LegCo Subcommittee on MPF System
Information Note
Separation of Assets

Purpose

This paper describes the proposals on the separation of scheme assets, comprising -

Protection of Scheme Assets

  1. the prudent manner to hold assets of a registered scheme separate and to keep them distinct from the personal assets of the employer, the trustee and the custodian (paragraph 2 below); and
  2. the circumstances that assets of a registered scheme could be subject to a charge, pledge, lien, mortgage, or other encumbrance (paragraphs 3 to 5 below).

Restricted Investments

  1. loans to the relevant employer or associate (paragraph 6 below);
  2. investment of an employer sponsored scheme in shares or other securities of the employer or its associates (paragraph 7 below);

Proposal

Protection of Scheme Assets

Separation of Scheme Assets from Employer, Trustee and Custodian

2. We propose that assets of a registered scheme shall be at all times -

  1. maintained separate from the assets of the employer, the trustee, the custodian and other custody providers;
  2. credited to the account of the scheme on the books and records of the trustee of the scheme;
  3. registered, held, recorded, identified or otherwise controlled in such manner, as may be established and customary or may otherwise be prudent, in the circumstances; and
  4. be applied only for the purposes of the scheme.

Charge, Pledge, Lien, Mortgage or Other Encumbrance

3. We propose that assets of a registered scheme shall not be subject to any charge, pledge, lien, mortgage or other encumbrance except -

  1. the trust governing the scheme;
  2. any charge, pledge, lien, mortgage or other encumbrance created for the purposes of securing loans necessary for meeting the liabilities of the scheme; and
  3. any charge, pledge, lien, mortgage or other encumbrance granted in the normal course of business to acquire for valuable consideration any interest in the assets of the scheme.

4. We further propose that any charge, pledge, lien, mortgage or other encumbrance created over the assets of a registered scheme shall be void to the extent to which the creation contravenes paragraph 3 above.

5. We propose that the trustee may only borrow on behalf of the scheme -

  1. for the purpose of -
    1. making payments on the withdrawal or portability of accrued benefits (without resort to a distressed sale of the assets of the scheme) provided that the borrowing is for a term not exceeding 90 days; or
    2. covering settlement of a transaction for the acquisition of investments where it was likely that the borrowing would not be needed at the time the relevant investment decision was made and the term of borrowing does not exceed 7 days;
  2. the amount of borrowing should not exceed 10% of the value of assets of the scheme; and
  3. the borrowing is not part of a series of loans or other transactions and repayments.

Restricted Investments

Loans to Employer or Associates

5. We propose that loans to the relevant employer or associate, other than loans made by way of deposits with authorized institutions within the meaning of the Banking Ordinance (Cap. 155) or foreign banks with a minimum short term rating of ‘A-1’, should be prohibited.

Investment of an Employer Sponsored Scheme in Shares or Other Securities of the Employer or its Associates

6. We propose that the investment of the assets of an employer sponsored scheme in shares or other securities of, or issued by the employer or its associates should be subject to both of the limitations in (a) and (b) below -

  1. such shares or other securities should be limited to -
    1. shares or other securities listed on the Stock Exchange of Hong Kong or other recognised stock exchanges; or
    2. bonds, convertibles or other debt securities with a minimum credit rating of "BBB" or equivalent;
  2. not more than 10% of the assets shall consist of such shares or other securities including covered warrants issued by a third party on the shares of the employer or its associates but excluding covered warrants issued by an associate of the employer on the shares of a third party.

7. Notwithstanding paragraph 6, an employer sponsored scheme where the employer is a government, a government agency or associate, may invest in government or other public securities meeting the restrictions and guidelines on debt securities.

Justification

Protection of Scheme Assets

Separation of Scheme Assets from Employer, Trustee and Custodian

8. The proposal in paragraph 2(a) above is intended to keep the assets of a registered scheme out of the reach of creditors of the employer, the trustee, and the custodian in cases of bankruptcy. Paragraph 2(b) deals with how assets of a scheme should be accounted for by the trustee so that a record of scheme-specific allocation of assets can be maintained.

9. It is recognized that various custody providers are involved in the custody of scheme assets and there are variations in international market practices in the custody of securities. The proposal in paragraph 2(c) above is intended to provide a flexible approach to the exercise of the duty of prudence by the trustee for him to make the scheme assets traceable through potentially various levels of custody providers (e.g. the trustee, the global/master custodian, the local subcustodian and the central securities depository) under different market conditions.

10. The proposal in paragraph 2(d) is to ensure that assets of a scheme should only be applied for the purposes of the scheme in accordance with the governing rules of the scheme consistence with the provisions of the Ordinance.

Charge, Pledge, Lien, Mortgage or Other Encumbrance

11. As a matter of ordinary commercial practice, it is necessary to supply certain assurances or security to a lender before he may agree to lend. The proposal in paragraph 3(b) above traces the language of the relevant section of ORSO, which recognizes the necessary advances of money incurred to meet bona fide liabilities of a registered scheme. In the event of insufficient cash to meet unexpected large payments, the trustee of a scheme may resort to temporary borrowing to enable him to make benefit payments of the scheme rather than a distress sale of scheme assets.

12. The proposal in paragraph 3(c) above also traces the language of ORSO, which recognizes the benefit of permitting charges, pledges, liens, mortgages or other encumbrance to be granted in relations to acquisitions of interest in the assets of a registered scheme. Temporary borrowing is used to cover settlement of a transaction for the acquisition of securities when there are unanticipated delays or difficulties in the settlement of an earlier disposition transaction.

Restricted Investments

Loans to Employer or Associate

13. As proposed in the information note on Investment Restrictions and Guidelines, the provisions of loans would be prohibited outright, except where the loan is made by way of deposits with qualified banking institutions.

Investment of an Employer Sponsored Scheme in Shares or Other Securities of the Employer or its Associates

14. Many retirement schemes in Hong Kong have invested into stocks listed in the local exchange and such investment opportunities should be made available to the schemes of the listed companies themselves. The scheme of a locally listed company may also want to invest a portion of assets into shares of the company and its listed associates in order to closely follow the performance of the local stock market. A similar case can be made for qualified debt securities of the employer or its associates. To allow flexibility, it would be reasonable to permit a small percentage of scheme assets to be invested into the listed shares and qualified debt securities of the employer or its associates. Our proposed 10% limit is adopted from the Occupational Retirement Schemes Ordinance (ORSO).

15. On the other hand, it is recognized that there might be difficulties in applying the 10% limitation on shares or other securities in relation to the employer or its associates in the context of master trust schemes. The reasons are -

  1. there may be difficulties for investment managers to comply, for trustees to monitor and for auditors to audit, as a master trust scheme may have a number of participating employers - and their associates - which issue shares or other securities;
  2. the rule may be too restrictive to other scheme members who are in the same master trust scheme but are not employed by the companies mentioned in (a); and
  3. in the context of portability in MPF, a member may retain his accrued benefits in the master trust scheme to which a former employer contributed. At the request of the employee and if permitted by the new employer, contributions may continue to be made to that scheme. If the rule was not relaxed for master trust schemes, the new employer by contributing to the previous scheme would otherwise influence the investment policy of the scheme prompting a series of new restricted investments. This would be unreasonable on other members of that original scheme.

16. As explained in paragraph 14 above, under ORSO, both individual schemes and schemes under pooling arrangements are subject to a 10% restricted investment rule on securities in relation to the employer(s) or its associates. As pooling arrangements attract scheme participation mostly from the small employers which are not listed, the 10% restricted investment rules would have caused little compliance problems on these pooled schemes. The situation, however, is expected to be different for MPF.

17. Although MPF master trust schemes will mainly cater for the small employers, it is likely that some large employers will also join such schemes because under the proposed ORSO interface arrangement, the employees are given the right to opt for MPF coverage. The employer would need to either set up an employer sponsored scheme or to join a master trust scheme. Since most large employers have ORSO schemes with more generous terms than MPF and the standard MPF requirements, it is expected that few employees would opt for MPF and these employers would join a master trust scheme rather than set up a new employer sponsored scheme to cater for the small number of employees that opt for MPF. The inclusion of large employers in master trust schemes would make the trustee’s task of monitoring the compliance of the 10% investment limit rule much more difficult.

Mandatory Provident Fund Office
Financial Services Branch
24 November 1996
[Ref.: Paper/MPF/SC-10]

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