Post IORPS, a new generation of all-terrain, go anywhere, pan-European pension vehicles have been launched successively by the regulatory authorities in Luxembourg, Ireland, the UK, Holland and Belgium. Luxembourg's FCP, Dublin's CCF, Belgium's OFP and the Dutch FGR are setting standards for other countries to follow.

Every national regulator and financial services provider wants a share of the cross border market, despite the fact that as yet very few cross border schemes have been created. In fact, some sponsored pension schemes, such as British ones with members in the Republic of Ireland, seem to have gone in the opposite direction, doing everything possible to avoid cross border status.

"First of all, it takes time and management resolve to create a genuine cross-border pension scheme," says Martin Sanders, chief investment officer of Univest which is domiciled in Luxembourg. "Secondly the costs must be outweighed by advantages and these vary case by case."

Univest now runs assets worth €4bn invested across six regional equity funds and has €400m in one fund of hedge funds. These assets originate in the main from Unilever's UK and Dutch defined benefit schemes, but a total of 15 Unilever schemes now share this portfolio. "Most are defined benefit schemes. There are about eighty of these, spread across 50 countries, within the Unilever group as a whole," he adds This leaves room for many more to join Univest, but only with a part of their assets. Cash and bonds remain domiciled with schemes in their countries of origin.

Northern Trust provides Univest with custody services, which are becoming ever more complex. The share of the assets in each equity fund owned by a particular scheme must be hypothecated to it. This is now referred to as virtual pooling. Payments in and out also need to be exactly accounted for and accounting needs to be of the highest standard. There are real economies of scale to be extracted from participating in Univest for each member scheme. Northern Trust runs a stock lending programme on the equities held in the six funds creating a flow of income that offsets some of the custodian's fee charges. Member schemes also get access to the selected fund managers at relatively low cost, and receive a high quality of risk and performance reporting from Northern Trust. "This saves each scheme from doing their own manager selection and performance monitoring, with real cost benefits," adds Sanders.

If Unilever were taking the same decision now would it still choose Luxembourg. "Frankly, we would probably go via Holland, and I expect other Dutch employers following us will do so, although now we will not be reconsidering our current arrangement via Luxembourg," responds Sanders. This is an important clue to the likely shape of the future market. A few years ago it was expected that either Luxembourg or Dublin to become Europe's preferred domicile for cross border pensions. But as more and more EU member states pass very similar legislation to permit asset pooling, multi-nationals will opt to domicile their cross border schemes in their country of origin rather than in remote, offshore centre like Dublin or Luxembourg.

 

Of course, Univest pools pension assets cross-border but not liabilities. There is a reason for this. "IORPS steered clear of tax issues but specified that any genuine cross border scheme would have to be fully funded according to the funding standard used in the scheme's country of domicile," cautions Jeanette Holland a partner at law firm Baker & McKenzie. Under current regulations, defined benefit schemes undertaking cross-border activities must conduct valuations annually. If the valuation shows that the scheme does not meet the statutory funding objective, no longer than two years is permitted from this valuation to return the scheme to surplus. This is potentially very expensive and inflexible, and other national regulators permit longer periods of up to ten years.

In addition, trustees, boards and sponsors must ensure that schemes are so they are consistent with the social and labour laws of other EU countries from which the relevant scheme members are drawn. Variations in these laws are wide, implementation of this requirement potentially demanding. Last but not least, the tax treatment of contributions, fund roll-up and pensions in payment varies widely. Some EU domiciles use EET, some TEE, where E stands for tax exemption and T stands for subject to tax, respectively for contributions, roll-up and pensions in payment. The Skandia case has not removed practical impediments to equal tax treatment.

"The development of cross border pensions has been slow," observes Sikko van Katwijk, head of outsourcing sales at Citigroup, ‘ but the issues are complex and it is no surprise that sponsors should take their time on this. Many multinationals have varying degrees of responsibility and covenant with not only defined benefit, but defined contribution, hybrid and insured pension schemes. Some of these may be wholesale, some essentially retail in character. "Transitioning them into a IORPS is not that easy," says Van Katwijk. "Pooling does not bring a quick fix or panacea."

In some cases, sponsors may calculate that keeping existing defined benefit schemes open is the cheapest course of action. And there can be little reason to make changes to schemes that are closed to new members and possibly future accruals. "The factors in favour of pooling are not strong enough to make it happen quickly and uniformly in the corporate pension sector," adds Van Katwijk.

Meanwhile, sponsors like Shell are establishing their own asset management companies before considering other changes. But matters look different in the asset management inudstry. Here, market forces are strongly in favour of pooling, particularly as asset management and distribution are increasingly separated.

"Asset managers in various segments of the market, across pension, retail and insured funds, can see many cost benefits from pooling, and using a single, global custodian," Van Katwijk adds. An example of this is the current project between Aegon in the Netherlands and Citigroup, aimed at creating a flexible investment platform that will facilitate the use of a range of asset strategies, including portable alpha, through pooling.

This platform is a full service solution designed to support the custody requirements of a range of investors including pension funds. In addition, it should enable participating investors to meet their widely differing tax, accounting and regulatory requirements regardless of their countries of domicile. This is a big deal that will set an example for the industry. As part of the agreement, Aegon is outsourcing its back and mid office functions to Cititgroup for all of its Dutch domiciled assets, worth €4bn. Custodians are migrating from the back office to the mid-office.

Meanwhile, global custodians like Citi, Northern Trust and KAS Bank have all developed proprietary virtual pooling systems. "These allow the virtual pooling of assets from a group of schemes without change of ownership," says Kerry White, head of new business development at ABN Amro Mellon, which is now part of BNY Mellon.

From a custodians' point of view there is little substantive difference between the pooling vehicles offered by the likes of Luxembourg or Dublin, and the hoice of domicile is not significant for the custodians.

"What our clients want is a seamless service covering accounting and record keeping, dealing with the full complexity of pooling on behalf of the sponsor," she adds. More and more sponsors are becoming aware of the revenues that can be generated by a global custodian. Stock lending programmes are the most significant of these, but there are other revenues to be gathered from ‘reverse expenses'. "These come through custodians clawing back withholding taxes and claiming eligible expenses," adds White.

Pooling facilitates diversification and more and more schemes are moving from relative to absolute return benchmarks, investing in derivatives, futures and such as 130/30 funds that use these instruments on an ongoing basis. "Clients need to have confidence that a custodian can price these on an accurate and timely basis," believes Aaron Overy, head of business development at Northern Trust, "This is not something that any or every custodian is able do."

Risk management is another key area where custodians can help their clients: "We measure portfolio risk for pension funds and provide them with bespoke solutions," adds Overy.

The use of voting rights is another area where custodians need to exercise particular care on behalf of clients. Guidelines on voting need to be agreed and put in place when a pool is first established. "Not only voting but quality of governance in general is also becoming more and more important after IORPS," adds Weezenbeek. "This is a neglected area where custodians will be expected to keep comprehensive records of decision taking and transactions."

Meanwhile the regulatory environment for both pension schemes and custodians is due for major change over the next several years. A review of the implementation of the IORP Directive is expected in 2008, and is widely expected to impose more onerous funding and control requirements. This can only strengthen the position of global custodians in the cross border pensions market.