Asset pooling steals the limelight
Over the past few years asset pooling has fast become a global reality while pan-European solutions have remained castles in the air. But pan-European pension plans that pool assets and liabilities are still the ideal, although many legal, tax and infrastructure issues remain unresolved. The idea of pan-European pension funds may have given the initial impetus to cross-border pension pooling, but have they also stolen its limelight?
The basic idea behind asset pooling is that as opposed to having funds in different jurisdictions it allows a more cost-efficient management of a large pool of assets due to economies of scale, while still keeping a local presence. Diverse investment products can be managed and administered across multiple domiciles as a single portfolio of assets, which reduces costs. This is attractive to multinational corporates, as they no longer need to maintain multiple pension plans across different jurisdictions, each with its own regulations and personnel.
Multinationals have started to develop their own investment vehicles in which pension plans from around the world can invest and whose structure is determined by an investment committee. In multinational pension fund pooling - as opposed to investment managers that offer tax-transparent asset pools for pensions plans to invest in - a fund is established. The use of two tax-transparent pooling vehicles, the Luxembourg-based Fonds Commun de Placement (FCP) and the Dublin-based Common Contractual Fund (CCF), has helped to develop multinational pension pooling.
The fund enables multinationals to improve their risk-management, governance and economies of scale due to more centralised control. But the final investment decision remains with the pension plan trustee board. The board also decides over asset allocation, which, according to studies, is the primary determiner for risk-exposure and performance.
Multinationals will usually only offer asset classes that more than one subsidiary pension plan wants to invest in, such as global equity, global emerging market and global fixed income.
Kathleen Dugan, global product manager for cross-border pension pooling at the Northern Trust Company in Chicago, says that Northern Trust is currently the only custodian that provides these solutions to multinationals.
She says: “We are currently servicing about $7bn (€5.3bn) in assets in tax-transparent pooling and another $4bn in non tax-transparent pooling. Some of these are investment managers but a number of them are multinationals. Unilever, which set up the asset pooling vehicle Univest, is one of them.”
On the other hand, a single pan-European pension plan, which is open to participants from all over Europe, means elimination of independent pension plans and trustees in different countries. It merely focuses on Europe, while cross-border pooling is a global solution.
But a pan-European pension also needs a framework on taxation, social and labour laws and benefit coordination across countries, and this hinders it from becoming reality. While the taxation of contributions is being dealt with and expected to be resolved, withholding tax issues have not been addressed yet. Dugan says: “Unlike asset-pooling, my feeling is that pan-European pension plans are going to start small because major multinationals who already have sophisticated German, Swiss, British or Dutch pension plans will not eliminate them. We believe that pan-European pension plans are good and that they are coming, but they are not going to take off for a while.
“When we started asset pooling, we said we would create the best product based on existing law. We found we can achieve a lot through asset pooling but it does not achieve as much as a pan-European pension plan could.”
She adds: “Asset pooling is the first practical step towards pan-European pensions that pool both assets and liabilities, a goal that regulators, providers and multinationals are all aiming toward. Asset pooling vehicles such as the CCF and FCPmay become part of the solution, depending on the structural development of pension plans.”
But Bernard Hanratty, director global fund services, global transaction services EMEA at Citigroup in Dublin, disagrees. He does not see asset pooling as a step towards a pan-European pension plan or the IORP directive (Institutions for Occupational Retirement Provision), the legal framework established by the European Commission. The idea of the pan-European pension under the IORP’s single passport principle is that employees in multiple countries will all be members of a single pension plan for Europe, he says, rather than several individual European pension funds as in pension pooling.
In virtual pooling, funds in different countries can be managed efficiently as one pool of assets through IT technology. Entity pooling is often referred to as the master-feeder structure, which means that feeder funds in different countries invest in the master fund. Both ways are used depending on restrictions of the domicile country.
Entity and virtual pooling differ significantly in their legal and technological reporting perspective as well as in their accounting record but also share several components. Both have an investor coming to an aggregator - a pension fund, a mutual fund, or an insurance company - that invests in securities through a global custodian and then down into local markets around the world.
Dugan says: “From a pensions perspective, I believe virtual pooling raises concerns about the safety of assets. In virtual pooling you pool your assets under a common custody agreement, which is the only protection. Luxembourg and Irish vehicles, however, provide protection of regulatory oversight and well established law. I think investment managers can use virtual pooling for their own purposes, but for multinationals it does not provide an answer.”
Hanratty says virtual pooling works for multinationals but is unpopular as it is an unregulated activity of a custodian. Given the particular conservative perspective of pension trustees, he says, they feel much more comfortable going into an arrangement surrounded by independent regulatory processes.
He says: “A number of cross-border IORPS already exist today, particularly Irish-UK ones. But many of the UK plans that had non-UK members had to carve out those members into special plans because of complexities that arose from the introduction of the IORP. We think that we are some distance away from pan-European pensions. The question is who is going to drive that leadership - service providers, a particular country or a multinational? There has to be an incentive for whoever takes that lead. I expect insurance or fund management groups rather than multinationals to take the lead on the IORP.”
Currently, only a few multinationals have sufficiently diverse pension assets in terms of location and scale to really make all the effort for pan-European pensions worthwhile.
Hanratty believes that asset pooling gets very little attention in its own right because it is more difficult to understand.
The IORP directive has given some directions with regards to pan-European pension funds but also says the social and labour laws of the pension member’s country must be upheld.
Hanratty explains: “In order to make this happen you will have to be a Dutch pension fund, for example, and start with German members and then try to extend this out. I think the pension fund is going to have to take the form of a transparent entity so that the pension members from each country can take advantage of the treaty negotiations that their country of residence has in place with different member states.”
He believes that asset pooling and pan-European pensions will co-exist in the future as both create efficiency. But he sees very few signs of the trend going towards pan-European pensions at the moment, as the legislation is only just over a year old, the date by which it was to be incorporated into national law.
Some countries have not even incorporated the law, though this situation is changing.
But some companies are looking towards a pan-European pension future. German auto component maker Bosch signalled that the group might create a pan-European pension fund out of its existing German Pensionsfonds after the EU occupational pension fund directive, which was transposed into German law last summer, permitted German firms to create pan-European schemes.
And in the Netherlands a 2005 directive provides the legal framework for establishing pan-European pension funds through mutual recognition of pension fund rules and abolition of existing national legal barriers to cross-border provision of financial services across member states.
Companies regulated in one member state can now participate in pension funds established and regulated in other EU jurisdictions. In addition, funds can appoint investment managers and custodians from any EU country.
But national legislation can also restrict asset pooling. However, the UK’s Investment Management Association (IMA) says asset pooling has become the big trend, in particular pension fund pooling where significant savings can be made.
The EC released a white paper on asset management in November, which contains legislative proposals on pooling. The industry as well as investors will benefit from this, and organisations such as the IMA welcome the paper.
IMA’s head of European affairs Jarkko Syyrilä said: “Initiatives to develop the European pension fund legislation further are ongoing between EU member states with developments occurring under the IORP directive, but due to the countries’ different systems, it is still a long way to go. At the moment, it is crucial to make pooling techniques less costly and much clearer in all European jurisdictions, which would be helped by a single European framework.”
The European Fund and Asset Management Association (EFAMA) are currently working on the development of pan-European pension solutions. But pooling techniques are a much quicker and more practical way to improve the efficiency of the industry, according to the IMA.
Brian Hill, specialist at Investit, believes that asset pooling - already undertaken by a number of multinationals - is going to continue. But he is sceptical about pan-European pensions being able to cover all of the EU members’ liabilities.
He says: “A pan-European pension plan won’t happen because of differences in employment laws, benefit laws, retirement age, equal treatment regulations and tax situations. The IORP directive and other legislation has helped asset pooling but has failed to harmonise the employment laws and regulations across Europe.”
One problematic IORP requirement is the 100% funding level, as its definition remains unclear. Consequently, it has become a matter of implementation or operation, instead of policy. Many EU tax authorities are introducing legislation and financial vehicles to encourage joining of their European pension plans within their country. Generally, such vehicles are useful for the country that introduced them, but have disadvantages for other participating countries.
The problem with asset pooling is that a substantial amount of money is needed to make it worthwhile. In any individual portfolio or asset class at least a quarter of a billion euros in assets is needed. Otherwise, it is cheaper to buy into a manager fund. The number of European plans that have such size is restricted to the likes of Unilever, Nestlé, IBM, Ford, Shell and BP.
Hill says: “Assets are being harmonised and that is quite popular. But if you cannot harmonise the liability structure, you cannot have a pan-European pension plan.”
That means that as long pan-European pension funds are still only a dream of the future, asset pooling is unlikely of being upstaged.