts are to be taxed as wage income.
Thirdly, few small and medium-sized enterprises have established a corporate
pension. According to the MLSS, only about 50 such companies had established a
corporate pension as of the end of 2006, amounting to less than Rmb100 million,
under 1% of the corporate pension market. The procedures for establishing andoperating a corporate pension are the same for all companies at this time, but theincome earned by the firms administering corporate pensions is determined by thesize of the fund. This makes the administration of corporate pensions for small andmedium-sized enterprises relatively more costly, and explains why the firms thatadminister corporate pensions are not very keen on handling the plans of smaller
companies.
Because of this, it appears that in 2007 the MLSS sent its Draft Measures forRegulation of Enterprise Collective Pension Schemes (discussion draft) to certain
financial institutions to obtain their feedback. The Draft Measures attempt to solve theproblem noted above by having numerous smaller firms (corporate pension trustors)
sign an agreement with a single trustee to manage their funds collectively. To manage
risk, three different investment management companies must be selected. This differsfrom the Trial Measures for Enterprise Annuities and the Trial Measures for theManagement of Enterprise Annuities Fund currently in force.
Tax incentives would probably be effective in this regard, as well. A more solid
corporate pension plan can help to attract talent, thereby promoting the developmentof small and medium-sized enterprises over the long term. It is therefore conceivablethat additional incentives may be given for the pension plans of small and mediumsized enterprises, over and above the tax breaks for corporate pension plans in general.

2. Potential risks
There are also potential risks with the system of checks and balances among theinstitutions that administer corporate pensions.
As already noted, the trustee plays a critical role based on how a corporate pension
is organized. There are doubts over the trustee's ability to provide checks, however,given the situations that have actually arisen thus far. 23 These include investment
managers not following the rules when investing, and, amid increasingly intensecompetition, the investment management company being selected first after the
corporate pension plan is established, with the investment management company thenselecting the trustee, which is the reverse of the required order. Likewise, there arealso examples of the trustee making investments without using an investment
management company. All of these situations are problematic in relation to the safetyof corporate pensions.
23

Guo (2007)

China's Corporate Pensions - Current State and Future Challenges - 51

It has also been noted that trustees are compensated poorly in view of theimportance of their role and responsibilities. Trustees' management fees are limited tono more than 0.2% of the fund's net assets, but because of intense competition, few
trustees are able to receive 0.2%, and in some cases the trustee receives no fees atall.24 Because the trust business provides little income, some financial institutions arestarting to serve as trustee as well record keeper and investment manager. In fact,
combination roles such as this 3+1 have been possible since the second list of
corporate pension service providers was announced. This creates the risks that checks
and balances will not function as well within a single financial institution, and thatprofits will be shifted and transfer prices manipulated. The same is true when thetrustee selects a record keeper or investment manager from within the same financialgroup. The custodian is expected to function as the "checker" in these cases. It has
been noted, however, that the custodian does not incur a responsibility to the trustor(employees and the corporation) solely by virtue of an agreement concluded with thetrustee.25
In this situation, it is not always clear which party is responsible in the event thatthe corporate pension suffers a major loss or is involved in serious misconduct. Even
when the trustee, who signs a trust agreement with the trustor (employee andcorporation), has responsibility, it is a separate issue whether the trustee has thewherewithal to pay damages. If a corporate pension were to fail, it would raise
mistrust of corporate pensions and hinder their development. A bailout by the local
government would create a moral hazard, however, as well as the risk of the funds
being unlawfully managed.
It basically boils down to the same problems with China's financial system thathave been identified in other contexts, which are its underdeveloped financial
institution management and capital markets, as well as the inadequate enforcement of,and compliance with, laws and regulations. This makes government oversight andadministration important for the time being.

3. Oversight and administrative issues
As already noted, the oversight of corporate pensions is handled by the MLSS as
well as the financial institution regulatory bodies: the CBRC, CSRC, and CIRC. In
addition, the Ministry of Finance is involved with accounting issues, the SAT with tax
issues, and the SASAC with issues involving the administration of state-owned assets.
Similar regulations are issued by multiple governmental agencies, all of which appear
to be competing amongst themselves.26

24
26

Ibid
Yan (2007)
There were reports of a dispute between the MLSS and the CIRC regarding oversightauthority. Han (2007).

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Although the MLSS27 appears to be taking the lead role in oversight for now, it is
not set up to supervise and manage the risk of financial institutions, and this suggests
there may be a need to either create a new regulatory body specifically for corporate
pensions, or establish a committee or other coordinating mechanism among theoversight agencies. It would be desirable to expand the supervisory staff within the
MLSS.
Looking beyond just the corporate pension segment, as China's financial
institutions increasingly form conglomerates, the need will arise to improve upon thecurrent system of dividing oversight by industry segment. This is likely to become aparticularly large problem in the case of corporate pensions, given the many types offinancial institutions that are involved.

V. Conclusion
China's corporate pension plans have begun to operate under new rules. Corporate
pensions established under the old rules began shifting to the new rules in 2007, whena second list of approved corporate pension service providers was announced. Assets
held in corporate pension plans appear to have grown by over Rmb40 billion in 2007,
and we expect to see further growth over the long term.28
From the capital markets perspective, rules that prevented corporate pensions fromparticipating in the nationwide interbank bond market were lifted in January 2007.
During 2007, there were 94 corporate pension plans that subscribed to IPOs or otherstock offerings. Corporate pensions are beginning to establish a market presence as
institutional investors, and this presence is expected to gradually increase. Someobservers also expect corporate pensions to invest overseas.
Although expectations are high, in order for growth in corporate pensions to meetthese expectations, it will probably require that corporations and their employees
become more aware of the plans, and that the appropriate tax incentives also be
adopted. We also see a need to improve regulatory oversight so as to strengthen the
checks and balances among pension plan participants and service providers andthereby lower the risks.

27
28

The institutional reforms of March 2008 combined the MLSS and the Ministry of
Personnel to form the Ministry of Human Resources and Social Security.
The World Bank forecasts China's corporate and organizational pensions will grow to $1.8
trillion (approximately Rmb12.8 trillion) by 2030.

China's Corporate Pensions - Current State and Future Challenges - 53

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