In sight of the 'holy grail'
The multinational computer services company IBM announced earlier this year that it is seriously considering adopting the Common Contractual Fund (CCF) Ireland’s new tax-neutral pooling vehicle for its multi-country pension plan assets.
If IBM goes ahead, it would represent a feather in the cap of Dublin, which has yet to gain a customer for its vehicle. It could also spur on other multinationals that are looking for a pooling vehicle for their own multi-country pension plans.
The decision to provisionally back the CCF was the culmination of a process that began five years ago, says Martin Jack, director of IBM Retirement Funds EMEA (RFE). Speaking at a conference organised by Finance Dublin earlier this year, he says that IBM faced a number of challenges. One was the transfer of employees “We’re a people company. We move people about from the country to country and pensions are by far the biggest inhibitor to stop us doing that.”
IBM also faced the operational risk of a fragmented multinational pensions business. “We’re in a highly inefficient business. Probably in any day of the week one of the investment managers in one of my European funds will be buying the securities that one of the other managers will be selling on that same day. We can find no way of netting those transactions or making those transactions efficient.”
Investment risk was another challenge: “We spend a huge amount of detail worrying about the individual investment contracts and guidelines that we give our investment managers. Having picked the world class managers we then look over their shoulders with quite sophisticated compliance monitoring systems.
“There is a lot of attention at that level, but an awful lot less attention at the macro level – the really large risks that we’re taking. And that’s something that I think is going to change in time too.”
Multinationals have limited financial skills and resources and must be selective about what they do themselves and what they buy in, Jack says. “This means we tend to specialise, we decide what we’re going to do within the company and outsource everything else.
“It also means that we tend to take a narrow view of what to invest in . Pension plans have typically stuck to the quoted markets. Possibly to real estate to some limited extent but generally speaking they are not significant investors in private markets, hedge funds and so on. I think that’s about to change.” In an attempt to impose some efficiency on the multi-country pensions business, IBM has adopted a rules-based approach to the 20 pension funds it operates in Europe. “We have come up with rules to try to make sure they are all broadly doing the same thing at the same time,” Jack explains.
“To a very limited extent we have been successful. When the euro arrived they moved from domestic equity markets into pan-European markets simultaneously. And there was clearly an advantage to them in doing that.”
Yet the real opportunities for improving efficiency lie in the pooling of assets, he believes. “We wanted to move away from pension plans investing in segregated mandates and towards the pooling those assets in one place.
The IBM team set itself the objective of creating a series of centrally managed unitised investment pools in which all IBM country pension funds can invest. These would cover not only quoted investments but alternative investments as well. “This means that all our pension funds, no matter how small, can have an optimal asset allocation to these types of assets.”
In this system, the IBM RFE pensions team, which had evolved from a quasi-consultancy into a manager of managers, would choose the asset managers rather than the funds themselves: “This is very much something that is run on behalf of the pension funds but run by the company. So we to some extent moving away from where the fiduciary authority lies within the pension fund.”
Location was also an important consideration. “It was considered very important that the investment vehicle would reside in a jurisdiction that had a high reputational content and we spent a lot of time debating that before we made our first move.”
Finally, and perhaps most important, the vehicle itself had to be tax-efficient. “We clearly didn’t want to have any form of withholding tax drag which would reduce our investment performance.”
With this blueprint, IBM established a unit trust in Ireland in 2001. A year later it created its first multi country pooling vehicle for global bonds using the same vehicle. Almost all IBM’s global bond exposure, more $1bn (E833m) under management, is now invested in the Dublin fund.
In parallel with this development, the IBM team were considering the issue of tax transparency. “We had been looking at the holy grail which is how do you take assets away from very highly tax efficient pension funds take them offshore and avoid incurring additional withholding taxes. We spent a significant amount of money and time arriving at the answer, and towards the end of 2002 we felt we had found the answer in Luxembourg.”
The IBM team identified the Fond Commun de Placement (FCP) as a suitable vehicle for pooled assets. Although the FCP had not been used by institutional investors in the past, IBM believed it would enable them to avoid withholding taxes. Taxes would either not be applied or would be recoverable by the individual pension funds.
Coincidentally, legislation was being put in place in Ireland to create the CCF – a vehicle modelled on the FCP. For IBM the CCF came at just the right moment, says Jack. IBM now plans to establish a global equity pooling vehicle later this year not only for its European pension funds but some of the non European pension funds as well – possibly the Japanese and Canadian fund.
“At the moment we are very much backing the CCF model. We still have a little bit more work to do to make sure that we’re absolutely certain that the various tax authorities around the world are going to treat it the way we believe they will. But the model indeed looks very attractive.”
One small drawback is that the CCF is currently only available in the form of a UCITs. IBM, along with other institutional investors, is pressing Dublin for a non UCITs CCF to provide a platform for alternative investments in the future.
A pooled global equity fund will provide a number of benefits to pension funds, Jack points out. It enables funds to have full exposure to all investable asset classes. It also enables the smallest pension fund to have exposure to ‘best of class’ asset managers.
Large pension funds also benefit from pooling assets because of the further diversification of risk, he says. “In the global equity fund that we are creating we are putting together a mixture of investment managers who, based on their past record and their style of management, we would not expect to have a close correlation of results going forward. So we can optimise the combination of managers and thereby maximise their diversification of risk.”
Pooling vehicles also provides much-needed transparency. “Today we use third party commingled funds to a large extent. One of the disadvantage of that is that we buy a product we can’t see down to the underlying securities. We plan to basically move all of our assets into these pooling vehicles because that will give us transparency of what’s happening at securities level. It enables to continue to apply our compliance monitoring systems to these situations as well.”
The benefits to the multinational plan sponsor are also clear, says Jack.
Multinationals benefit from having less risk in their pension funds, since the individual funds are more optimally managed in terms of their asset allocation.
Pooled assets also enable IBM to be lighter on its feet, he says. “It will enable us to move a lot more quickly. We don’t need to wait for a quarterly trustee meeting of a pension fund to decide a manager is failing and should we take action on that manager. We can move an awful lot more quickly than that.”
Finally, pooling is an inexpensive strategy: “And at the end of the day we believe that this isn’t going to cost us anything. In fact we believe there are probably small cost benefits in doing this and very significant cost savings,” says Jack.