Northern launches mystery pool
With the pan-European pensions directive now a reality and the EC communication on taxation set to reveal some legal teeth this autumn against discriminating member states, the topic of cross-border multinational pension plans is firmly back on the agenda.
When pension plans’ returns were largely positive, few multinationals worried excessively about what their disparate pension arrangements globally were costing them. On the back of prolonged poor markets, however, many transnational companies have found themselves with underfunded local plans that require remedial investment activity at the local level but also have ramifications for the corporation as a whole in such areas as credit rating. Anxiety levels for local pension fund trustees and corporate benefit centres alike is higher than it has ever been.
Multinationals have long talked about what cross-border pensions mean for the liabilities side of their retirement commitments. The asset side of the equation has often received less attention. In the past, multinationals have often been unable to impose any investment pooling type structures on local plans when they had little or no idea of what were the pension assets held by the local subsidiaries or whether they would actually be saving money by pooling.
Global custodian, Northern Trust formed a consortium with Goldman Sachs and Mercer Investment Consulting to look at developing a new service aimed at pooling multinational pension assets. A key aspect of the project was evaluating the tax implications of pooling the assets of the various international pension funds. Although this approach had been discussed historically, no organisation or group had previously succeeded in turning a theory into a reality that was robust enough to cater for each client’s individual plan and collective needs.
The service developed by Northern Trust enables comparison of the existing tax position of a multinational’s subsidiary pensions plan against the proposed investment in a pooled vehicle – with the flexibility that it can look at any combination of asset classes, asset allocation strategies and different income yields. The service also works for any number of pension plans domiciled in multiple jurisdictions.
For the global custodian, the endgame is that by calculating the tax effect of investing in a pool for each country plan, multinationals and the individual country plans can be persuaded that pooling is a good idea.
In essence, Northern is trying to apply a further proof to the established arguments that pooling increases economies of scale, enhances investment possibilities, improves risk management and corporate control of assets and reduces the administrative burden for individual country plans.
In terms of application, Northern already had two multinational clients on its books, both of which, as Lucille Knapp, vice president corporate and institutional services, explains, had the kind of data available about their worldwide pension commitments that allowed them to compare, contrast and move to the next stage in introducing a cost-effective pooling structure.
“The two clients also had good governance with sound central control from the centre of the company and specialist teams looking at the area of pensions – all of which are necessary really for this kind of exercise.
“Firstly, multinationals have to know what they want to solve: what asset classes and what benefits they want to deal with. They don’t necessarily need to pool yet if they are just at the stage of looking at what they have,” Knapp notes.
With ‘live specimens’ to work with, Northern began the arduous rounds of discussion with tax authorities about what could or couldn’t be achieved in terms of pooling, along the way taking legal advice from City law firm Clifford Chance and tax advice from consultant Deloitte and Touche.
As Mark Schoen, head of product development at Northern in London, notes, tax authorities were often only really prepared to listen when there was an actual company being discussed. “One of the problems for companies looking at this issue in the past was that they had no clients as such and the tax authorities are reluctant to look at hypothetical cases.”
Schoen says Northern adopted four main principles by which it could judge whether a particular strategy would be successful. These were value creation for the client, no tax drag in comparison to existing arrangements, no governance problems for users, and clarity within the whole pooling structure.
“The challenge was to find legal structures that had characteristics that met the pension funds need, while at the same time finding the best regulatory environment for investment, particular mandates, asset classes and governance.
“The pension fund regime is the most tax efficient available, but we needed to be sure that investment diversification wasn’t hampered in any way, nor that there were any restrictions on the way a pooled fund vehicle might invest.”
In practice, this meant finding the best tax location for investment in different asset classes (equities, bonds, private equity) and finding a broadly similar vehicle for all of them.
Schoen adds: “This was necessary because if there was any kind of tax drag then the pooling proposition would be a difficult sell to any local trustee board.”
More technically, he explains that taxation issues included finding the right legal structure for different asset classes such as global equities or pan European equities and bonds; whether this was so-called ‘look through’ or transparent (tax treaty in location of investor applies), ‘look at’ or corporate (tax treaty in location of vehicle applies) or ‘non treaty’ where no tax treaty applies.
The firm also had to look closely at the respective issues of withholding tax in different jurisdictions. Less technically, Schoen comments: “The bottom line was that investors should be in the same tax position as if they had invested directly.”
Northern eventually found appropriate optimal fund structures, which it says meets the demands of each jurisdiction’s transparency tests. Knapp comments that for commercial and client confidentiality reasons, the firm is unwilling to reveal more about the structure publicly.
She adds that it is also difficult to assess what kind of savings could be made for an individual multinational, but points out that two companies are already happily pooling while another two are at the starting line.
“There’s no headline figure so to speak. It very much depends on the size of the fund and the asset classes that you want to pool.
“Large funds, however, should certainly be able to benefit from scale as well as value-added extras such as lending programmes, commission recapture and fee negotiation.”