China's NSSF and offshore PE: Still theory, no practice
Regulations proposed by the government for China’s National Social Security Fund include a provision that suggests the pension fund could invest in offshore private equity. But how soon?
Two weeks ago, China's State Council launched a public consultation on proposed rules governing the National Social Security Fund (NSSF). This is the first time the government has indicated that the pension fund will be subject to proper regulation. It could be an enlightening experience for all concerned.
The State Council's recommendations include expanding the NSSF investment program overseas. Reference was made to fixed-income, stocks and private equity.
The NSSF, set up in 2000 and managed by a government-backed committee called the National Social Security Council, has been making allocations to domestic private equity funds for a decade and is recognized as a significant LP. How quickly might it build up a similar reputation offshore?
"We are very encouraged to hear that the State Council published this new guidance. This is an acknowledgment of NSSF's leadership in investing into alternative assets particularly in the domestic market," says Frankie Fang, who heads the Beijing office of LGT Capital Partners. "In the meantime, it's sending an encouraging signal that the pension fund can continue with its preparation for overseas investments."
He adds that the key to the initiative still hinges on further detailed guidance from the Ministry of Finance (MoF) and the Ministry of Human Resources & Social Security. As such, the timing of the process is uncertain.
Overseas experiment
Unlike provincial insurance and pension funds in China, which receive contributions from employers and employees, the NSSF's capital comes from the MoF, state-owned enterprises (SOEs), and provincial pension schemes approved by the State Council.
In 2012, the NSSF took over the management of a RMB100 billion pension fund in Guangdong province as a trial scheme. By the end of June, the NSSF's assets under management (AUM) stood at RMB1.02 trillion ($165 billion), up from RMB20 billion at inception. Its annualized investment return was 7.95% as of June.
Several years ago, the NSSF lobbied the government for approval to invest overseas, as it had started to accumulate significant amounts of foreign-exchange reserves. Since 2006, it was been able to invest 20% of its total assets in overseas bank deposits, bonds, money market funds and other derivative products.
However, the current allocation is only about 10% of AUM - and it is limited to stocks and bonds, according to Lilian Zhu, research manager at Shanghai-based consultancy firm Z-Ben Advisors.
"When the NSSF makes overseas investments, it is mainly using foreign-exchange reserves. Following the State Council's announcement, foreign fund managers might speculate that the NSSF will use its onshore reserves to invest, which are much larger," Zhu adds. "The NSSF could either covert its current renminbi holdings into US dollars, or the MoF might allocate US dollars for it to invest abroad."
The State Council announcement offers no hints as to what the next step might be. The possibility of allocations to offshore PE managers has been under discussion for almost four years, but it has yet to get anywhere due to regulators' concerns about risk. Global fund managers are therefore skeptical about the latest announcement delivering real change.
"I think it's just kind of politically correct. The State Council wants to go through an official process in terms of doing public consultation, drafting regulations and finally giving the NSSF approval to invest abroad. If the fund loses money, it can say it has followed regulatory procedures. It is the right thing to do because pension funds are much more in the public eye than insurance companies," says one GP.
Domestic power
The pension fund's first commitments to domestic PE funds came in 2004. Four years later, the NSSF won regulatory approval to deploy up to 10% of its AUM in domestic private equity funds. To date, it has invested in 19 PE and VC funds, including renminbi-denominated vehicles raised by CDH Investments and Hony Capital.
"The NSSF is one of the most established institutional investors in China. In terms of PE allocation, it construct its own fund portfolio and I think it is sophisticated enough to allocate to overseas funds," says Vincent Wang, managing director at consultancy Promise Advisors.
In June, Zhongmin Wang, vice president of the NSSF, told a public forum that he was regretted not being able to participate in Alibaba Group's financing rounds, while two key shareholders in the company are foreign - Japan's SoftBank Corp. and US-based Yahoo.
However, even if the NSSF is permitted to venture into offshore PE, it will follow the cautious approach of its insurance industry brethren by backing established global fund managers.
"Insurance companies have been allowed to invest in overseas PE funds for more than two years, but only a handful of them are trying to build up overseas exposure. As a result, I wouldn't expect this new development involving the NSSF to have a significant impact on overseas PE in the near future," says Xuan Zhang, a Hong Kong-based counsel at law firm O'Melveny & Myers.
Nevertheless, the NSSF's assets are growing. Following the Guangdong pension fund arrangement, the NSSF has held talks with the Shandong provincial government about the transfer of a social security fund worth $15 billion. It raises the possibility of multiple provincial pension funds being managed by centralized NSSF platform.
At present, the government maintains a tight grip on how local government pension funds can be invested, directing them towards the most conservative assets, such as bank deposits and government bonds.
"It's too early to tell whether Guangdong's case was an experiment or the start of a national roll-out. We would not be surprised if smaller local pension funds are consolidated, given their in-house investment capabilities are limited," says LGT's Fang.
The situation is comparable to that of the smaller insurance companies. They don't have asset management arms, so management of public equities as well as some fixed income products is outsourced to larger industry players, such as China Life, Ping An, or Taikang Life. Fang expects the alternative asset industry to follow a similar path.
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