Pension Funds
The Chinese Pension System
February 12, 2025
Pension funds are large investment funds that control trillions of dollars worth of investments worldwide. Pension funds exist in almost every important economy of the world. Hence, pension funds are controlled by many different types of regulators.
Despite this heavy policing of the activities of pension funds by regulatory bodies, they still face a lot of challenges when it comes to governance. There have been many instances where investors of pension funds had to bear losses because of the lack of good governance.
In this article, we will have a look at some of the governance-related challenges being faced by pension funds.
- Front Running: Front running is an important problem being faced by pension funds across the world. Front running is when managers of pension funds use insider information to gain personal financial benefits. For example, if the manager of a pension fund knows that the fund is going to purchase a certain stock, they can take a position early in that stock.
Hence, when the fund starts buying the stock and the stock price begins to rise, they can divest their shares and earn a handsome profit.
Front running is illegal in most parts of the world. However, regulators have found it very difficult to control the information and actions of people associated with pension funds. This is why despite many regulations being passed, front running remains an important problem as far as pension fund governance is concerned.
- Conflict of Interest: Conflict of interest is another mammoth problem that the pension fund industry has been grappling with. Conflict of interest arises when pension fund employees who hold important positions in the fund misuse their power to gain personal financial advantage.
For instance, pension fund managers have control over the investments of the firm. They have the power to select the stocks in which the money of the general population will be invested. Hence, there have been cases where stock brokers or promoters of companies have bribed pension fund managers in order to attract fund investment. The end result is that the investors in the funds obtain sub-optimal returns and the promoter benefits.
Pension fund officers have been known to accept kickbacks in lieu of influencing the fund’s investment decision. Many pension funds do not provide full authority to select the investment portfolio to a small group of people. However, time and again, influential managers have been found to be involved in a conflict of interest-based scenarios. Even though there are strict laws that can lead to imprisonment, pension funds are still struggling with corruption in their ranks.
- Internal Controls: The large amounts of money that pension funds control need to be invested carefully. Many times, the employees may not be corrupt. However, it is likely that they can be incompetent and incapable of managing such large sums of money. Hence, it is important to have internal controls in place in order to ensure that any employee is not able to wrongly invest the pension funds money.
The Barings bank case is a famous example when a rogue trader was able to bring down an entire bank due to poor decision-making. Pension funds need to have strong controls in place to ensure that investors do not have to bear losses because of the negligence or incompetence of the pension fund workforce. This can be very difficult to implement since fund managers generally want autonomy when it comes to making investment decisions.
Increased autonomy also has a significant correlation with better investment performance. This is the reason that striking a balance between internal controls and the autonomy provided by fund management can be highly challenging.
- Problem of Scale: All pension funds do not face similar problems. There are many pension funds across the world that operate on a much smaller scale as compared to larger pension funds. Hence, they do not have access to the best human resources as well.
A lot of the management, as well as employees in these pension funds, are not capable enough to handle the complex management needs of a pension fund organization. This often creates a governance problem because in such cases neither the guidelines are properly laid out nor are they followed correctly.
- Political appointments: Last but not the least, pension funds are influenced by governments and political bodies. This is particularly true in the case of developing countries. This is because of the fact that government bodies do want access to funds at lower costs for large periods of time. Since pension funds control the funds with this same risk and maturity profile, governments and politicians have an interest in manipulating the functioning of the pension fund.
Political leaders often undertake vanity projects which do not have a high chance of generating a positive cash flow in the future. These projects are often financed by pension funds. In order to ensure that such financing continues unabated, governments often try to keep their people at the helm of a pension fund. This creates governance problems for the industry as a whole.
The bottom line is that there are some significant governance-related challenges that are being faced by pension fund organizations across the world. The industry needs to pay due attention to these challenges. However, each and every one of these challenges are complex problems that may not be very easy to resolve.