The Chinese Pension System
February 12, 2025
Entrepreneurs who start up new companies have to deal with a lot of different types of stakeholders. As a result, they have to enter into a wide variety of agreements with these different stakeholders. Over the course of time, it is possible that the entrepreneur and an external party may not agree on some of […]
Banks in the modern world face an inherent risk of insolvency. Since the banks are so highly leveraged, there could be a run on the bank any moment if their reserves are considered to be inadequate by the market. Hence, banks must maintain adequate capital in their vaults if they want to survive. However, what […]
In the previous article we learned that free cash flow to the firm is closely related to the concept of cash flow from operations. The major difference was in the way free cash flow to the firm (FCFF) treats long term capital expenditures versus how they get treated in the regular cash flow statement. The […]
Formula Price to Sales Ratio = Current Market Price / Reported Sales Revenue Many companies state their revenue after removing the effects of onetime events whereas others continue to state the revenue without any adjustments. Meaning The price to sales ratio tells an investor how many dollars they are paying for every dollar that the […]
While valuing firms, free cash flow has to be calculated over a number of years. Hence, there is a good chance that the firm may change its financing policies during such a long period. It is for this reason that we need to consider what happens to the cash flows in the event financing policies […]
Pension funds are one of the most regulated financial investment vehicles in the world. Pension funds all over the world are subject to various types of restrictions. These restrictions affect every part of the pension funds’ operations. The governance mechanisms have to rigorously be followed while funds are being taken in, invested, accounted for, and disbursed.
However, it also needs to be understood that pension funds all over the funds are not subject to the same type of regulation. The rules that govern the regulation of pension funds are quite different in almost every country. However, these rules emanate from two basic systems of pension governance.
These two systems are called the “prudent person rule” and the “quantitative restrictions system” In this article, we will have a closer look at these two systems of pension governance.
The prudent person principle is a set of rules which attempts to control the way in which decisions are made when it comes to pension fund investments. This means that the regulations do not require the trustees to have exceptional expertise or to follow a particular schedule. Rather the trustees are expected to behave in a manner that would enable them to preserve the capital which grows at a reasonable rate.
The prudent person rule does not levy any explicit restrictions on the type of investments that the fund managers choose. However, since they are legally required to be prudent, it is safe to assume that questionable investments such as penny stocks or cryptocurrency are not considered an option while making investment decisions. The prudent person principle provides a lot of freedom to trustees and fund managers while expecting them to be rational and ethical.
As a part of the quantitative restriction method, there is an explicit list of instruments that pension fund managers can choose from. There is a clear and tangible demarcation between the types of investments that are allowed and the ones that are not allowed. Also, there are rules governing the types of financial instruments which are allowed.
There is a maximum percentage of the funds in the portfolio that can be allocated towards asset classes. For instance, governments can mandate that not more than 40% of the fund’s assets can be held in equity assets. This means that the portfolio managers will be required to continuously rebalance their portfolios to ensure that they are complying with the law.
It has been observed that countries that have relatively well-developed economies and financial markets choose the prudent person rule as their regulatory principle. However, countries that are not as developed rely more on the quantitative restrictions system. This choice is governed by certain factors which have been listed below:
For instance, if a large number of pension funds follow the defined benefit method, then the government is more likely to impose a quantitative restriction system. This is because the government indirectly becomes responsible for guaranteeing pension payments. On the other hand, if defined contribution plans are commonly followed, then the government is more likely to follow the prudent person rule.
Hence, it can be said that there are two main types of governance systems when it comes to the regulation of pension funds. The choice of the governance system depends upon a wide variety of factors. This choice has a significant implication on the performance of pension funds worldwide.
Your email address will not be published. Required fields are marked *