The retreat conclaves that were held around the turn of the decade were instructive affairs for people like me. This was the pre-National Pension System (NPS) era. Participants, typically policymakers, think tanks, fund managers and annuity providers, reflected on pension plan design, regulation, ecosystem and global best practices. Time was spent discussing occupational pensions in the organized sector. During the sessions, everyone turned to EPFO bashing. The focus was not on delivery and results, but on the allocation of EPFO’s assets and its funds. Speaker after speaker lamented the lack of choice in asset allocation. It was a time when pension plans only invested in government securities and PSU bonds. Everyone was thinking about liberalizing asset allocation (read: introducing equities). There were hints of dissent with the occasional speaker citing the speculative nature of equities and suggesting the EPFO remain focused on fixed income.
Some of the suggested changes made their way into policy several years later. Three years ago the government liberalized the investment guidelines for pension fund trusts. While the highlight of the change was the introduction of equities as a mandatory investment category, other notable changes included a greater choice of fixed income securities, more corporate bonds and a wider range of instruments to choose from. These changes have caused some euphoria among pension fund managers. Pension funds affected by falling interest rates after demonetization rushed into NBFC debt for a variety of reasons: diversification and returns.
But the fears of opponents are not unfounded. While the journey with equities has been fraught with uncertainty, surprisingly greater risks have emerged in fixed income securities. The singularly most significant event this year in the area of pension funds was the default of IL&FS and the resulting pressure on NBFCs. Emphasis has been placed on the impact on other asset aggregators such as mutual funds, banks and insurers, but if these institutions have buffering mechanisms (reserves, shareholder injection, investor acceptability) to manage stress, FPs will face greater challenges due to beneficiary resistance and sponsors also bear the impact of the haircut and the archaic regulation that imposes the impact of these haircuts on employers. It may also be more difficult to assess the impact on FPs since MTM (mark-to-market) is not the predominant accounting standard. While the immediate impact is felt on employees, employers and government, the long-term consequences of the IL&FS and NBFC crises are greater.
Consolidation in the retirement landscape: It is expected that many small and medium-sized pension funds with limited risk-taking capabilities and limited attention to governance will consolidate into larger pools such as EPFO and LIC. Such consolidation is good from a policy and regulator perspective because it improves oversight and reduces costs for regulators. But it’s unclear whether larger institutional pension funds will be able to tailor their provision to meet beneficiaries’ service expectations. Furthermore, such consolidation results in a unique impact on design and delivery – the bane of Indian pension. Remember that most exempt FPs operate due to the inefficiency of the services of larger institutional alternatives.
Focus on governance and supervision: This year’s events will also allow for greater emphasis on guardianship and governance of investments. The role of the trustee in a trust, the responsibilities and obligations of the trustee will be highlighted. Equally important will be the governance surrounding trusts and how they operate. The operation of these plans has been focused on compliance and regulation. Accounting, controls, reporting, governance, investment control will become important pillars of their operation. Indeed, the sophistication with which these plans must operate due to their size and the lives they affect is significant. The days of entrusting the operation of the trust to the local accountant are over.
A potential setback: The NBFC issue is not the first time pension plans have faced risk. Long before this crisis, defaults were occurring from IFCI and various state government enterprises. Pension fund trusts were then saved by government intervention, lackadaisical accounting and an era of small pension fund trusts. Little has changed since then. Limited and unviable exit options, coupled with the inability to engage in costly litigation and the constant need to invest in such instruments, remain a recipe for toxic risk. Little has changed on the supply side as well. A retreat towards security may not be unthinkable.
As the reality dawns on the extent to which the IL&FS and NBFC crises have burned pension funds, we must ask ourselves a question that was asked all those years ago – in pension conclaves – the money pensions in India may be ready for broader asset allocation but are these markets ready for pension money?
Amit Gopal, India Business Leader – Investments, Mercer
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