The demand from pension funds for greater transparency from their custodians is growing more urgent, finds Iain Morse
Dutch pension assets total €951bn and insurance company assets a further €300bn, making the Netherlands a lucrative market for custodians. “Among global custodians, KAS Bank has the largest number of pension scheme clients, although BNY Mellon is widely used by the fiduciaries and asset managers, says Maurice Kemper, senior consultant at Mercer. The two custodians share over 50% of the market by assets under management.
While most funds still offer some form of defined benefit scheme, usually career average, there has been rapid contraction by merger, absorption and wind-up, while smaller defined benefit (DB) schemes have joined industry-wide funds. “The regulatory environment is complex,” says Mark van Weezenbeek, managing director of sales and business development at KAS Bank. “Fees are thin, custodians need to be committed to this market. Local competence is crucial.”
There are also several large fiduciary managers, including APG, which manages €300bn for pension schemes, including ABP, according to IPE’s 2012 survey of fiduciary managers, and PGGM, which manages assets of €123bn. Next comes MN, with €85bn, followed by Syntrus Achmea, €55bn, and Blue Sky Group, €14bn.
The relationship between custodians on the one side, and pension schemes and fiduciary managers on the other, can be complex. Harmen Geers, spokesman for APG, says his firm uses three global custodians. “They provide us with safekeeping, trade settlement, income collection, reporting, fund accounting, pricing, investment accounting, and corporate actions,” he says.
However, APG carries out a range of other functions in-house, such as hedging interest rate and currency risk, collateral management and transformation, and reporting and fund accounting for client pension funds. Determining which functions are carried to out by the custodian, and which by the manager must be done case by case.
Over the last decade, the number of pension schemes has shrunk from 900 to just over 400, as they seek economies-of-scale in a tightening regulatory environment. “We think this process of consolidation will continue and industry-wide schemes will grow assets and liabilities,” says Weezenbeek.
In 2007, there were 180 company final salary company DB schemes, but by the third quarter of 2012 this had fallen to 102 schemes, according to the regulator, the DNB. Meanwhile, DB average-pay schemes fell from 364 to 271 in number over the same period. Over the same period, industry-wide DB final salary schemes fell from eight to three, while average-pay schemes rose from 99 to 103. Active membership in corporate DB schemes halved over the period, those in corporate average-pay schemes fell by 25%, while the total for industry wide schemes rose.
DB company pension schemes have assets worth €244bn, while industry-wide schemes have assets of €682bn, the balance being accounted for in hybrid and money-purchase schemes, according to the DNB. Out of total pension assets, over €575bn is in equities, €217bn in bonds, more than €83bn in derivatives, loans worth in excess of €26bn, and real estate in excess of €9bn.
Over the last couple of years the Dutch pensions regulator and the Federation of Dutch Pension Funds have introduced far greater transparency on the levels of fees and charges paid to administrators, custodians and asset managers. “Demand for greater transparency is strong,” says Weezenbeek. “Custodians will play a key role in delivering the required data.” In April 2011, the NRC Handelsblad, a leading newspaper, published an open letter from the Federation demanding that “expenses incurred by pension funds in relation to pension administration and asset management must become transparent”, followed in November by a comprehensive series of recommendations from the Federation relating to administrative costs.
Key recommendations are that pension management costs should be reported in euros per member where membership includes both active members and pensioners. It also states that asset management costs should be reported as a percentage of average invested capital. In addition, these costs are to be reviewed in terms of the portfolio asset allocation of each scheme, any benchmark costs arising, and against long-term portfolio returns. Lastly, the Federation wants transaction costs reported separately as a percentage of average invested capital. Reporting is to be under a ‘comply or explain’ basis, leaving pension boards some flexibility. A compliance timetable requires that 100% of pension management and asset management costs must be 100% disclosed by the end of 2014.
In November 2012, a further set of recommendations was issued by the Federation, with a strong emphasis on asset management and a section on custody fees. This focuses on custody in relation to listed securities and specifies a range of additional services – cash sweeps, processing of corporate actions, compliance monitoring, accounting, filing dividend claims, and pre-financing refundable withholding taxes. Nothing more is said about the role of the custodian.
However there is a lengthy section on transaction costs, which are normally compiled by a custodian. “Obtaining a clear picture of all transaction costs will be a tall order for the Dutch pensions sector as they invest in many markets on a net price basis,” states the relevant section. Brokerage fees, spreads between bid and offer prices, and the cost of processing and registering transactions in an investment manager’s accounts are separately identified and will require distinct measurement in cash terms.
At present, a relatively simple indication of transaction costs will be acceptable. For instance, brokerage fees or spreads on fixed income securities. Market impact, the effect on price of ‘market moving’ transactions, are will be included later. It is also intended to drive transaction cost analysis down through layers of fund management where these exist. For example, a fiduciary manager or fund-of-fund provider will be expected to separately disclose the transaction costs of any autonomous sub-managers.
Elsewhere, formulae and tables are introduced which are likely to be taken as market benchmarks. ‘Overview’ transaction costs for AAA government bonds are set at 10 basis points, emerging market bonds at 50 basis points and so on. There are some surprising areas of ambiguity. For instance, there is no prescription on determining ‘long term’ returns on investment, save a mention of ‘several years’. This may yet be refined to five and 10 years periods. Attention has also been given to the valuation and costs arising from private equity, real estate, and hedge funds.
There is much more detail in the November 2012 recommendations, the implementation of which will have major consequences for the pensions funds and custodians in the Netherlands. “We are seeing sponsors looking to appoint a single global custodian for all their pension schemes, with custodians asked to carry out more risk reporting not just on the asset but also the liability side,” adds Kemper.