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The middle way

Gail Moss outlines how public sector pension entities can get the best out of the procurement process

The EU Public Procurement Directive establishes tendering rules designed to throw open the provision of services to public entities across Europe.

Accordingly, local authorities must advertise their mandates in the Supplement to the Official Journal of the European Union, or its online version Tenders Electronic Daily.
The scope of the rules has widened.

In July 2010, the European Court of Justice (ECJ) ruled that large German local authorities had to put certain occupational pension services out to tender. Under the collective agreement for local authorities, the handful of Zusatzversorgungskassen (supplementary pension schemes), Kommunalversicherer (local sector insurers) and Sparkassen (saving banks) had been automatically chosen as occupational pension vehicles.

Following the judgement, this practice was changed to include a tendering process, although employers with under 2,400 members are exempt.

The judgment was transferred through a binding internal regulation issued by the German Association of Local Employers, which said large employers with more than around 2,400 employees must not follow the rules of the collective agreement. Instead, they have to follow the code of tender and contracts for services, which enshrines the EU tendering rules in German law.

In spite of what might be seen as regulatory interference, the procurement rules do have their benefits, according to Stephen Birch, head of research, Hymans Robertson in the UK.

“They encourage a wide range of providers to apply, so pension funds become aware of all options available to them, rather than speaking to just a few companies,” he says.
“Furthermore, as it’s a competitive process it encourages candidates to put their best foot forward. This may have a beneficial effect on cost and quality.”

However, there are drawbacks. The tendering process can itself rack up the costs for pension funds, as it is generally a multi-stage process involving a pre-set timetable and scoring methodology. It can also take time – months instead of weeks – to implement a change of manager.

Furthermore, it may not necessarily be the best (for the public pension fund) organisation that wins. Existing, sound, business relationships might be changed. And contract periods may be too short to create a good track record.

For pension funds, the process can become a minefield.

“One way to make things easier is to be very clear as to what you’re looking for upfront,” says Birch. “You should agree how the process will take place and who’s responsible for what, specifying to applicants beforehand what you’re looking for.”

“Pension funds need to create an experienced team which can send out these tenders as smoothly as possible, the emphasis on being ‘light’ and not overly bureaucratic,” says Michel Thomas, director at PensPlan Invest. “Best practice these days is to get the message out using mail distribution, pension fund web sites and specialised pension fund organisations or professional bodies. A points system is used to make the shortlist, followed by interviews.”

There is now an increasing tendency for pension funds to use ‘frameworks’ from which to select providers. These are set up using the standard EU procurement process. However, having established a framework – effectively a short-list of, say, five or six appropriate investment managers – the local authority has the option to restrict future procurement exercises to those on the short-list, using a simple ‘mini-competition’ to make the final decision concerning appointment. Typically, this makes the process a lot faster, removing the onerous work needed to consider a wide range of candidates each time. EU rules allow this pre-selection of framework candidates to be used for up to four years after it establishment.

There are two basic approaches to carrying out a procurement exercise; these consist of a two-stage (restricted) versus a single-step (open) process.

For a restricted process, the mandate is advertised throughout the EU, the advert including the broad requirements of the mandate and the criteria by which the pension fund will make an initial judgement as to whether an applicant has the required capability.

All participants are scored on the published criteria, then a subset – typically, the top ten to fifteen out of a hundred applicants – is sent the full invitation to tender, with detailed documents including due diligence questionnaires.

For an open process, all of the providers replying to the original advert are sent the full tender application documents, the shortlist being drawn up on the basis of their replies.

From the candidate’s point of view, the restricted approach means that by the stage they are required to complete detailed documentation, they are one of a few candidates, so the commitment of the required resources is easier to justify. With an open process, they might be competing against fifty other providers.

From the client’s point of view, a restricted process has the benefit of whittling down replies, so there are fewer detailed submissions to be looked at during the second stage.

However, while this saves time for services offered by large numbers of providers, such as asset managers, there may be some areas, such as custody services, where there are far fewer providers. In this situation, an open process may be faster because the pension fund can efficiently deal with a small number of tender candidates.

Throughout the procurement process, public sector pension funds have to demonstrate transparency and clarity.

“In terms of transparency, candidates should be told how you’re going to measure them before you ask questions and score them,” says Birch. The pension fund should give candidates feedback on their scores: an example might be to list the criteria used, then give candidates their score for each criterion, along with the winning candidate’s score.

Once a service provider has been chosen, the pension fund must decide if, or when, to review the contract. Typically, asset management contracts are arranged on an ongoing basis, with a short notice period.

Most of the time, a review is prompted either because the pension fund is unhappy with performance, or by a change in the investment approach. With an asset management mandate, for example, the pension fund may change the underlying investment strategy, say, by selling equities and buying bonds.

“Most of these institutions are planning for the long term, so managers will retain their contracts for at least five to seven years and they are not hiring and firing on a regular basis,” says Birch.

At a European level, and while local authority pension funds in countries such as Germany and the UK for example are working within the EU tendering rules, the position of other countries remains unclear.

“The rules of collective agreements are negotiated between the social partners, and in nearly every European country the freedom of the social partners is protected by the constitution,” says Hagen Hügelschäffer, managing director of Germany’s local and church pension scheme association AKA. “This creates a conflict between the freedom of social partners on the one hand and the procurement rules on the other, although public procurement for larger employers is not a problem in Germany because they are used to it.”

However, given that Germany’s social partnership set-up did not preclude the ECJ’s court decision on public tender rules, it is possible that other countries could be caught.

“We are of the opinion that other countries have a similar system to ours, so they could come under these rules as well,” says Hügelschäffer. “However, we haven’t heard of a similar case elsewhere, so it appears that the ECJ is not going to intervene.”

Although the Germans have adapted to the tendering rules, the European Association of Public Sector Pension Institutions (EAPSPI), of which Hügelschäffer is also secretary general, is opposed to the rules altogether.

Its position paper on the subject says: “As the supplementary public pension schemes are not carried out for the immediate economic benefit of the public employer, they do not fall under the scope of the Public Procurement Directive. The balance of employers’ and employees’ interests serves as a guarantee of a transparent selection process and as a control mechanism.”

Because the picture across Europe is so fragmented, EAPSPI says it has no plans to start a Europe-wide initiative to build co-operation and economies of scale, or to produce guidelines.

In any case, there are already some local rules – for instance, different German regions have different guidelines for their local authority pension funds on maximising value for money when procuring services.

Meanwhile, some local authority pension funds in the UK are now setting up frameworks which can be used by their peers, improving objectivity and transparency. This is particularly helpful to smaller pension schemes. Normally no charge is made, beyond a small administration fee.

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