A minefield of diplomacy
Most industries are based upon relationships and the investment industry is no exception. But, unlike other industries, the investment community comes under close regulatory and media scrutiny for what are perceived as the inevitable conflicts of interest associated with a handful of investment banks dominating the industry.
A number of these investment banks have pension groups that are keen to solicit business from pension funds, but they also have their own asset management arms fishing in the same pool. With many investment banks and asset managers under the same ownership the asset manager sometimes ends up implementing solutions from a related bank.
In general it is difficult to elicit comment from banks on this sensitive topic and even harder still to get them to admit that conflicts of interest can be an issue. But, regardless of whether banks feel that the media overplays the significance of these conflicts, their main priority is to convince their clients that they can surmount any potential conflicts of interest and work together for their benefit.
Nick Horsfall, seniorinvestment consultant at Watson Wyatt, says: “Clients nowadays are so concerned about potential conflicts of interest that there is a higher onus on good execution in the case of an asset manager using related bank products. Although it is by no means rare, it is not the way things normally happen. In general, asset managers only do this when there is clear blue water in terms of the pricing”.
In order to be able to reassure clients and compete for their business, most banks will have a transparent internal structure that allows both sides of the business to co-exist alongside one another. BNP Paribas Asset Management (BNP AM) has established a working group covering all five business lines including fixed-income, equity derivatives, property, asset management and securities services, which meets once a quarter. Shona Whitesmith, head of UK institutional business development at BNP AM, explains: “The objective of these meetings is to understand the different aims of each business line and to keep abreast of the contact they’re having with UK pension funds. In order to avoid any potential conflicts we have to understand what each unit is trying to achieve. In some cases, we may have to observe Chinese walls in order to preserve client confidentiality”.
At times the relationship between investment banks and asset managers can be mutually beneficial. Serkan Bektas, director and head of pension solutions at Barclays Capital, says: “Investment banks and asset managers offer complimentary services. There will always be a need for a fiduciary to look after the pension fund's interests as well as a product provider to provide the solution. We're cooperative in that dialogue. Our business model places great emphasis on supporting the asset manager and the successful implementation of their solutions".
A realistic approach to the complications of running two competing businesses (where banks acknowledge that there may be concerns about conflicts) is more beneficial to the client. Mark Azzopardi, head of insurance and pensions, Global Risk Solutions at BNP AM, says: “In this industry it is easy to have conflicts of interest. What’s really important is how you handle them. The client needs to rely on its advisers to be professional whilst we equally need to manage any conflicts that arise in a professional manner.”
But it is not just internal relationships that have to be handled with care. For an investment bank, pitching to a pension fund is a very delicate process, sometimes exacerbated by tensions between the different groups looking to implement a pension fund solution. Frequently, the finance director introduces the investment bank to the trustees of the pension fund or the treasury department suggests adopting a solution from an investment bank with which it has an existing relationship. This situation can sometimes create difficulties and there is a danger that the trustees will look upon this kind of introduction with suspicion.
Although the company may get the bank to the negotiating table, in some cases the fact that it was introduced to the trustees via the company may ultimately go against it. Azzopardi says: “Trustees have their own advisers who are sometimes critical of banks that are introduced in this manner. But this is not necessarily deliberate and may only be a side effect of advisers doing their job properly. Any adviser has a duty to the client to research the market and the relationships within it fully”.
Now that there is a new governance model associated with pension plans, the corporate sponsor has its own advisors working out the direction of the pension plan and the policy is formulated independently of the trustee. Mark Duke at Towers Perrin says: “Banks are keen to talk to companies about the services they offer and may stray into the advisory space even though they are focused on delivering a product. Some companies use their banking relationships to help them to formulate their strategy. The challenge is how to translate this corporate strategy in a way that is acceptable to trustees.”
Trustees have a duty to do the best for their members, no matter what the ins and outs of their relationship with the corporate sponsor are. Nick Horsfall, senior investment consultant at Watson Wyatt, says: “Trustees should n’t care who they execute with and should look at the price at the time of execution first and foremost, regardless of whether or not the solution is introduced by the finance director or the treasury department”. According to Neil Walton, head of strategic solutions at Schroders, trustees need to be careful as most banks are remunerated on a transaction basis and thus the advice and strategic planning appear to come for free. He adds: “Trustees should be wary of being constrained by one bank and should work in a framework that ensures proper prices are achieved for any derivative transactions. This may involve the use of an asset manager to implement trades or consultancy input to validate pricing.”
But not all pension funds have a difficult relationship with the corporate sponsor and Walton says the relationships between an investment bank and the finance director can be very helpful. He says: “The pensions groups of the big banks understand the key pensions issues and are able to consider these in the context of the corporation's overall financial structure and objectives. Often this can facilitate a good dialogue, particularly covering risk management, between the corporation and the trustees”.
Meanwhile, Bektas feels that any solution being tabled should have at least a possibility of consensus. He adds: “In some cases, the fact that the company has introduced the bank might be a source of comfort to the trustees. The trustees are looking for a sensible solution and may be reassured that the bank has met the company's objectives. While exceptions naturally exist, in a lot of cases the company and the trustees do see eye to eye, especially on the topic of risk mitigation. There is a greater degree of consistency than one would imagine.”
It is clear that getting all parties involved to agree on a pension fund solution is a delicate situation that has to be handled diplomatically. If negotiations set off on the wrong foot and trustees view the bank as a threat then anything the bank says will be tarred with suspicion. (This is more likely to happen when the trustees’ adviser greets the presence of the bank with misgiving or when things have not been explained properly). But experienced banks will be aware that no matter who introduces them, the trustees are the final decision makers and success or failure will depend on the relationship they build with them.