Shanghai Pension Fund: a Story of Risk

By Staff Reporters Hu Runfeng, Yang Haipeng, Fu Tao, Ji Minhua, Luo Changping and Li Zhigang

The Shanghai Labor and Social Security Bureau has been embroiled in the biggest scandal since its establishment eight years ago. Zhu Junyi, the head of the bureau, is suspected of graft and mismanagement of the social security fund and has been fired from his position.  After several local officials and businessmen were also interrogated in relation to the case, information about the irregular—and in some cases, illegal—management of the Social Security Bureau began to emerge.

has learned that the Shanghai Social Security Fund invested in several failed real estate projects in the early 1990s.  To reduce its losses and increase the value of its assets, the government later authorized Pudong Development Bank to manage the fund, estimated to be over 10 billion yuan (US＄ 1.25 billion) at its peak. When the bank was listed publicly in 1999, part of the fund was still tied up in real estate, adding to the financial risks of the multi-billion yuan pool.

During the fifteen years of the fund’s hazardous operations, the nascent Chinese social security system slowly became more efficient and disciplined.  But an investigation into the Shanghai fund's considerable investments shows that the secret risks decision-makers took have not only harmed the long-term security of the fund but also spawned enormous opportunities for corruption. Once known for its efficient pension dispersion, the Shanghai fund's illicit activities may cause future payment problems.

At the center of the issue is the bureau's dual role as both administrative regulator and investment manager of the fund—despite public demand to entrust the fund to market-oriented operators.  The monopoly it created is at the root of the fund's current problems.

Zhu Junyi and Early Investments

Before entering the government, Zhu Junyi was a model manager in various state-run enterprises.  He became the head of the Labor Bureau in 1996. That was also the time when the city’s pension fund was most heavily invested in the real estate market. Source say as much as 6 billion yuan (US＄ 750 million) from the fund went into speculating in the housing market. 

In 1992, the bureau had established Shenbao, a real estate developing and trading company, to manage real estate investments as well as balance the pension—a slate of responsibilities that mixed the functions of both enterprise and government.

After Shenbao incurred severe losses through a string of risky and unsuccessful operations, the municipal government decided to authorize a financial institution to manage the social security fund in 1994. Pudong Development Bank was its first choice. The city entrusted some 4 billion yuan to the bank with a guaranteed base interest rate much higher than the market rate. Although this model was once approved by the People's Bank of China, experts say it forces the bank to venture into highly speculative projects so as the meet the profit target. Investment in the ballooning real estate market sky-rocketed, and so did the risks.

Defeat at the East Sea

By the mid-1990s, work had begun on the fund's five major real estate investment projects. All were large development projects situated in the city’s prime commercial areas. Despite the involvement of the Pudong Development Bank, the books of these projects reveal a shocking state of chaos and lawlessness.

First, sources say, neither the bank nor the Social Security Bureau had final say on investing into these projects. Instead, billions of yuan were poured into them at the orders of senior government leaders whose identities are yet to be disclosed. Some of the developers behind these projects had no money in their accounts before the pension funds arrived; others didn’t even have all the required permits to lay a brick.

The funds that went into such projects were neither insured nor legally guaranteed a return; many investment deals were based on simple oral agreements between the bureau and developers. Should the development fail and legal disputes ensue, sources told , the pension fund would be subject to steep losses.

Such dire predictions came true in the East Sea Square project. Situated at 1688 Nanjing West Road, the project was developed by the Tianyi Real Estate Company, a shady but powerful “private” developer with strong connections to senior officials.

Though Pudong Development Bank was instructed to invest 480 million yuan (US＄ 60 million) to start the project in 1994, Tianyi refused to establish a project company, and thus the development and investment didn’t have a legal status. The money was given to the company as a bank loan, instead of a partnership investment.

By 1996, the managers of the fund had realized the risks of investing in real estate projects in the name of bank loans, and began to require the establishment of project companies and legal representation in these projects.

After a dispute between Tianyi and Pudong Development Bank in 1998 concerning the bank’s investor rights, the developer sought to kick the bank out of the project and find foreign investors instead. The bank sued in 1999, but a Shanghai court ruled in favor of the developer because there were national regulations barring commercial banks from investing directly in real estate projects. In addition, the court found the original 20% annual interest promised by the developer illegal, and ordered the developer to repay the bank a total of 548 million yuan (US＄ 68.5 million), far short of the bank’s profit targets.

Even so, the project had come to a halt and Tianyi had no means of repaying the money. Only after the Shanghai government intervened by arranging for a local state enterprise to take over the project, did the bank receive its 548 million yuan.

Clear Violation

In 1998, the Shanghai Labor and Social Security Bureau was established to combine the former Labor Bureau and Social Security Bureaus. Zhu Junyi, who was head of the Labor Bureau, became the top official of the new organization. Starting in 1997, the central government had required that social security funds be invested in only treasury bonds, and had forbidden all other types of investments.

Under Zhu’s lead, the Shanghai bureau started withdrawing investments from a myriad of projects. The next year, the Pudong Development Bank agreed to return to the bureau within three years all the funds it had been entrusted with.

At that time, however, an investment of 550 million yuan (US＄ 68.8 million) was still tied up in the Wandu Center, another mega-commercial development project in the city’s Hongqiao Economic Development Zone.

Since the social security fund’s initial involvement in the project in 1995, the value of the investment had ballooned to 550 million yuan by early 1999. But sources told that the developer, a Hunan-born Hong Kong businessman named Zhong Jianguo, never injected the pension funds into the construction of Wandu Center. Instead, he had secretly shipped them off to his other speculations. By the time the bank and the bureau wanted the money back in early 1999, the planned 54-story main structure of Wandu Center had run out of money and laid half finished.

Again, unnamed senior city leaders intervened, saying “the tallest building in Puxi must be completed,” sources told , even if that meant the Social Security Fund would need to continue pumping money into the project. That was a decision clearly in violation of newly minted national policies.

To this day, it remains unclear if the social security fund will be able to get all its investment back from the project. Given the frantic growth of the Shanghai real estate market in recent years, analysts say, it is possible that Wandu Center may have made enough money to return the loan.

In 2002, the bureau completely withdrew the social security fund from Pudong Development Bank.  By the end of the year, it registered two public institutions to take over its functions: the Social Security Fund Settlement Center (Social Security Center) and the Corporate Annuity Development Center (Annuity Center).

To ensure the liquidity of the fund and of current payments, the central government had restricted the investments of the social security fund since 1997.  However, policies did not restrict enterprise annuity.  The Social Security Bureau soon reverted to its maverick investment strategies of the early 1990. It is now in charge of not only the city's social security fund but also several billion yuan of enterprise annuity.

The Social Security Center's investments in expressways and the stock market were questioned for violation of regulations.  Last December, the Annuity Center was established to take charge of the bureau's investments, ostensibly ending what insiders say has been a long tradition of mixing the social security fund with enterprise annuity.

In May 2004, the Ministry of Labor and Social Security issued Trial Measures on Enterprise Annuity and Trial Measures on Enterprise Annuity Fund Management, which stated that the management of enterprise annuity should follow the “trustee model,” which means government management should have been replaced by market-oriented operations, but the Shanghai Labor and Social Security Bureau still held the right of trusteeship of the management of enterprise annuity.

Irregular investments and the associated losses and risks are only part of the problem with Shanghai's social security system.  Another increasing concern is the local pension deficit—a research report in 2004 showed a deficit of 700 million yuan in 2000, 3 billion yuan in 2001, and 4 billion yuan in 2002, an alarming rate of growth.

Staff reporters Ren Bo, Cheng Jiji, Ling Huawei and Yu Ning also contributed to this article.
English version by Lei Yongjian and Jennifer Liu.