Navigating the US Credit Downgrade Crossroads: Hong Kong Pension Funds and the Case for Regulatory Pragmatism

The interplay of sovereign credit ratings, regulatory constraints, and global market dynamics has thrust Hong Kong's Mandatory Provident Fund (MPF) system into a pivotal crossroads. As the United States faces its first-ever sub-Aaa/AAA rating from all three major agencies—Moody's, S&P, and Fitch—the rigid AAA requirement embedded in Hong Kong's pension fund rules creates a paradox: US Treasuries, long the bedrock of global risk-off portfolios, now risk being treated as “non-exempt” assets should Japan's R&I agency follow suit. This regulatory straitjacket threatens to force HK$484 billion in MPF assets into abrupt sales, even as Treasuries remain a unparalleled safe haven. The solution lies in revising rules to reflect market realities, not outdated ratings dogma.

The Regulatory Trap: How Hong Kong's Rules Lag Behind Reality

Hong Kong's MPF system permits pension funds to hold more than 10% of assets in US Treasuries only if the US retains a AAA rating from at least one of four agencies. While this rule once aligned with the US's unrivaled creditworthiness, it now risks catastrophic unintended consequences. As of July 2025, only Japan's R&I maintains the AAA rating, with the US's debt-to-GDP trajectory (projected to hit 134% by 2035) and rising interest costs fueling speculation of further downgrades. If R&I acts, MPF funds face a forced sell-off of US Treasuries, destabilizing their portfolios and amplifying market volatility.

The stakes are immense. The MPF's bond and mixed-asset funds hold over HK$484 billion in Treasuries—a testament to their perceived safety. Yet regulatory rigidity turns this safety into a liability. Unlike broader markets, which treat US debt as a near-risk-free asset even at AA+, Hong Kong's rules risk transforming a prudent holding into a forced liquidation in a stress scenario. This is regulatory myopia at its worst.

The Case for Policy Pragmatism: Beyond AAA Dogma

The argument for revising the MPF rules hinges on three pillars:

1. Market Reality vs. Regulatory Formalism: Global investors treat US Treasuries as a safe haven irrespective of ratings. shows that yields compress and demand rises during crises, even post-downgrade. Treasuries remain the world's deepest, most liquid market—a function of institutional credibility, not just ratings.

2. Systemic Risk Mitigation: Forced sales of HK$484 billion in Treasuries would create a self-fulfilling crisis. Yields would spike, exacerbating US fiscal costs and triggering contagion across global bond markets. Hong Kong's rules, designed to protect fund members, could instead become a vector for systemic instability.

3. Opportunity Costs of Overcaution: US Treasury yields are near decade highs amid geopolitical fragmentation and Fed policy uncertainty. Restricting access to this asset class deprives MPF portfolios of a critical diversifier and inflation hedge. A rebalancing toward Treasuries at current yields (e.g., 4.5% on the 10-year note) offers compelling risk-adjusted returns.

Strategic Asset Allocation: Seizing the Opportunity

For fund managers, the path forward is clear:

• Advocate for Policy Change: Push regulators to align MPF rules with market practice by permitting Treasuries rated AA+ or higher. This would preserve access to the world's safest bond market while avoiding forced liquidations.

• Rebalance Proactively: Use the current yield environment to increase Treasury allocations. highlights Treasuries' superior risk-adjusted returns amid rising regional interest rates.

• Diversify Liquidity Management: Build cash buffers and short-duration bond ladders to weather potential volatility. This mitigates the need for panic-driven sales if ratings actions occur.

Conclusion: Time to Modernize

The US credit downgrade saga is not an isolated event but a symptom of broader fiscal and geopolitical shifts. Hong Kong's pension fund system must evolve to reflect this reality. By revising the AAA-only rule, regulators can avoid becoming an unwitting catalyst for market chaos while enabling MPF funds to harness Treasuries' enduring value. The alternative—a rigid adherence to outdated criteria—risks turning a pillar of financial stability into a source of systemic fragility. The choice is stark: adapt or amplify risk.

Investors should act now to position portfolios for this shift, treating US Treasuries as a core holding despite ratings downgrades. The market has already priced in the risks; the last thing Hong Kong needs is a regulatory-induced crisis atop them.