Sea changes in global financial markets bode well for individuals seeking pension security in continental Europe. Those of us who watched the US mutual fund market take off at the turn of the last decade expect the same experience in Europe over the next 10 years. The catalyst will be countries’ development of tax-advantaged products for their citizens.
In the meantime, shareholders can thank high-performing markets for causing major banks and global entities that once focused primarily, if not solely, on institutional needs, to expand their focus to include Main Street’s appetite for equities. “The future is in retail funds,” so the current sentiment goes, and everyone, including new-economy kids on the buy- and sell-side blocks, want a piece of the action.
Accelerating consolidation in the industry has intensified competition as evidenced by mergers such as: Allianz-Dresdner-Pimco-Nicholas Applegate; UBS-Painewebber-Brinson; AXA-Alliance-Bernstein; Amvescap-Aim-Invesco-GT-Trimark-Perpetual and others. As investment and commercial banks continue to acquire fund management firms, the line between the buy and sell sides blurs and best-of-breed deals spur growth in asset management products.
Global suppliers find this highly charged atmosphere, fuelled by recent unprecedented market volatility and regulatory requirements, pushing managers to seek service arrangements that allow them to focus their resources on managing investment assets and distributing financial products to both retail and institutional investors.
Highly dependent on advanced technology, fund administration alone is experiencing both increases in pricing frequency and ongoing reductions in settlement times. Accordingly, managers can achieve operational efficiencies through integrating technology to service their front, middle and back offices. New financial conglomerates have additional challenges related to integrating back-office services and systems in terms of handling not only proprietary products, but also servicing multiple products across multiple providers.
As more human and capital resources become necessary for middle and back-office support functions, fund managers and sponsors want suppliers with a single global view rather than a singular geographic or functional focus, that can deliver the full range of services in multiple locations around the world.
As developments, including the UCITS Directives, Investment Services Directive, the Second Banking Co-ordination Directive and the generations of life and non-life insurance directives slowly encourage the integration of European financial markets, the foundation is being laid for a pan-European future that will support a robust pensions market.
Pension reform may be one of Europe’s toughest economic issues, but it is also the single most important potential source of economic expansion. The problem is well known. Currently, under state pay-as-you-go schemes, seven people of working age support every two pensioners. By 2025, projections show only two workers per pensioner and worse in some nations. Continuing to rely so heavily on state systems is untenable.
The European Commission says there is “an urgent need” for supplementary pensions, and the current directive is an important step in the right direction. All EU investors would benefit from enactment of the proposal that allows for the creation of employment-based, pre-funded pensions and moves toward a single market in which consumers and suppliers of pensions would gain rights to move freely across EU borders.
The initiative is intended to reduce the burden on states and increase the role of private pension investments. Currently, it is estimated that the 13% of total amount of pension money currently paid out across the EU by either employment-based pre-funded plans or personal investments needs to increase to 33% by 2020.
Furthermore, the initiative could well spare the average worker from bearing the burden of future tax increases as well as give them far greater labour mobility. Funded pensions would reduce the pressure on public systems, thereby lessening the need for tax increases to fund those systems. Finally, the proposal would create large pools of pension assets that would be invested to spur economic growth throughout Europe.
Though most Europeans are unaccustomed to their pensions being invested in equities, shareholders in countries permitting such investments have realised essential growth through equities and equity funds in their pension portfolios.
The US and Chile are just two examples of countries that have seen a measure of success through supplementary pension plans. Though the structures of the schemes vary widely, the key to success in every case has been the tax advantage to the individual.
France and Germany are progressing in their respective development of supplementary pensions. The French have begun investing in equities, but still 40% of households invest in cash and deposits. Traditional (bank) distribution networks are opening, foreign firms are entering the market and financial supermarkets distributing multiple fund products are emerging.
Germans may, in time, benefit from recent German bank and UK fund manager mergers. Fund management is very leverageable on the investment manager side. Global financial organisations with the scale to purchase pieces of business in different places are looking towards developed markets with growth characteristics and legislated tax-advantaged products.
While much of the Swiss-sponsored fund market is domiciled in Luxembourg, where funds can be sold cross-border more efficiently, there is still strong growth potential for Swiss-domiciled funds. Zurich Insurance, UBS, Credit Suisse and others are finding it more economical to offer fund products to the lower end of the traditional high net worth market than to manage private banking portfolios. Distribution of third-party products by major global asset management houses into Switzerland is also raising the profile of mutual fund products and shifting monies into collective investments.
As European countries begin introducing defined contribution plans, an opportunity exists to create products to provide the important benefits to participants, while being mindful to simplify the product structure to allow for the efficient, cost-effective service of these plans. This is the area where Europe could transcend existing plans, many of which have a very high cost of service.
Establishing a regional service centre in Luxembourg is the best way to concentrate service activities and achieve scale in anticipation of the day when countries can register their retirement products there for centralised, pan-European servicing. Given the scale of Luxembourg’s mutual fund market, second only to the US in size, it is likely to leap the e-commerce development curve and host the launch of aggregated one-stop shopping for personal financial planning this year.
Timothy Caverly is managing director of State Street Investment Services, Europe, in Luxembourg