In May this year, the UK’s Nationwide Unit Trust Managers appointed Pittsburgh-based Mellon Trust to provide administration for its new stakeholder pensions. In July, German car maker Volkswagen announced that it was developing a company defined contribution (DC) pension fund and had formed a
partnership with Boston-based State Street to manage the administration of the new fund. These deals could represent the shape of things to come as companies and individuals across Europe and the UK move to DC and stakeholder pensions.
Because they entail an investment account for each individual, these new forms of pensions generate a far greater administrative burden than defined benefit (DB) schemes. And with regulatory and commercial pressure to keep costs down, those providing the pensions are looking for the most cost-effective means of getting their back office tasks done. One option is to outsource, as Nationwide and Volkswagen have done, and a number of organisations like Mellon Trust and State Street, that already provide services to the pensions industry, see a new market opening up and are getting ready to take on this new business.
“What we are undertaking for Nationwide is member record keeping and back office functions,” says Tim Harrison, head of marketing in the UK for Mellon Trust. Nationwide is the first customer for Mellon’s new service which it recently introduced into the UK and Europe. A second, as yet unnamed customer, has signed up for these functions along with Mellon’s custodial service, says Harrison.
Some big custodians, such as Mellon and State Street, believe they are well positioned to attack the new market. They already have relationships with pension funds and they have global processing technology, in many cases already have experience of providing services to DC schemes in the US. Wrapping all their services together puts them in a unique position to offer pension funds the support they need in the back office, the custodians claim.
“Our strategy is to provide bundled services solutions,” says Jeff Conway, senior vice president and managing director of investment services for the UK for State Street. In anticipation of the new market developing, State Street has been building up its capabilities so that it is now able to offer a raft of services including record keeping, daily valuation of investments, compliance and mandate monitoring, performance analysis and commission recapture, as well as its traditional custody offerings.
From the pension fund point of view, outsourcing removes a demanding and distracting chore. In May, Philips Pensioenfonds in the Netherlands hired State Street to provide it with a package including custody, accounting, global securities lending and performance and analytics. Gabriel van de Luitgaarden, senior vice president and chief financial officer of the fund, said that the package would allow his staff “the opportunity to focus on our core business”.
But, with much debate still underway in Europe about the nature of pensions and how they should be regulated, the market for outsourcing services is still in its early stages. Lucille Knapp, European business development manager for Chicago-based global custodian Northern Trust, says that although there are similar moves afoot in many European countries, there are still many differences and peculiarities in various jurisdictions.
“It is not clear yet as to exactly what the new style pension funds will look like and what sort of entity will be best equipped to provide the information required by both the corporations who provide access to the scheme and the individuals who participate in the scheme,” says Knapp. “However, the role of the custodian as the independent record keeper and compliance monitor can go a long way towards removing some of the work from a pension fund’s back-office.”
Northern Trust already offers a wide range of services and has recently helped multinational pension funds by creating offshore pooled investment vehicles, with common reporting and administration at the local plan and the parent headquarters levels, she says.
Traditionally, pension funds have done their own administration in-house or have outsourced to specialists, such as the companies that already provide them with actuarial services, such as global consultancy Towers Perrin. These firms are also watching developments in the industry closely and some are already adapting their infrastructure to meet the new requirements.
Scott Stearns, technology and administration consultant with Towers Perrin, says that his firm is making a ‘huge investment in technology’ to be able to service the new schemes. He is sceptical about how effectively many custodians, or even other traditional administration services providers, who have built their infrastructure and service approach around defined benefits will compete. Instead of opening the door to the big traditional players, the change in the pension industry in Europe could favour newcomers, says Stearns.
“Small, nimble companies who are building online capabilities from the ground up are well positioned (to succeed),” he says.
Global consultancy, William M Mercer, provides a range of advisory and other services to pension funds and looks at administration from the point of view of employers sponsoring schemes and “what they will have to do to ensure that promises are kept to members,” says Robert Plumb, European partner with Mercer. “In DC schemes, it comes down to record keeping. Whereas most employers did their own record keeping for DB schemes, most employers setting up defined contribution schemes say that they will get someone else to do it,” he says.
Custodians like State Street have indicated that they want to be that ‘someone else’. To provide record keeping capability, State Street is using European Financial Data Services, the European arm of Boston Financial Data Services, a record keeping specialist that State Street jointly owns with Kansas City-based investment technology services provider DST Systems. Nevertheless, even with such capability, custodians still might not be best placed to provide the service, especially for those schemes that use multiple investment managers.
“If the scheme wants to have choice, then they want someone that can link to a range of investment managers,” says Plumb. “A consultancy could be better placed to this.”
Furthermore, organisations such as Towers Perrin and Mercer are used to working closely with pension funds, whereas custodians relationships with funds tends to be more removed. “Although pension funds appoint the custodian, the day-to-day contact (of the custodian) is with the investment managers who are making the trading decisions,” says Suzanne Findlay, manager in the financial services practice at global consultancy Deloitte & Touche.
But the debate over whether to perform administrative chores in-house or to hand them over to third-parties is not yet over. Outsourcing of technologically demanding tasks is common in many industries and often controversial. There can be many hidden costs, as well as loss of control and flexibility. And efficiency gains don’t always materialise. There are software packages available for those funds that want to go it alone from companies like Profund Systems based in Bath, England, and Aquila based in Redhill, England. But the nub of the issue is, as Stearns explains, “if you are going to do the administration internally you need dedicated resources and people who know what they are doing.”
Furthermore, outsourcing services can be better equipped to manage the frequent change in the pensions environment, says Findlay. “When an in-house system is first put in place it is usually efficient,” says Findlay. “But when there is a change in legislation or members’ expectations, then it can be easier for a (third-party) provider to manage because it is making the change for many clients.”
Although the move from DB to DCs is happening more slowly than many expected, it is changing the landscape of the industry and forcing many organisations to review how they will deal with their administrative responsibilities. A recent survey by London-based Capita Hartshead showed that in-house administered schemes were 14% more expensive than outsourced schemes and that more and more organisations were considering using third-parties in the future (see page 74). It is still an open question who will win most of this business.

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