In a world of their own
Size matters when it comes to pension funds. The bigger the fund, the better value it can give scheme members, through economies of scale on the investment side.
On the other hand, when a single pension fund has to cover an exceptionally broad geographical area, the costs can mount up. If membership crosses national boundaries, administering benefits can become a headache. So how does a retirement plan cope when its members will ultimately live in 58 separate countries?
This is just one of the challenges faced by Europe’s many supranational pension schemes. Retirement schemes catering for staff at pan-European organisations such as the European Parliament, Europol and the Council of Europe often enjoy freedom from the regulations which govern national pension funds, but they do have to cope with problems such as the logistics of communication between board members who do not speak the same language.
The European Patent Office has a pension fund for staff of the institution, which has a capital value of around €2.2bn.
The EPO fund is based in Munich, and operates as a reserve fund rather than a pension scheme, fund administrator Silvio Vecchi points out. “We are not involved directly in the scheme and its administration,” he says.
This means the fund has nothing to do with one of biggest complications supranational pension schemes face – making pension payments to members in different countries in a variety of currencies.
Though physically based in Germany, the EPO fund is not subject to German regulations which would normally apply to a pension fund being run within its national borders.
However, the fund does have its own set of rules which have been approved by the supervisory board. These include investment rules and guidelines, says Vecchio.
For example, there are limits on the use of derivatives within investment strategy, and caps on the amount of assets that can be put into any single security.
The fact that the fund’s supervisory board is populated by individuals from many different countries is not a problem at all, says Vecchio. On the contrary, it is an enrichment,
“It makes it even more interesting for us, because of the opportunity for gathering experience from different countries,” he says.
Europol’s pension fund has just 350 members and assets of just €15m. The asset mix is heavily largely weighted towards bonds, with 80% of assets in domestic and European fixed-interest, and the rest in domestic and European equities. The scheme is run on a defined benefit basis and based in the Hague.
Pension fund secretary Jennie Vermeulen says the scheme’s main challenges are two-fold – achieving and funding an indexed final pay system for all staff, and finding a system of transfers of values which is recognised across borders.
Even though the fund is located in the Netherlands, as an EU institution it has immunity from local regulations, he says. “The Dutch rules about publication of figures to authorities do not apply,” he says.
“The rules used are imposed by the European communities in the staff regulations that apply to Europol. Different fiscal regimes in countries severely hamper the possibilities of transferring in or out pension money of the fund,” he says, adding that some counties even block the possibility of doing this.
There are investment rules that the investment team has to adhere to, but these are set by the fund itself rather than government. “The reserve is invested according to an investment plan which is approved by the management board of the fund,” says Vermeulen. “In principle there are no other limits than that the investments have to be safe and sound and have to guarantee that the fund can fulfil its obligations in the future.”
At the moment, pension payments made by the Europol scheme are spread over three countries, but currency is not an issue for the administrators. “The currency for calculating and paying pensions is the euro,” says Vermeulen. “No other currencies are regarded.”
In common with most pension funds around the world, the Europol scheme keeps track of its participants, and this is part of its administrative burden. Vermeulen points out that the scheme does depend on the information given to it by former participants.
But it takes a decade of service before Europol staff earn the right to a pension under the scheme, and this does keep the number of pension scheme members down.
“Since the fund has a rule that a pension right will only be achieved after 10 years of participation and contracts are for limited periods only, there will not be many ‘sleepers’
in the fund – which reduces the administrative burden,” he says. “People who leave Europol within 10 years will receive a severance grant as compensation.”
The Pension Scheme of the Co-ordinated Organizations is a non-capitalised pension plan based at the OECD in Paris. The scheme covers employees from six organizations
– the Council of Europe, the European Centre for Medium-Range Weather Forecasts, the European Space Agency, the Western European Union, NATO and the OECD.
Michel Garrouste is head of the joint pension administrative section at the OECD.
“Each international organisation is a specific and complete unit; each is managed by its own governing body representative of those states that have adhered to the basic treaty,” he says.
In line with this, each of the six organisations applies its own rules to its staff and to its former members of staff, says Garrouste. The organisations have set up pension schemes which are distinct from national pension schemes in most cases, he says.
“They were designed to offer benefits equivalent to those of national civil service pension schemes.”
“Our pensioners are not subject to local rules – except where taxation is concerned because benefits are subject to taxation,” he says.
The pensions paid out are calculated in the currency - and on the salary scale - of the employee’s last duty station, but pensioners can opt for another salary scale if it is that of their nationality and if they settle in that country.
“We pay benefits in more than 40 different countries and indeed this implies some administrative difficulties,” says Garrouste.
From the investment point of view, there are real economies of scale to be won in operating a supranational pension scheme, says Adrian Cunningham, company secretary of the MEPs’ Pension Fund.
“You can pool the many expenses of actuaries, investment managers and so on, and substantially reduce costs,” he says.
However, at a scheme level, the administration of benefits can be very complex for a plan that covers members from many different countries.
“There are so many different things happening at a national level,” says Cunningham. “Pension taxation and regulations vary from one member state to another, and I can’t see them getting any closer in the near future.”
On a practical level, when an MEP joins the scheme from France, for example, the pension scheme is unable to advise them on how the benefits would be treated in their home country. It is up to the members themselves to get their own advice on this, says Cunningham.
Some supranational schemes get around this problem by paying out a lump sum on retirement rather than a regular retirement income. For example, the European Bank for Reconstruction and Development, which has its headquarters in London, has a retirement plan which provides a capital value rather than a regular income in retirement.
The EBRD plan is a mix of defined benefit and defined contribution. When the plan was set up, the bank did not want to become involved in paying out pensions, nor did it want to have a pensions department.
Administering pension payouts would be a particularly complex task, since the staff at the bank come from its 60 shareholding countries. If staff at the bank leave early, benefits are retained by the bank until retirement, but it is up to the employees to convert their capital sum into an annuity.
Currency is a big issue for members of the Brussels-based MEPs’ Pension Scheme, says Cunningham. But the scheme’s administrators are lucky that the fund was originally set up in ECU rather than different national currencies. When the euro was introduced, the new currency unit was simply swapped for the ECU.
Benefits are paid in euro, which presents no currency problems for most members, though three of the hitherto 15 member states in the EU - the UK, Denmark and Sweden - do face some exchange rate fluctuations.
Since enlargement, more members will have the currency issue to deal with, as the European Parliament now contains members from 25 states. However, none of the new parliamentarians from the new members states have yet reached retirement.
“If you have a pan-European scheme, your board should reflect that,” says Cunningham.
So the board is composed of people from many different countries, and this does broaden the investment perspective overall, he says. However, there are significant
costs involved in navigating the multi-lingual environment.
“Often you can’t have a direct conversation with two or three of your board members and many of your members,” he says.
The scheme also has to produce 21 language versions of its annual report. Translation and interpretation is expensive, though the scheme is lucky enough to have the language resources of the European Parliament on hand.
Though the scheme as a whole operates outside any one member state, investments take the form of a Luxembourg Sicav. This means they are subject to the banking regulations that apply to Sicavs in the Grand Duchy.
The fund does have limits on how it invests, but it is free of the home bias that affects most nationally-run pension funds, says Cunningham. Pension funds in the UK, for example, tend to hold 60% to 70% of their assets in UK-based investments.
“As we’re based in Luxembourg, we have no home bias; we’re truly pan-European,” he says.
The New-York based United Nations Joint Staff Pension Fund covers 20 member organisations and has 88,356 active members of the scheme. The UN pension fund has its assets distributed in a more even manner, in terms of weights, than national pension funds do, says Chieko Okuda, director, investment management services. “We diversify our investment all over the world,” she says.
“We have a lot of exposure to non-US equities compared to US pension funds… and we have more exposure to UK and European companies compared with Asian pension funds,” she says.
But Okuda does not agree that it is necessarily a benefit to have no home bias. “I do not say it’s an advantage or a disadvantage,” she says. “After all, the investments of a pension funds should be done in accordance with the liability structure.”
In the UN’s case, investment concentration within one country is not appropriate, she says.
The fund faces challenges not purely from a market point of view, but also in terms of the investment vehicles it uses, because of the different regulatory environments it has to work its way around. “If we only invested in developed markets, we wouldn’t have these problems. But we also invest in emerging markets very actively, and this is where we encounter problems with regulations.”
Withholding tax is a particular issue for the UN pension fund. As with most pension funds, the UN fund has tax-exempt status, but some of the countries in which it invests do not have conventional treaties. In these cases, the tax is withheld and must then be reclaimed by the fund.
“The procedure is not standardised across countries,” says Okuda. “Following up those issues costs a lot in terms of manpower and energy.”
Between 5% and 6% of the UN fund’s total equities are invested in emerging markets, she says, and some is held in emerging markets fixed income. The fund invests in more than 50 emerging markets directly and also through pooled funds.