Insights

Expanding Responsible Investment at the National Pension Service Requires
 a More Active Role from the National Assembly

ㅣTaehan Kim, COO of KoSIFㅣ

As of May 2023, the National Pension Service, or NPS, had 22.25 million subscribers—slightly fewer than half of Korea’s total population.

Considering that many older people were unable to join the system when it was first introduced because they did not meet the eligibility requirements, the proportion of the population covered by the National Pension is expected to continue rising.

With the exception of those enrolled in separate public pension schemes for civil servants, private-school teachers, and military personnel, most Koreans are likely to be affected by the National Pension system.

The NPS fund is, in effect, the public’s money. Yet not all of the assets held by the National Pension Fund were contributed directly by subscribers.

According to the NPS Investment Management, the fund had accumulated KRW 997 trillion in assets as of August 2023. Since the introduction of the pension system, the NPS had collected KRW 777 trillion in contributions, paid KRW 315 trillion in pension benefits, and spent approximately KRW 11 trillion on operating and other expenses.

These figures do not fully account for the fund’s current size. The difference—approximately KRW 546 trillion—was generated through fund management and investment returns.

Money loses value when it remains idle because of inflation. KRW 10,000 ten years ago did not have the same value as KRW 10,000 today. At current prices, that amount may no longer be enough to pay for a typical lunch.

The National Pension operates by collecting contributions today and paying benefits in the future. Moreover, the system is designed to return more than subscribers originally contributed. Benefits are adjusted not only for inflation but also to preserve real purchasing power.

     Responsible Investment Protects Subscribers’ Assets

To provide higher benefits in the future, the NPS must generate more income than it pays out. It has two main sources of income: pension contributions from subscribers and investment returns earned through fund management.

Addressing Korea’s low birth rate and ageing population by expanding the number of contributors is the fundamental response to concerns about long-term pension sustainability. Increasing investment returns is no less important.

Major pension funds around the world—including Norway’s Government Pension Fund Global, the California Public Employees’ Retirement System, and the Netherlands’ ABP—have actively adopted responsible investment strategies that incorporate environmental, social, and governance factors into investment decisions in order to improve long-term returns.

Investing means identifying companies whose future value is likely to exceed their current value. That future value is closely connected to social change.

Companies that anticipate social trends, develop products that respond to emerging needs, and prepare appropriate business strategies are more likely to grow in value. Companies that fail to adapt are more likely to fall behind.

The global economy has continued to grow since industrialization. As economies develop, public awareness and expectations regarding quality of life also tend to rise.

Individual countries may experience temporary setbacks in public standards because of war, political change, natural disasters, or other factors. From a long-term and global perspective, however, public expectations have generally continued to advance and are likely to do so in the future.

For long-term investors such as pension funds, it is therefore reasonable to assess whether investee companies are capable of responding to rising expectations regarding the environment, labor standards, and human rights.

This is not simply about protecting the environment or human rights. It is about protecting the assets of pension subscribers and the public.

A company with strong ESG management is not guaranteed to succeed. But a company that consistently fails to manage ESG risks may eventually lose its ability to survive.

The same principle explains why companies that illegally discharge wastewater or rely on child labor are no longer accepted in today’s economy.

     NPS Responsible Investment and Concerns over ESG Washing

On the surface, the NPS now appears to be taking a more active approach to ESG investment, which should be a fundamental consideration for any long-term investor.

In July 2018, it adopted the Stewardship Code, or principles for responsible ownership and active shareholder engagement. In January 2019, it also introduced responsible investment principles for incorporating ESG factors into investment decisions.

In May 2021, the NPS announced that it would cease investing in certain coal-related assets. Its reported responsible investment assets also increased rapidly, reaching KRW 384 trillion at the end of 2022—nearly three times the previous year’s level.

Does this mean that the system is working as intended?

During a National Assembly audit, lawmaker Han Jeoung-ae of the Democratic Party of Korea argued that the responsible investment figure reported by the NPS had been significantly overstated and could amount to ESG washing. NPS Chairman Kim Tae-hyun acknowledged the criticism.

Previously, the NPS classified only externally managed assets specifically designated under a “responsible investment” mandate as responsible investment assets.

It subsequently changed this approach and classified all externally managed assets as responsible investment. As a result, the reported value of externally managed responsible investment assets increased from KRW 7.7 trillion to KRW 284.4 trillion.

The NPS argued that assets managed by firms receiving additional evaluation points for adopting the Stewardship Code, establishing detailed guidelines, or maintaining responsible investment policies could reasonably be classified as responsible investment assets.

However, Han’s criticism appears more persuasive. Under the NPS’s logic, not only the assets managed on behalf of the NPS but potentially all assets managed by those firms—including publicly offered funds—could be described as responsible investment assets.

Why did the NPS take such an expansive approach to measuring its responsible investment portfolio?

It must have understood that increasing the reported figure alone would not achieve the original purpose of responsible investment: improving long-term and stable investment returns.

Is it unreasonable to suspect that the decision was connected to its earlier target of increasing responsible investment assets to 50% of total assets by 2022?

     Why the National Assembly Exists

Every organization has its own internal logic.

Companies are generally assumed to operate indefinitely, yet few employees expect to remain with the same organization for their entire career. One reason organizations make decisions that do not serve their long-term interests is that the interests of the organization and those of individual employees do not always align.

Public institutions such as the NPS are no exception. The interests of the state and the public cannot always be assumed to align perfectly with those of an organization or its employees.

Responsible investment may benefit all pension subscribers over the long term. But when the incentive structure for fund managers is based primarily on short-term performance, it is difficult to expect responsible investment to be implemented properly.

Democracy is built on institutionalized doubt. Oversight and checks and balances are what allow it to function.

Finance is complex and often treated as the domain of experts. But trusting an institution simply because the subject is difficult is not a sign of virtue. It is an abdication of responsibility.

Some organizational failures result from deliberate misconduct. Many others arise naturally from institutional structures and incentives.

The public grants the National Assembly significant authority so that it can identify structural problems in public institutions and prevent those institutions—or their employees—from prioritizing organizational or personal interests over the interests of the public as a whole.

The devil, as the saying goes, is in the details.

With the general election approaching, the 22nd National Assembly should include more lawmakers capable of looking beyond appearances, identifying small but important details, and asking the necessary questions.