Iain Morse assesses the state of the Irish custody market
Ireland’s new National Pension Framework, released this February, signals big changes for the Irish pension system and the custodians who serve it. “The impact of the credit crunch is very acute, because so many domestic schemes were overweight in domestic equities and exposed to the property market,” cautions Noel Collins, senior consultant at Mercer in Dublin. Both markets suffered huge losses leaving an estimated 80% of defined benefit schemes in deficit. In September 2009, the Pensions Board, Ireland’s pension regulator, laid out options for trustees facing deficits which included the reduction of benefits in payment.
After a period of consultation, the Framework will serve as the basis for a round of future legislation. It proposes re-structuring defined benefit schemes after the credit crunch, with the experience of other countries like the Netherlands taken into account. Key features will comprise fixed contribution rates for members and employers, changed benefit design to accommodate member longevity, but crucially also flexible benefits. Flexibility means far greater discretion on annual benefit revaluations. Trustees will be obliged to demonstrate that the rate of revaluation in any given year is sustainable and consistent with the long-term viability of the scheme rather than immediately affordable.
Meanwhile, the Pensions Board is stretching the 10-year limit previously in force for schemes to eliminate their funding deficits. Funding reviews are annual, providing plenty of work for scheme actuaries and custodian-administrators. Out of approximately 1,000 schemes, 353 have between 100 and 1,000 members, 67 have 1,000-10,000 and only five have more than 10,000 members. Two thirds of schemes are, however, closed to new members, although 62% of all members are in open schemes.
Asset allocation is shifting dramatically: “Ten years ago, the average asset allocation was 75% in equities,” recalls Collins, and some schemes held only domestic Irish equities. “The fall in Irish share equity values, by around 60%, has forced change in scheme asset allocation,” adds Willie Slattery, Ireland country head for State Street. Irish real estate, accounting for around 9-10% of scheme assets, has also had a rocky ride: “Taken together the impact of both falling share prices and collapsing property values has left many schemes with big deficits,” adds Slattery.
Schemes in deficit, and in breach of the minimum funding requirement, must prepare a funding proposal and submit this to the Pensions Board; between 50 and 100 schemes are thought to be preparing a submission in 2010. Meanwhile, the average allocation to equities has shrunk dramatically to around 55%, with further to fall, says Collins. LDI solutions, swaps and the like, now account for around 5% of portfolio value and this is predicted to rise to as much as 10% over the next couple of years.
Local banks used to dominate the local custody market, but most - except Bank of Ireland Securities Services (BOISS) - have withdrawn or sold their custody businesses to one of the global custodians. BOISS has a majority of the small to medium-sized schemes, but its dominance does not extend to the medium and large ones. This is a market where small defined benefit schemes have assets of €5-10m and medium sized, up to €60m. There are a dozen schemes with assets over €500m.
“There is steeply rising demand for non-domestic equities and these need to be looked after by a global custodian,” claims Mark Berwick, head of UK and Irish Pension Relationship Management at BNY Mellon. “We are also seeing much more use of derivatives, which also require a global custodian with the appropriate level of expertise.”
Allocations to bonds and fixed interest instruments are also increasing rapidly: “These were in short supply during the credit boom, with surplus bonds hard to buy, but this has changed with governments increasing issuance,” adds Slattery.
These changes in asset allocation are playing in favour of the global custodians. Pricing derivatives, reporting on portfolio risk, far greater attention to counterparty risk are all high on trustees’ agendas. “In that sense, the Irish market looks very similar to the UK,” notes Sonja Spinner, senior consultant at Mercer’s Sentinel Group. Elsewhere, Bank of Ireland Asset Management, a major provider of passive funds to the Irish institutional market, has reportedly written to clients to say it is recommencing stock-lending programmes. “All passive funds rely on earnings from stock lending to meet transaction costs and Bank of Ireland will have struggled to meet these costs without these revenues,” she notes.
There are probably no more than a couple of dozen Irish schemes lending via their custodians to any degree. Most portfolios are too small and the shift from Irish to non-Irish equities is usually accomplished by selling directly-held equities and moving to unitised funds.
Many schemes are also paying custodians cash minimum fees. Schemes with assets in the €200-300m range can expect their custodian to charge 3-5bps of portfolio value for core custody with extra cash charged for ‘value added’ services.
Elsewhere, Ireland’s role as an offshore financial services centre has created huge demand for fund administration and custody. There are currently €1.2trn in assets under management through Dublin, of which €158bn are in equities, €100bn in bonds and €32bn in hedge funds. All the major global custodians compete in this market, as do administrators and prime brokers catering to hedge funds. Some providers of hedge funds are converting to UCITS qualifying vehicles as a means of reaching a wider range of investors.
These custodian-administrators and prime brokers are now major employers in Ireland, and have expanded out of Dublin into regional centres like Cork. “There has been a slight uptick in new fund launches, with fresh activity around qualified investor funds and exchange traded fund launches, which could indicate an end to the recession,” notes Ross Whitehill, head of offshore management at BNY Mellon Asset Servicing. Nevertheless, salaries are static, or declining, across much of the custody industry, with annual staff turnover down from 25% three years ago to less than 5% today.
Meanwhile, the big question facing Irish custodians is whether the current rate of closure of defined benefit schemes will be curtailed by future legislation and any recovery in asset values. On the evidence of the UK situation, this is unlikely to happen.