PLC Bills Committee on
Provident Fund Schemes Legislation (Amendment) Bill 1997
Total Picture on Security of Scheme Assets
This paper summarises the proposed measures on the security of scheme assets consisting of:
- Trusteeship of Scheme Assets
- trust arrangement (paragraph 4)
- statutory duties (paragraph 5)
- fiduciary duties (paragraphs 6 and 7)
- separation of scheme assets (paragraph 8)
- protection of scheme assets (paragraph 9)
- internal control in scheme management (paragraph 10)
- Regulation of Service Providers
- trustee (paragraphs 12 to 14)
- investment manager (paragraph 15)
- custodian (paragraph 16)
- segregation of duties (paragraph 17)
- delegation to other service providers (paragraph 18)
- Investment of Scheme Assets
- investment standards and restrictions (paragraph 19)
- forbidden investment practices (paragraph 20)
- regulation of investment management (paragraph 21)
- approval of pooled investment funds (paragraph 22)
- proper investment conduct (paragraphs 23 and 24)
- transparency of investment operation (paragraphs 25 and 26)
- capital preservation product (paragraph 27)
- Regulation of Marketing Activities
- regulation of intermediaries (paragraph 28)
- approval of marketing material (paragraph 29)
- publish investment results (paragraph 30)
- Proactive Supervision and Monitoring
- review of accounts and reports (paragraph 31)
- field inspection (paragraph 32)
- special audit (paragraph 33)
- conduct of investigation (paragraph 34)
- auditing (paragraph 35)
- monitoring by employees (paragraph 36)
- whistle blowing by service providers (paragraph 37)
- Remedies of Non-compliance
- indemnify losses (paragraph 38)
- corrective and remedial action (paragraph 39)
- sanctions of trustees (paragraphs 40 and 41)
- replacement of trustees (paragraph 42)
- Safety Net
- capital requirements of service providers (paragraph 43)
- performance guarantee (paragraph 44)
- indemnity insurance (paragraph 45)
- compensation fund (paragraph 46)
2.It is essential to have a very high degree of security of scheme assets to safeguard the accrued benefits of scheme members. However, the requirements to achieve this goal should be reasonable so as not to reduce the cost efficiency of scheme management by service providers.
3.A very comprehensive range of measures to ensure a high level of asset security has been presented to the Sub-Committee on Subsidiary Legislation of the MPF System. A summary is given in the paragraphs below.
Trusteeship of Scheme Assets
4.All MPF schemes must be properly constituted under trust which is governed by Hong Kong law. Under a trust arrangement, all assets of the scheme are held legally by the trustee with beneficial ownership vested in scheme members. The governing rules contained in the trust instrument of the scheme must comply with all the provisions of the Ordinance. Where there are provisions in the governing rules contrary to the MPF requirements, such provisions shall be void and of no effect.
5.The trustee of an MPF scheme must discharge properly his administrative duties as specified in the statute in the administration, management and maintenance of the scheme. A detailed description of the administrative duties will be written in the regulations and rules to facilitate the better and more effectual carrying out of the provisions and objectives of the MPF system by the trustee and other service providers. A breach of the statutory duties, depending on the circumstances of the breach, may result in sanctions being imposed on the trustee, prosecution as an offence, or a payment of financial penalties to the MPF Authority.
6.The trustee must also comply with the list of fiduciary duties as codified in the subsidiary legislation. These fiduciary duties are the bedrock obligations of the trustee which promote the protection of scheme assets and prevent misuse and mismanagement on the part of the trustee. There are four basic categories of fiduciary duties : (a) the duty of prudence, (b) the duty to diversify investments of scheme assets, (c) the duty of loyalty, and (d) the duty of compliance with governing rules.
7.These fiduciary duties will be specified as implied covenants of the governing rules imposed on the trustee, which cannot be superseded, limited or diluted by express covenants in the governing rules. A breach of the fiduciary duties may result in sanctions being imposed on the trustee (same as paragraph 5). In addition, given that they will be implied covenants of the governing rules, scheme members can claim damages against the trustee as a result of a breach.
Separation of Scheme Assets
8.The trustee must keep the assets of a registered scheme separate from the assets of the employer, the trustee and the custodian. Such assets must be credited to the account of the scheme on the books and records of the trustee and properly registered and held for the scheme. In keeping with the spirit to insulate scheme assets from the fortune of the employer, an employer sponsored scheme is restricted in its ability to invest in securities of the participating employers or their associates.
Protection of Scheme Assets
9.Scheme assets should not be subject to any charge, pledge, lien, mortgage or other encumbrance except for securing loans to meet bona fide liabilities (e.g. benefit payment to scheme members) of the scheme or to acquire an interest in the assets of the scheme (e.g. when there are difficulties or delays in the settlement of securities transaction).
Internal Control in Scheme Management
10.Trustees are required to have adequate internal control and procedures in their trusteeship of MPF schemes and the management of scheme assets. They are required to prepare a report setting out the control objectives and specific controls and procedures to achieve those objectives in areas specified by guidelines issued by the MPF Authority. These internal controls will fall within the scope of the annual scheme audit.
Regulation of Service Providers
11.All MPF service providers will need to satisfy minimum requirements to ensure that they are qualified to conduct MPF business. They will also be regulated on the segregation and delegation of duties relating to MPF schemes.
12.All trustees of MPF schemes and controllers of corporate trustees must seek prior approval from the MPF Authority. Corporate trustees must be trust companies dedicated to the conduct of trust business and meet requirements on capital adequacy and financial soundness. A corporate trustee must maintain sufficient presence and control with administration and processing capability to serve scheme members.
13.Corporate trustees must have at least 5 directors with one independent director and a majority of the directors with experience and qualifications in retirement scheme business. The controllers, chief executive and directors should all be fit and proper persons vetted by the MPF Authority before their formal appointments.
14.Employer sponsored schemes may be administered by individual trustees with at least one independent trustee with qualifications and experience in retirement scheme whilst others as members of the scheme. They must all have a performance guarantee provided by an authorized financial institution or an authorized insurer.
15.Investment managers must be incorporated in Hong Kong with capital and net assets not less than the specified minimum requirements and registered as an investment adviser with the SFC.
16.All scheme assets must be under the custody of a qualified custodian which is an authorized financial institution or a registered trust company meeting the capital requirement and is associated with a substantial financial institution . The custodian must be capable of performing the minimum custodial functions and appointed by way of a custodial agreement. The trustee, however, may act as the scheme custodian if it so qualifies.
Segregation of Duties
17.As in the case of unit trusts, we will require the investment management function to be performed by an investment manager independent from both the trustee and the custodian. The investment manager directs instructions on the acquisition and disposal of investments, whilst the trustee will settle the transactions and hold title to all scheme assets. This will provide checks and balance in the system.
Delegation to Other Service Providers
18.The trustee may allow the investment manager to sub-delegate part of the investment management function to an associated investment management company. Similarly, the trustee may permit the custodian to delegate part of the custodial function to other sub-custodians. The delegations can only be made to qualified sub-delegates and by way of written agreements. Notwithstanding the delegation, they are not relieved from their obligations under the MPF schemes.
Investment of Scheme Assets
Investment Standards and Restrictions
19.To provide for flexibility in investment strategies to cope with dynamic market conditions whilst safeguarding against undue investment risks, we have prescribed an exhaustive list of permissible investments. These permissible investments are subject to quantitative and qualitative constraints which are drawn up with regard to investment grades, liquidity and valuation consideration. The standards and restrictions will apply to each constituent fund of an MPF scheme which is available for members to choose.
Forbidden Investment Practices
20.It is possible that certain investment practices will develop in future which may prejudice the financial soundness of MPF schemes and may require prompt action to protect the interests of scheme members. The MPF Authority can after consultation with the Financial Secretary publish guidelines on Forbidden Investment Practices not to be undertaken by MPF schemes.
Regulation of Investment Management
21.There should be a properly documented process before the trustee enters into an arrangement with an investment manager in respect of the management of scheme assets. The trustee is required to formulate a Statement of Investment Policy which shall form part of the investment management agreement with the investment manager. Alternatively, the trustee may use approved pooled investment funds as the investment arrangement for scheme funds.
Approval of Pooled Investment Funds
22.Unit trusts and mutual funds authorized by the SFC and retirement scheme policies issued by authorized insurers under the Insurance Companies Ordinance may be used by MPF schemes only if they are approved by the MPF Authority as to their compliance with MPF investment standards and restrictions.
Proper Investment Conduct
23.The trustee and the investment manager in their dealing with other parties in any financial transaction in respect of the scheme must do so at arm's length. Furthermore, the investment manager's dealing with associates should in aggregate not exceed 50% of the total value of the transactions in respect of a scheme in any 12-month period.
24.The trustee and investment manager should be required to provide fair and equitable treatment to all MPF funds under their management. The SFC's restrictions on cash commission rebates and soft dollar benefits would also be adopted for MPF funds.
Transparency of Investment Operation
25.The trustee is required to compile an investment report showing an analysis of the investments held by the scheme and the investment income earned during the financial year. Verification of the scheme investments by external auditors will give reassurance to scheme members that the scheme assets exist and are safeguarded. The accounts should include the overall investment performance which can be monitored by scheme members.
26.All pooled investment funds, with the exception of insurance policies with investment guarantees, should be fully unitised to provide a high degree of transparency in the investment operation. In the case of products with investment guarantees, they must be backed up by adequate level of reserves disclosed in the guarantor's accounts and monitored by the Monetary Authority and the Insurance Authority respectively.
Capital Preservation Product
27.To protect the interest of low income earners, all MPF schemes will be required to provide a capital preservation product. The investment of the fund will follow investment restrictions more stringent than SFC's rules for authorized money market funds. The MPF Authority will require monthly reporting to monitor the compliance with the stringent requirements.
Regulation of Marketing Activities
Regulation of Intermediaries
28.All MPF products must be marketed through properly registered intermediaries. These include registered investment advisers and registered investment representatives under the Securities Ordinance and the authorized insurance brokers and appointed insurance agents under the Insurance Companies Ordinance. We proposed that training courses should be organised to ensure proper understanding of MPF requirements by the intermediaries.
Approval of Marketing Material
29.The marketing material and advertisement on pooled retirement funds are required to be approved by the SFC under the Protection of Investors Ordinance. To protect the interest of contributors and investors, MPF products, as a kind of pooled retirement funds, would not be exempted from this requirement.
Publish Investment Results
30.The MPF Authority will publish in its annual report a compilation of the investment return statistics on all MPF funds. This will enable scheme members to gain access to information on the investment results achieved by MPF funds tabulated on a comprehensive and consistent basis.
Proactive Supervision and Monitoring
Review of Accounts and Reports
31.The MPF Authority will review the annual accounts and reports submitted by trustees to ensure compliance with MPF requirements. Rules will be prescribed for the format of the annual account and report. These will include an investment report with analysis of the investments held by the scheme. Appropriate HKSA accounting guidelines will be incorporated. In addition to the annual reporting, the MPF Authority may also request for ad-hoc reports to be provided by the trustees.
32.The MPF Authority will carry out proactive routine on-site inspections to monitor the performance and compliance of approved trustees. This will enable deficiencies in scheme administration to be detected early and prompt remedial actions taken before the situation further deteriorates.
33.When the MPF Authority reasonably believes that there are circumstances where the interest of scheme members may be prejudiced, the Authority may require a trustee to engage an auditor to conduct a special audit on such circumstances. The Authority may publish the report and/or make it available to scheme members.
Conduct of Investigation
34.On more serious cases where there is a breach of trustee duties or contravention of the Ordinance, the MPF Authority may appoint inspectors to carry out an investigation. The inspector may enter the premises of the trustee and require the production of documents and records. Findings of the investigation will be summarised in a report which can be published by the Authority and/or made available to scheme members.
35.Trustees are required to engage external auditors to perform audit on both the annual accounts, including scheme investments, and the report on internal control of an MPF scheme. This will provide an independent control over the trustee and ensure that important documents are properly prepared. The reporting also enables the MPF Authority to assess whether an MPF scheme complies with the relevant requirements of the MPF legislation.
Monitoring by Employees
36.The MPF System will require employers and trustees to disclose sufficient information to employees in order to enable them to gauge the performance of the scheme. This includes:
- employers must inform employees the amount of contributions deducted from their salary and remitted to the trustee;
- trustee must provide each scheme member an annual benefit statement as well as facility to enquire about benefit entitlements;
- scheme members may request for annual reports, audited accounts and statement of investment policy; and
- scheme members may make complaints and enquiries to the MPF Authority.
Whistle Blowing by Service Providers
37.To facilitate timely detection of non-compliance or contravention in the MPF System, auditors and other service providers (e.g. investment managers, scheme administrators, custodians) have a duty to report to the MPF Authority if they detect any incident in their course of work which will adversely affect the financial position of an MPF scheme.
Remedies of Non-Compliance
38.In the event of a breach of duties on the part of trustees or other service providers, they will be required to indemnify the scheme and scheme members for losses. This requirement will be in the form of statutory provisions to be imposed on all service agreements and governing rules of MPF schemes.
Corrective and Remedial Action
39.Trustees are required to take corrective and remedial actions to rectify any default or breach in duties in the administration of MPF schemes. The MPF Authority may require the trustee to appoint external specialists to assist in the correction of matter of concern to the satisfaction of the Authority.
Sanctions of Trustees
40.The MPF Authority may revoke or suspend the trustee if the trustee has contravened an approval condition or is unable to perform trustee duties. The MPF Authority may also suspend or terminate the trustee from the administration of a scheme if the trustee carries on any conduct or course of conduct which has, had or may have an adverse effect on the financial soundness of the scheme in the interests of the scheme members or has committed investment related breach.
41.The MPF Authority may instigate prosecution proceedings against serious offences for failure to comply with the statutory requirements. In addition, the MPF Authority may impose financial penalties on less serious offences in order to deter non-compliance and expedite rectification.
Replacement of Trustees
42.In the best interest of scheme members, the MPF Authority will, upon the suspension or termination of an approved trustee's administration, appoint a replacement trustee to take over the trusteeship of a scheme and make an order vesting the legal interest of all scheme assets to the replacement trustee.
Capital Requirements of Service Providers
43.The capital adequacy requirements on trustees, custodians and investment managers will ensure that, in case they fail to discharge their duties under the scheme properly or to exercise adequate control and supervision over their delegates, they will have -
- the financial means to indemnify losses to scheme assets as a result of such failure; and
- the resources to rectify deficiencies in scheme administration, management and maintenance.
44.An individual trustee has to be covered by adequate performance guarantee by way of a bank bond or fidelity insurance policy payable on demand to the MPF Authority to satisfy amounts for which he is personally liable when he fails to discharge his duties in the proper manner causing losses to scheme assets.
45.The approved trustee of a scheme is required to make the necessary arrangements for adequate indemnity insurance to cover the scheme for losses in scheme assets, including insurance against misfeasance or other illegal conduct by the approved trustee, other service providers and against losses caused by any other persons. This insurance coverage should be comprehensive so that it can indemnify the scheme for losses in scheme assets.
46.A Compensation Fund will be set up to compensate scheme members for losses resulting from misfeasance or illegal conduct. If the loss to a registered scheme has not been totally satisfied by the resources of the trustee and other service providers, the performance guarantee of the trustee or the indemnity insurance, the MPF Authority may apply to the court to use the Compensation Fund as the last resort to compensate for such losses.
47.We have set down a very robust framework for the trusteeship of scheme assets and prescribed prudential standards on the qualifications and regulation of all service providers including the intermediaries. Under the proposed regulations and rules, scheme assets are safeguarded by the many levels of protection and can only be invested prudently within the parameters prescribed in the investment standards and restrictions. Furthermore, the administration and management of schemes are overseen by the MPF Authority who can use the many interventionary powers to deal with non-compliance.
48.Should any abnormality happen to an MPF scheme, many courses of actions are available for the remedies of non-compliance, be it initiated by the MPF Authority and/or scheme members. In addition, we have provided many layers of safety net to provide the necessary means for deficiencies to be redressed.
49.It can be seen, therefore, that scheme assets are highly secured in the MPF system.
Mandatory Provident Fund Office
Financial Services Bureau
25 November 1997