The Regulation of Pension Funds

Almost all types of financial products are supposed to be regulated. Most of the stocks and bonds that we can buy in the financial markets have been vetted by regulatory agencies before they can be sold to the public at large. Some degree of regulation is important since it forms the basis of working in a capitalist system. However, when it comes to pension funds, the degree of regulation is quite high.

Governments all over the world take a lot of interest in ensuring that pension funds are closely regulated. Each investment made by pension funds is audited to ensure that it follows the highest moral and ethical standards. A lot of people believe that pension funds are excessively regulated and that this excessive regulation is an impediment to the functioning of pension funds.

In this article, we will have a closer look at what pension fund regulation is and what are the factors which make it necessary to closely govern the functioning of pension funds.

What is Pension Fund Regulation?

In order to understand the importance of pension fund regulation, it is important to first understand what constitutes pension fund regulation. The following activities are considered to be related to pension funds governance:

1. Setting up rules which form a framework that can be used to ensure that the money in pension funds is used for the betterment of the investors and not embezzled by functionaries and intermediaries.

2. Creating explicit moral codes of conduct and clearly defining the fiduciary duties which need to be performed by pension fund personnel.

3. Creating procedures to ensure that the rules which have been created are followed diligently. Also, levying fines, and penalties and taking corrective action to ensure that the rules are followed in letter and in spirit.

4. Controlling the level of risks that can be taken by pension funds. This is done by controlling the asset classes in which the pension funds can invest money and also by controlling the proportion of total assets which can be invested in a certain pension fund.

Pension fund regulation ensures that the interests of the investors are protected from unscrupulous financial practices. It is important to distinguish between regulation and supervision.

Regulation is about creating a framework of rules and creating a system of checks and balances. The actual work of supervision is often delegated to different authorities. Regulation is a higher-level activity whereas supervision is a day-to-day level activity.

Why is Pension Fund Regulation Required?

There are many economic experts who believe that pension funds should not be regulated so closely. However, there are certain factors that make it more important to closely regulate pension funds. Some of these factors have been written below:

1. Job Security: For most people, a pension is provided by their employers. Hence, they are quite hesitant when it comes to voicing their opinion about their pension funds. They believe that since the employer has chosen the service provider, any opinion stated against the pension fund will be considered to be an opinion against the employer. This makes many investors nervous about their job security.

   As a result, investors decide to not raise their voices even if they have some concerns. It is for this reason that a strong regulatory body is required which takes cognizance of the interests of the investors on its own and controls the working of pension funds.

2. High Degree of Complication: The pension fund is a complex financial product. The money is invested every month and the value of the pension fund is also split across many asset classes.

   Hence, in order to truly evaluate the working of a pension fund, a financial expert is required. This is because analyzing the working of a pension fund requires knowledge about advanced concepts related to the time value of money as well as the characteristics of various types of asset classes. Since it is impossible for every investor to have this knowledge, a regulatory body is created in order to represent the interests of a pension fund investor.

3. Huge Impact: Most investors contribute money to pension funds for a long period of time. Hence, the amount of money accumulated in pension funds becomes quite significant.

   A lot of investors have a significant amount of their net worth locked up in pension funds. Hence, if the value of their pension fund drops suddenly, they will be forced into old-age poverty. Since governments will have to provide welfare for these people, they try to take preventive measures to ensure that the pension funds are closely regulated.

4. Lack of Transparency: Last but not the least, pension funds in many parts of the world do not openly disclose data relating to their investments and work.

   Many pension funds have started investing heavily in assets such as cryptocurrency and private equity. These asset classes are known for being opaque. It is the job of the regulator to ensure that the interests of everyday middle-class people are thoroughly protected when pension funds start undertaking excessive risks.

The bottom line is that pension funds need to be closely regulated. The lack of regulation will create an atmosphere where the retirement savings of people will be endangered. This will create a situation wherein people will stop investing in pension funds altogether.

Authorship/Referencing - About the Author(s)

The article is Written By “Prachi Juneja” and Reviewed By Management Study Guide Content Team. MSG Content Team comprises experienced Faculty Member, Professionals and Subject Matter Experts. We are a ISO 2001:2015 Certified Education Provider. To Know more, click on About Us. The use of this material is free for learning and education purpose. Please reference authorship of content used, including link(s) to ManagementStudyGuide.com and the content page url.