The digital revolution is coming for H.K.’s retirement system
Regulator MPFA’s call for a more radical approach to streamlining retirement savings and investments must be heeded.
Senior regulators at the Hong Kong Mandatory Provident Funds Authority (MPFA), which supervises HK$858 billion ($110 billion) in retirement savings, are calling for a radical redesign of the system based on cutting-edge fintech.
In December 2018, MPFA chairman David Wong wrote a blog piece on the regulator’s website highlighted the decision to implement a central platform to unify the current hodgepodge of processes among 12 administrators. The government set up a working group to push for the centralized platform, called eMPF, in 2017.
Now the MPFA is following up with a “request for information” that it issued on its website last week, calling for ambitious ideas to be submitted by May 3.
Behind this bland announcement is a call for a radical, even revolutionary, overhaul. A centralized platform, or C.P., cuts at the heart of the inertia plaguing the system.
Because so much of the MPF system is based in legislation, the regulator is unable to do much. Instead it wants to submit a proposal to the city’s Legislative Council in 2021, based on a tender to a winning plan to be issued by March next year. The new centralized platform would begin to roll out in 2022.
Achieving that, in a meaningful way, will not be straightforward. There are two reasons why this change has been slow in coming. First, pensions are the “third rail” in Hong Kong politics, a difficult subject that no single government department has responsibility for, or wants. Second, it has become a den of vested interests, a trough at which trustees and administrators feed.
Fees have gone up
Fees in the system are high because of its design, which necessitates a lot of paperwork. But it’s MPFA staffers who are responsible for reconciling errors in collecting payments and chasing deadbeat employers; the administrators are mostly just paper processors. Indeed there are 200 people at the MPFA tasked with such soul-destroying minutia.
Yet it is the admins and trustees who capture the majority of fees paid into the system. And those fees have gone up.
In 2012, the total fees, expressed as a fund expense ratio, were 1.74% on a base of about HK$430 billion assets. That meant members (the 4.3 million people with an account) paid around HK$7.5 billion (about US$1 billion) in fees that year.
As of January 2019, the FER has come down to 1.52% but on an asset base of HK$858 billion, which means in 2018 those same members paid HK$13 billion (US$1.7 billion) in fees for the same service. The lion’s share is paid to trustees and administrators, with a sizeable chunk also going to fund managers.
There are 14 trustees and 12 fund administrators for MPF schemes, including Bank Consortium Trust (a bespoke group for MPF), AIA, BoCI-Prudential, HSBC, Manulife, Principal, and Sun Life.
In an era when, in the U.S., Fidelity and J.P. Morgan Asset Management are offering ETFs at ultra-low or zero management fees, the status quo for the MPF is clearly failing Hongkongers.
Stuck in the past
There’s more to it than just fees, though. The system was supposedly designed to have free-market competition among fund managers. Its greatest flaw was to also farm out the operations end. The 12 administrators operate their own systems, which don’t communicate with one another. This, plus requirements baked into the original legislation of 1995, make the system a nightmare of paperwork and obsolete requirements (such as mandating that employers submit their monthly contributions by check).
This rigidity has hobbled the ability of MPFA to play a more meaningful role in people’s financial lives. Members end up with new accounts every time they change jobs (or add a gig, if they’re part time). The ineffective MPFA website and heavy paperwork means people rarely bother to consolidate their accounts.
Full portability is impossible until silos are razed
The same goes for getting people to make voluntary contributions. The MPF has over 450 funds among 30 providers, but the siloed, cumbersome nature of the system means it has failed to develop into a competitive marketplace.
So while operations consume most fees, the fund managers themselves have had no incentive to lower their fees, either. And full portability of schemes for members is impossible until these silos are razed.
Time for something radical
It is a sad oddity that MPF, which touches more Hongkongers than any other financial institution, is almost universally viewed as an irrelevant nuisance. This has always been the case: launched in 2000, it was immediately attacked by politicians and business groups in the wake of the Asian financial crisis and the 2003 SARS epidemic, and the then-Chief Executive, Tung Chee-hwa, considered axing the entire thing. MPF survived only because repealing the legislation was too much trouble.
Yet the assets amassed there are now substantial. And the one great achievement of MPF is that, simply, it’s still here. The assets are legally bound to individual members, ringfenced from political meddling, corruption or theft.
MPFA has woken to the need for radical change
MPFA executives have woken to the need for a radical change, not a band-aide. Yet it has taken them two years since the original assignment from the government to come around to seeking out-of-the-box fintech solutions. And this latest “request for information” leaves fintechs and their allies only about a month to gather responses.
DigFin can only speculate as to what sort of tussle over eMPF has been taking place behind closed doors. The government mandate has not changed, however. What seems to have changed is the willingness, or even urgency, to seek ideas beyond those service providers already involved with the system (EY has served as consultant to MPFA for a number of years).
What to do
This is to be welcomed. Here is what needs to be done.
MPFA wants to eliminate the 12 administrators and replace them with a centralized system. These admins are also arms of the 14 trustees, whose role as fiduciaries will continue.
Doing this will require building two large systems. First is a means of routing instructions, collections and benefits. Second is a database.
One reason why MPFA statistics are often late and incomplete is that the MPFA does not have data on its 4.3 members: the 12 administrators do, in their particular systems. The government seems determined now to assert control over user data.
If successful, this could have fundamental, long-term repercussions. If every MPF member has a unique identity in the system, that could be used as the foundation for connecting them to other government and financial services. Today, banking, insurance and investments are blurred, and digital technology is further tearing through the borders. MPF and its assets remain in not-so-splendid isolation.
This opportunity will of course have to be balanced with protecting that data and ensuring privacy. The creation of a centralized platform will bring the risk of a “single point of failure”, i.e. a hacker’s honey pot.
Solutions, not least decentralized computing, exist to address this problem. Collaborative technologies can also help automate processes among trustees, fund managers, employers, and the new C.P.
And while the status quo seems secure, it is also opaque, and technology can introduce transparency – the bedrock of fairness and price discovery.
Furthermore, open API is being phased into the banking sector; the principles should apply to MPF accounts, too – for consolidating funds, for portability, and for connecting MPF to other retirement-related industries (housing, healthcare, leisure).
Imminent 5G advances in mobile communications suggest new ways to integrate MPF-related activities into everyday life.
Robo-advice seems ideal for providing goal-oriented portfolio construction for the majority of people who are confused by the system with its hundreds of choices.
The hardest part may be finding a solution that incorporates the administrators. They may resist or sabotage efforts to pry their grip off their captive fee-paying subjects. But they also have two decades of operational experience in MPF. They are necessary partners.
To win their cooperation will require a vision of a greater-pie retirement system that, thanks to digital technology, is no longer relegated to the fringes of Hong Kong finance and society – but repositioned at its heart.
Half of Invesco’s China sales now via digital
But as the PRC joint venture learns how to distribute digitally, Invesco remains unsure of robo’s role in Asia.
This week DigFin is highlighting three asset-management firms’ approach to digital distribution, particularly in China. See also strategies from AllianceBernstein and BEA Union Investments. Go here for more insights into digital asset and wealth management.
Invesco is using its joint venture in mainland China, Invesco Great Wall, to figure out digital distribution.
The business now manages about $50 billion of assets, of which about 80% is retail, making it the fourth-largest Sino-foreign fund house in China. Over the past two years, half of retail inflows have come from new digital channels, as opposed to the traditional reliance upon banks, says Andrew Lo, senior managing director and Asia-Pacific CEO of Invesco in Hong Kong.
This is in keeping with a broader trend in the global mutual funds industry, which is shifting from one based on products to one focused more on investment solutions. “There’s an emphasis on designing outcomes for clients, such as through asset allocation or structuring,” to combine types of risk and asset classes.
That’s driven both by client demand as well as market volatility and challenges to active fund houses to deliver alpha (outperformance) on a net-free basis, compared to ultra-affordable passive investments tracking a benchmark.
That’s been an emerging story for the funds industry over the past decade. But on top of that is a new wrinkle: the ability to use technology to speed up operations and to reach more people.
“Technology is now changing the distribution landscape,” Lo said. “In China, it’s having quite an impact on reaching retail investors.”
For now this has been a story unique to mainland China, where existing bank channels (which dominate funds distribution in most Asian markets) are not well developed, and where regulation favors digital disrupters like Ant Financial.
The power of digital was evident in Ant’s success with money-market funds (under an affiliated fund house, Tianhong Asset Management), but it has now extended to equity and quant products onshore – products that Invesco’s J.V. now sells through fintech channels, including Ant, East Money Information, JD.com (Jingdong) and Snowball Finance (Xueqiu).
This has not been straightforward, however. Fund management companies are designed to cater to bank distributors, and are built on old-fashioned tech.
“We learned how to do digital marketing,” Lo said. “It’s very different to traditional distribution. It’s iterative, it changes fast, and you have to listen to customer feedback.” Partnering with digital channels has also required a different sense of product design, and to rebuild the company’s operational process to support round-the-clock digital sales and support.
Lo says the experience will be increasingly relevant as other markets digitalize, although they may need to be tweaked, depending on local regulation, client behavior and distributor demands. “Some things we can learn and apply elsewhere as the world goes digital,” Lo said.
The onshore funds market manages about Rmb14 trillion (almost $2 trillion) in total assets among 135 asset managers authorized to sell to retail clients, of which are 44 Sino-foreign JVs.
But most of these JVs are run by the local partner, with foreign shareholders having less influence. They are limited to stakes no greater than 49%, and local partners are often banks or other powerful institutions. One analyst told DigFin that local fund houses are not particularly bold when it comes to digital channels; and even if they are, the lessons don’t flow to the foreign partner.
But Invesco Great Wall’s case is different. Both Invesco and Great Wall Securities own 49%, with two other shareholders holding another 1% each. Given that Great Wall Securities has its own in-house funds business, it has been willing to let Invesco drive the business. (Beijing has recently permitted J.P. Morgan Asset Management to take a 51% stake in its funds J.V.) Invesco Great Wall is also among the oldest funds JVs in China. It is today led by Shenzhen-based CEO Ken Kang Le.
In China, Invesco is leading the way in digital opportunities. Elsewhere it seems to be running with the rest of the herd. In the U.S. and the U.K., it has made digital acquisitions: Jemstep, a B2B robo-advisor that services U.S. bank distributors, and Inteliflo, a British platform to support financial advisors.
“We haven’t found the right use case in Asia,” Lo said. Onboarding a digital B2B (of B2B2C) platform needs scale, but Asia is fragmented, with each market requiring its own business and compliance needs.
“Digital transformation is still evolving,” Lo said. “My guess is it can be like it is in China, where it’s a real thing that has become a major part of the industry.” But what that looks like elsewhere remains hard to know – or at least hard for justifying a business case.
New China distribution not just for money-market funds
Investors on digital platforms are beginning to look to other products, says BEA Union’s Rex Lo.
This week DigFin is highlighting three asset-management firms’ approach to digital distribution, particularly in China. We will also provide strategies from Invesco and AllianceBernstein. Go here for more insights into digital asset and wealth management.
Retail investors in China accessing funds via digital platforms are beginning to diversify away from money-market funds. That is creating opportunities to push ETFs and active funds, says Rex Lo, managing director for business development at BEA Union Investments.
China’s retail funds industry is mainly about money-market funds (MMFs). The total industry size is Rmb13.2 trillion, or $1.9 trillion, of which MMFs account for 57%, or Rmb7.7 trillion.
Among MMFs, by far the biggest player is Tianhong Asset Management, whose product, Alibaba’s Yuebao fund, is Rmb1.2 trillion in size, or $162 billion – the largest money-market fund in the world.
It’s no surprise then that digital distribution platforms in China mainly cater to MMFs. Lo says until recently, MMFs accounted for about 80% of all funds sold on digital platforms. This is propelled businesses such as Tianhong (which of course is sold via Ant Financial) and a few bank-affiliated fund houses with big MMF products, such as CCB Principal and ICBC Credit Suisse.
But it has made digital distribution of limited interest for fund houses looking to sell equity funds or other actively managed products; for them, traditional distribution via banks has remained the only viable channel.
MMFs: less big
Lo thinks this is changing, however.
The popularity of MMFs lies mainly in the fact that they offered high returns combined with guarantees, real or assumed by investors – assumptions the government has been reluctant to upset.
Yuebao and other MMFs usually invest in non-standardized wealth-management products (themselves supposedly “guaranteed”, with investors assuming a government backstop), that returned 5% to 8% to those managers. They in turn offered investors 5%, an equity-like return on what’s meant to be an ultra-safe and liquid asset class.
Over the past few years, however, Chinese banking and securities regulators have been trying to shift the funds industry onto a footing that respects risk and return, and clamping down on the supply of shadow-banking instruments available to portfolio managers.
“Today MMFs return only a little over 2%, while A shares are doing well,” Lo said. “As demand for money market funds declines, turnover has fallen, so these distributors are now promoting index or active funds.”
In recent months, Lo says, MMFs account for only 70% of sales on digital channels, with ETFs now gaining ground.
Accessing the mainland market
BEA Union is able to sell its Hong Kong-domiciled Asia fixed-income fund to Chinese retail investors through a scheme called MRF, Mutual Recognition of Funds.
This program, which began in 2015, allows fund managers on either side of the border to sell eligible products through a master-agent arrangement. Regulators in mainland China have been slow to approve such funds, however, and there are only seven Hong Kong products available via MRF, including BEA Union’s (and 48 mainland funds available for sale in Hong Kong).
Lo is hoping to take advantage of the shifting fortunes among asset classes to use digital channels to push BEA Union’s bond fund.
Platforms such as Ant Financial are requesting the fund house for more material around equities and active funds management. It’s a big, long-term commitment to investor education – especially for foreign fund managers whose ranking is low on Ant Financial and other digital platforms.
“Domestic investors want familiarity,” Lo acknowledged. “But we continue marketing because we want to be on the platform. Today it’s more for exposure than real [inflows], and ticket sizes are as small as Rmb100 ($14). But if you have 100,000 investors, that becomes a lot of money.”
The intention of this ongoing marketing is to become sufficiently well known among Ant’s users to take advantage when retail investors want to invest overseas.
New ways of doing business
Adding platforms such as Ant to traditional distribution methods has been an eye-opener, Lo says. “They don’t think like a traditional finance company. They’re a fintech, so they’re very responsive and open to new ideas. And they’re independent – they’re not a bank with its own funds J.V. – so there aren’t conflicts of interest.”
Marketing was not the only part of business that had to adjust.
“I was amazed when we began to work with these firms,” Lo said. “Enhancements that would take months to get done in Hong Kong take them a few days. We can learn a lot from working with fintechs.” It’s knowledge that will come in handy as more banks in Hong Kong and Asia add mutual funds to their mobile trading apps, as Standard Chartered did earlier this year.
There are limits, however, to how far a fund house can go selling products on mainland China’s digital platforms.
Those channels are limited to funds from either local licensed retail-facing houses, or offshore products eligible via MRF. The retail funds market in China, at $1.9 trillion, is only a fraction of the total investments industry, which is about $9.7 trillion – but that includes separate licensed businesses for asset managers linked to insurance companies, or to trusts, or to banks. Those businesses for now can’t market to retail or use sell via e-commerce players.
BEA Union is a joint venture formed in 2007 between Bank of East Asia and Germany’s Union Investments. Its initial business model was to service local pension and insurance customers, so its investment expertise has been mainly in Asian fixed income. It has since developed funds in Hong Kong and Asia equities, and its total AUM is now $11.2 billion.
It is the only foreign fund house to establish a wholly owned foreign enterprise (Woofie) in Qianhai (part of Shenzhen), as opposed to Shanghai. This was partly because the authorities in Qianhai were very welcoming, and because Bank of East Asia has a presence in southern China, and the fund house hopes to take advantage of this should cross-border opportunities emerge (under the concept of a “Greater Bay Area”).
This medium-term ambition is another driver of BEA Union’s strategy to build an online brand on Ant Financial and other digital platforms.
AllianceBernstein looks to add value to digital channels
Ajai Kaul, regional head, says the buy-side battleground is moving to banks’ evolving digital distribution.
This week DigFin is highlighting three asset-management firms’ approach to digital distribution, particularly in China. We will also provide strategies from Invesco and BEA Union Investments. Go here for more insights into digital asset and wealth management.
Asset managers need to be ready to work with banks’ digital capabilities to reach retail investors.
Ajai Kaul, the Asia ex-Japan CEO at AllianceBernstein, a $580 billion investment firm, says digital distribution remains a puzzle for the industry. Although new channels are emerging, particularly in China, asset managers will likely adapt to what their existing distributors do online.
“Banks have the capital and the captive client base,” he said. “As asset managers, we deliver a product and service the client, including their digital engagement. So we need to understand how we’re going to plug into what banks are doing.”
Over the past two decades, banks in Asia have transitioned away from supermarket approaches involving dozens of manufacturers to a core set of perhaps 20 asset managers on the shelf.
Banks represent the vast majority of sales to retail investors in the region, so asset managers remain dependent keeping these relationships. Although buy-side firms recognize the importance of “digital transformation”, in Asia at least they are waiting to see which way their distributors move.
Follow the banks
“Banks are already responding with their own digital strategies and we need to continue to engage them and plug into their platforms,” Kaul said, adding this is likely to be more around operations, education and reporting than marketing or front-office activities. “We’re having conversations now about what this might look like…I do not believe banks are about to cede customers to the digital and online service providers.”
One aspect is likely to change how asset managers support distributors with things like marketing material. This will increasingly be less about papers and statements, and more about real-time online communication. And it will change the way asset managers arm financial advisors, bank salespeople and other intermediaries with information about their products, and about investing.
“People want convenience,” Kaul said. “They’re used to instant transactions. But we need to ensure that they understand what they’re buying.”
That principle sounds simple but it’s not clear how it will materialize. Does that information get communicated at point of sale, or via a continuous stream of back-and-forth with investors? Who is responsible for education – and who finances it?
The prize for getting this right is data-driven insights that enable fund mangers to build better products, with more tailored, suitable features, be it about liquidity, or asset classes, or risk. “You can scale faster if you get a real insight,” Kaul said. “And there’s a lot of data – if you ask the right questions.”
What about direct?
Is there a point at which asset managers will also go direct to consumers?
Kaul says this could emerge as a complementary strategy, but: “We’ll always be working with banks. Wealth management and financial advice are just tools for banks, along with loans, credit cards and foreign exchange.”
In other words, banks will retain the overall customer relationship, at least as far as asset managers are concerned – although banks themselves are now eager to cement their customer relationships in the face of being themselves swallowed up into “ecosystems” dominated by consumer-facing tech platforms.
Kaul is also looking at more direct digital channels, notably in China, where AB, as the firm is known, is licensed as a private fund manager, which can raise money from professional investors but not retail.
This makes PFMs unappealing to domestic banks, which can’t sell their products to their retail clients. Most sales are institutional in nature, but digital channels are becoming relevant.
This is still however more theoretical than real for firms like AB. But Kaul and his colleagues are putting time into studying the market.
“We need to understand mobile platforms and how we engage with them, in general,” he said. “In mobile environments, we can’t just be a product on a shelf.”
The China experience
So far the majority of funds sold in China through such channels are money market funds. But platforms such as Ant Financial, EastMoney and WeChat are beginning to develop more advice-based services that will help users with financial planning.
“How does a fund manager add value?” Kaul said. “If a transaction is on a mobile phone, that’s a very small piece of visual real-estate to work with, or become prominent on.” Fund products are usually three, four or five clicks away from where users spend their time on these platforms. Foreign fund managers do not enjoy brand recognition in China. “Just being a product isn’t sufficient to win traffic,” Kaul said. “You have to present something of value that creates interaction between the user and AB.”
He says China offers a good place to begin this learning process, given the popularity of these channels for everyday use. And within the Chinese context, these digital platforms are similar – if a fund house can master one, it can adapt a similar method to the others.
What’s special about mainland China isn’t the platform so much as it’s the investor culture, which ever since the stock markets appeared in 1990, have been habituated to short-term trading.
“How we build and deliver product may not match the local wealth market, which has developed its own biases toward duration, time horizons and the purpose of investment,” Kaul said. “But the population there has fully embraced mobile platforms, as we can see by the sheer volume of transactions now taking place. China is the front line of innovation.”