Indian Express, 21 May 2013
FDI in pensions could bring in knowledge and expertise on fund management
In the furore of the last session, Parliament lost another opportunity to discuss the Pension Fund Regulatory and Development Authority (PFRDA) bill. It would have been an ideal chance to debate on the issue of foreign direct investment, cleared by cabinet last October.
The National Pension Scheme, which would be regulated by the bill, is an individual account pension scheme. Contributions get invested into pension funds, and, on retirement, the individual is expected to buy an annuity that will help towards financing retirement consumption. The scheme has been operational for Central government employees recruited since 2004. Most state governments have also shifted to the NPS for their new employees. Citizens of India can open their pension accounts with the NPS, as can low-income households through the Swavalamban scheme initiated in 2010. The interim PFRDA oversees the functioning of the system. The bill will bring statutory power to the PFRDA, and firmly establish what has been functioning for almost a decade now.
There are a few aspects of the bill that merit discussion. First, the bill separates distribution from fund management, that is, pensions are not sold by fund managers, but through separate entities called the points-of-presence (which includes bank branches). This removes the conflict of interest that arises when distributors paid by the fund managers sell products without any concern for the suitability of the product to the customer.
Second, the bill allows for portability between various employers. Unlike the Employees' Provident Fund Organisation, which pays lip service to portability, the NPS account stays with the individual through job and geographical changes.
Third, the bill allows for choice of investment. It also ensures that one fund manager is a government-owned entity and one scheme is a "safe scheme" with no exposure to equity, for those who have greater faith in the public sector, and wish to have no equity investments. The choice ultimately rests with the individual.
Fourth, the bill empowers the PFRDA to appoint fund managers and set up investment and other compliance guidelines that the fund manager will have to follow.
Finally, the bill makes a provision for individuals to purchase a market-based guarantee on their pension schemes. Explicit pricing of guarantees makes the cost, and the risk-return trade-off transparent. This is the correct way to think about assured returns.
The cabinet decision on allowing 49 per cent FDI in pensions has been under intense scrutiny while the other, more substantial provisions of the bill remain ignored. But what does FDI really mean? Ultimately, what the fund (any foreign or Indian intermediary) can do, the fees it can charge, where it can invest, rests with the PFRDA. At worst, the foreign fund is no different from Indian fund managers. At best, it brings in knowledge and expertise on fund management from having managed much larger funds for much longer horizons in international markets. It is unclear why there is opposition to FDI if all intermediaries, regardless of ownership, are subject to well-drafted prudential regulation and customer protection measures.
For all that is novel about the bill, it falls short of allowing fund managers to invest in international markets. This means, whether a fund manager is domestic or foreign, it will be required to invest only in India. This is like putting all eggs in one basket, and riskier than allowing international exposure. Gains from diversification are the only free lunch in economics, and regulation does harm by not providing members the choice to invest in international markets. Investors with different preferences will choose according to their risk appetite, and the regulator should not be the one making this decision for them.
The PFRDA bill, even with its short-sightedness on international diversification, is an important piece of the financial regulatory landscape in India. It hopefully heralds the beginning of the rationalisation of a fragmented pension market and can, over time, bring all pension schemes under one umbrella.
The writer is a research economist at the Indira Gandhi Institute of Development Research. Views are personal.