Pacific Pension Institute Asian Roundtable, Kuala Lumpur 11 November 2011

1. Pacific Pension InstituteAsian Roundtable, Kuala Lumpur 11 November 2011 Pension Reform: Issues in Asia Andrew Sheng President, Fung Global Institute Adjunct Professor, University of Malaya

2. Outline • The global financial crisis (GFC) has changed many fundamentals • Implications of GFC on Pension Schemes • How are Asian pension schemes rated? • Key issues for Asian pension designs • Concluding Thoughts

3. Changes since Asian Pension Fund Roundtable, November 2007 Singapore • Asia showing signs of perfect storm of increasing elderly population (EDR) and declining youth dependency ratio (YDR) • 2008 global crisis caused losses of $5.5 trillion in retirement savings worldwide • 2010 Allianz study suggest that more people exited workforce than youth entering in Europe. This is leading to lower growth, increased public expenditure on pensions, health and aged care. • Pension funds forced to re-think portfolio structure, moving more from defined benefit to defined contributions.

4. We live at a time of grave confusions as the world undergoes tectonic shifts • The convergence of secular global mega-trends has changed not only our thinking, but also the role of Pension Funds in macro-economic and micro-economic planning, strategy and implementation. • These megatrends include: global re-balancing (rise of BRICS); changing demographics; social network technology; effects of climate change and social tension – income disparity, unemployment, water stress, terrorism • Finance remains too large relative to real side of the economy [deleveraging only beginning) 4

5. Current analytical tools inadequate for making sense of the world • Our current tools of analysis have failed us, in terms of flawed theory, faulty data, wrong diagnosis and blundering prognosis • “The difficulty lies, not in the new ideas, but escaping from the old ones.” – John Maynard Keynes • Investing in new environment requires back to basics analysis of what is value in world of huge distortions • As parts of Asia begins to age and wealth increases, time to think seriously about what is the right pension model and its impact on long-term competitiveness, financial sustainability and social equity. 5

6. Current State - Overview

7. A Growing Crisis of Confidence Banking Private debt • Systemic banking crisis spreads from US to Europe • Subprime crisis originates in US banks Sovereign • Problems in euro periphery sovereign debt • Medium-term debt burdens in core AE Political • Difficulty in reaching political consensus on fiscal consolidation and adjustment

8. Cumulative Spillovers from High-Spread Euro Area Sovereigns to the European Banking System (€ bn) Euro area sovereign risks have spilled over to the EU banking system ... €300 €200 €80 €60 Spillovers from . . . Greek sovereign Irish & Portuguese sovereign Belgian, Spanish & Italian sovereign High-spread euro area banking sector

9. Global finance is going through major transformation • In the advanced markets, finance has become too large, too leveraged and too speculative to serve the real sector. • Although Asia is less hurt by the European crisis, Asian finance faces different challenges on how to meet Asian real sector needs – large scale infrastructure investments, SME credit, long-term pension and consumer needs. • At the same time, Asia needs to cope with inflation, exchange rate appreciation, volatile capital flows and asset bubbles.

10. Re-balancing: Deficit countries vs. Surplus countries Capital Flows to rise to US$825 Billion in 2010 - IIF 10

11. Globalised Finance is Interconnected and Interactive Source: McKinsey Global Institute（2009）

12. Asian Financial Markets Even long-term funds have not escaped market crash

13. 2. Asian financial markets • Current financial crisis has triggered a fundamental review of the international financial order and architecture • Clear trends are shaping the road ahead: tighter regulation driven by a strong attention to public risk, policy coordination, and the shift of geopolitical, economic and financial power to the emerging markets • At the same time, internationalisation of renminbi (and forthcoming rupee internationalisation) will have a major impact on Asian economies and businesses

14. Asian finance has excellent prospects due to favourable demographics, high savings and growth • By 2050, estimates are the Asia will have half of global financial assets, with major financial centres located in Asia (Hong Kong, Singapore, Shanghai, Mumbai, Sydney, Tokyo, Seoul). Major centres for asset management and insurance must evolve, with depth and liquidity • By then, at least three Asian currencies will be global – Yen, RMB and Rupee. Asian currencies will play major roles in SDR and international financial architecture. • Asia will be partners in global price-making and rule-making

15. Asia continues to rely heavily on global financial intermediation • Global financial intermediation conducted in reserve currencies – the dollar and euro – continues to be dominated by giants based in New York and London • The top 5-10 banks typically account for 50-80% of total financial business (esp. in financial derivatives) • Global banks also dominate most of emerging market corporate and investment banking business, due to their willingness to invest in people and knowledge. • To compete, Asia needs to have regional players with regional footprints

16. China is emerging as a major investor in terms of both direct and portfolio investment • China's outward foreign direct investment (ODI) has surged since 2003 • In 2009, China’s ODI reached US$56.53 billion, nearly 20 times 2003 levels, and accounted for over 5% of global FDI

17. Closer integration, not just in economic but also in financial terms, could enhance stability • Asia needs to mitigate high degree of volatility of capital flows and asset prices • Measures would include possible uniform Financial Transaction Tax and macroprudential measures to control asset bubbles. • Further upgrading of Asia's liquidity support system (the Chiang Mai Initiative Multilateralisation (CMIM). On May 4, 2011, the ASEAN+3 Macroeconomic Research Office (AMRO), an independent surveillance and regional monitoring office, was established.

18. Investing in an Uncertain World

19. How the Melbourne Mercer Global Pension Index is calculated

20. Netherlands, Australia, Nordic countries performed well

21. Asian pension funds ranked poorly in Mercer Index Source: Melbourne Mercer Global Pension Index

22. Global assets under management (AUM) recovered in 2010 to $35 trn, but not net inflows Source: McKinsey Global Asset Management database

23. Inflows into Emerging markets, but not into maturemarkets Source: McKinsey Global Asset Management database

24. Total Institutional Investors grew to $60 trillion end-2009, down from $63 trillion in 2007 (IMF data)

25. Bulk of funds AUM came from Pension Funds, Retail and Insurance companies

26. Asset allocation: equities share declined relative to fixed income, but Alternative assets rose from 11% to 15% (2006 to 2010)

27. CAGR Percent • 4 • 4 • 3 • 5 • 1 • 2 • 3 ASIA EMERGING AS GROWTH ENGINE FOR NEXT TWENTY YEARS Regional share of world GDP, Percent • Eastern Europe • ME/A • Rest of Americas • Non-Japan Asia • Japan • Western Europe • North America Source: Global insight

28. Global Share of Capital Markets, 2010 US$ trillion(IMF GFSR: Table 1)

29. Recent Market Trends in Asia • Deposit-taking Institutions – demographics changing customer pattern – growth of consumer banking, wealth management products • Risk-pooling Institutions - still foreign dominated, but demand growing • Contractual Savings Institutions - huge liquidity pools, but shortage of professional fund management skills • Market Makers - key investment banking skills still dominated by large foreign players, with foreign fund managers as key clients • Specialized Sectoral Financiers - policy-based bank role being re-evaluated; venture capital and private equity more important • Financial Service Providers – exchanges demutualizing and possibly alliances with regional and global players

30. Changes in Fund industry • Central banks have begun to invest in alternative assets and equity • Sovereign Wealth Funds growing in importance • Rise of ETFs, REITs and Commodity funds • All investment strategies are being influenced by Zero Interest Rate Policies, Quantitative Easing and Chase for Yield • With faster computerized trading and algorithms, very difficult for retail and emerging pension funds to compete in terms of speed of execution • In many emerging markets, retail investors have moved into sidelines

31. What premises of investment theory have changed? • Efficient Market Hypothesis • DCF Valuation of Assets • Bonds are safer than stocks • ETFs are low-risk bets on market • Diversification reduces risks • Markets are not random, information is imperfect, and can be manipulated • What is value when Discount rate is zero? • Even sovereign debts can have high default risks, but are not priced right • Delta One trading – ETF based on market indices that could be artificial • Markets highly co-related with each other. Liability Diversification increases risks. 31

32. FTSE EDHEC-Risk Efficient Indexes:August 2011, September 23, 2011 • United States -5.01% • United Kingdom -3.96% • Eurobloc -10.12% • Developed Europe -8.02% • Dev. Europe ex. UK -9.55% • Japan -5.36% • Dev. Asia ex. Jap. -7.09% • Asia-Pac. ex. Jap. -7.31% • Asia-Pacific -6.32% • Developed -5.93% • Emerging -6.39% • All World ex. US -6.68% • All World ex. UK -6.10% • All World -5.99% • EDHEC-Risk Alternative Indexes: Aug 2011 (Estimates) • Conv. Arb. -2.09% • CTA Global 0.27% • Dist. Sec. -4.08% • Emg. Mkts -3.90% • Eq. Mkt Neut. -1.64% • Event Driven -3.78% • Fix. Inc. Arb -0.68% • Global Macro -0.34% • L/S Equity -4.07% • Merger Arb. -1.20% • Rel. Value -1.86% • Short Selling 6.97% • FoF -2.57%

33. Re-think Capital Markets to Protect Savings • Economies that failed to change governance during demographic endowment period and have not built up capital markets to protect real savings in the long run, will find growth slowing as the demographic burden begins to grow. (Japan lesson) • Need to address education, labour flexibility to changing economic needs, social inequality, deteriorating environment and rising health care burdens that add to social costs. • Every economy with an aging demographic problem must build its capital markets and retirement funds to protect the real value of pensions when its labour force begins to retire. • Irony of super Asian household savers who cannot afford to spend when old

34. Re-think Financial System relationship with Real Sector • As China and others go through Lewis turning point, real wages will rise and savings growth will slow • As households age, greater expenditure will be spent on medical and support care – households will need higher retirement income • Government fiscal debt are reaching higher levels as there is global drive to lower tax rates and increase welfare expenditure – room for pension contributions limited • Asian corporate governance need to switch from high investment model to high dividend and transparent model • Hence, we need to re-examine the impact of pension schemes on labour market efficiency, labour mobility, consumer expenditure and fiscal positions. • Need to think beyond conventional portfolio strategies to thinking long-term impact on economy and strategic risks

35. Queries on current strategies • Long-term funds are not exploiting advantage of being long-term – hedging and quarterly reporting also making them pro-cyclical in market behaviour – investment strategies often influenced by short-term trading and model driven • Need to re-think role in corporate governance and social responsibility – lack of institutional interest in forcing corporate management to deliver value • Long-term funds should begin to invest in future by having greater long-range planning and input into pension design

36. Observations • Pension funds are natural institutions to think about long-term structural issues facing the economy and the impact of globalization on pension burdens and social welfare • Young economies with demographic endowments can afford not to worry about pension design. • Aging economies must think this through before the demographic deficit creates structural “hardening”, fiscal unsustainability, distortions to corporate efficiency and financial fragility

37. Thank You Questions to as@andrewsheng.net