Law of unintended consequences
The demands of corporate governance, international financial reporting requirements and guidelines from Dutch regulator PVK are leading to more bureaucracy, increased emphasis on risk control and higher costs for pension funds, according to a report* on the attitudes of senior executives from Dutch companies and pension schemes.
The poll, conducted during June and July on behalf of US-based asset management and technology solutions provider SEI, was intended to assess the major issues in the overall pension environment in the Netherlands and how decision makers are preparing for the future, specifically regarding the IFRS/IAS19 international reporting requirements. And in the process it quantified the extent of concern among Dutch pension funds at the growing legislative and regulatory pressures.
“The changes have resulted in some unfavourable and unintended consequences for Dutch pension funds,” notes SEI managing director of the Nordic and Benelux regions Bart Heenk. “These include reduced benefits for employees and increased costs for them and their employers.”
Having started his career with Shell in the Netherlands 18 years ago, Dutch-born Heenk has since enjoyed a career that has taken him back and forth across the North Sea on several occasions to work variously on Shell’s derivatives trading desk, to head Rabobank’s derivatives sales operation, and to run Citibank‘s Dutch dealing room, its London-based European forex sales operation and its sales and trading operation in Indonesia, and subsequently to run a London consultancy company.
So on his recent return to the Netherlands – to establish and run SEI’s Dutch office and to break into the manager of managers sector – he brought with him a considerable awareness of the Dutch market within an international context.
“My overriding view on my return is that the pensions sector in Holland is very good,” he says. “The Netherlands is one of the few countries in the world that not only has a funded system but, more importantly, has a system that covers the overwhelming majority of the working population. The white hole is very small indeed – I think that some 95% of the working population is covered in some shape or form by a pension plan that is not dependent on the government. But while we have established a system to be proud of, the research reveals that we have allowed both the new accounting regulations and the Dutch regulator to potentially undermine some
of the fundamental elements, notably solidarity and inflation adjustments.”
The study, conducted on SEI’s behalf by UK-based Continental Research, is based on interviews with some 43 senior finance executives – 25 from of pension schemes and 18 from companies – with most of the pension funds having AUM of more than e300m.
It found that more than three-quarters of respondents believe that decision-making was becoming more bureaucratic and 61% expected that the situation would get worse. In addition, 64% expected that the companies for which they manage pensions would demand greater involvement in their investment and risk management policies because the valuation of pension liabilities under IFRS/IAS19 would increase volatility in annual corporate financial results. Further, 66% of those surveyed said that their pension funds assets and liabilities would increasingly be included in corporate finance decisions.
“While the intention of the new IAS19 accountancy rules – to increase transparency for investors in corporations – is laudable, they will have an undesired side effect,” observes Heenk. “This is that they bring companies as corporate sponsors much closer to the investment policy of the pension funds. So whereas the Dutch system legally separated the investment fund from its sponsor, this may prove to be increasingly tricky in the future because corporate sponsors may want to have much more say over the investment strategy of pension funds.
“And the result of that is that the companies are preparing to revert to more drastic steps, with the report showing that they are converting final salary schemes to average salary schemes. And while that of itself was not so bad, average salary schemes are dependent on wage and price indexation and because there are so few instruments that allow pension funds to hedge inflation risk it is likely that wage and price indexation will be limited and will be made conditional on how well a pension fund is doing, how high its funding ratio is.”
The second major threat highlighted by Heenk is the impact of a new set of PVK rules. “It is requiring that pension funds carry out some stress testing on their portfolios, on their assets and liabilities, and this will have a profound influence on the investment strategy of pension funds,” he warns. “The stress testing means that the part of the portfolio that is made up of equities needs to cope with a larger impact than the part made up of fixed income and similar investments. That in turn means that pension funds are driven towards a less ‘risky’ strategy.
“I assume, as do most people, that equities will generate higher returns in the long run than fixed income. So, while it may well be true that in the short term fixed income is less risky than equities, the regulation implies that in the long-term pension funds will forgo the benefits of having a large equity proportion in their portfolios.
“And while the new regulation means you get the benefit of less risk in the short term, the question is whether the regulator really wants to achieve that. In addition, it is doubtful whether the effect has been what the PVK intended because most pension funds are seeking the easy way out by reducing the proportion of equities in the portfolio to better match assets with liabilities so that they obtain a return that is more predictable and is more in line with liabilities. However, this is probably to the detriment of the beneficiaries.”
The research also found that over the past two years pension funds have implemented or considered implementing several measures to restore the pension liabilities coverage ratio, ranging from increasing employee contributions (stated by 56% of respondents) and employer contributions (54%), to adjusting their indexation policies (63%). SEI noted that the sample did not exclude the possibility that future or existing pension benefits could be reduced or that greater investment risks could be taken in the future to improve the coverage ratio.
In addition, fund managers reported dissatisfaction with the existing level of risk management and the investment process, with 56% complaining at excessive
costs, 49% the wait-and-see attitude of external advisers and 70% the inadequate options to intervene in the investment process in a timely manner.
Greater risk control was one of the three key features making up the ‘ideal’ pension management process identified by finance executives in the report, along with thorough quantitative and qualitative manager selection, and easy on-line access.
*Attitudes Towards the Pension Management Process in The Netherlands. Available on www.seiglobal.com