GLOBAL - Regulators should promote pensions consolidation as small pensions funds are handicapped when it comes to setting up internal governance, a new working paper by the OECD argues.

The research on pension fund governance suggests there are various challenges within retirement systems worldwide to be tackled such as trustee knowledge, the lack of stakeholder representation in some forms of retirement provision as well as fund size.

"Small funds are likely to be backed by small employers, which may lack workers and even executives with relevant skills and experience to sit in the governing board," the report points out.

In an interview with IPE, Juan Yermo, principal administrator for private pensions at the OECD and co-author of the report, noted size should not necessarily to be seen in absolute terms, but added: "We are thinking about pension systems with hundreds of small funds, mostly for one single company with less than €50m in assets."

The report highlights Ireland as one case in point but suggets though some countries have similarly small funds, even on a multi-employer level, no further consolidation in these countries is necessary, according to Yermo.

In Austria, for example, where funds are also relatively small, it is believed the system and with it the funds are  "set to grow" so they will reach critical size sooner or later, he pointed out - in stark contrast to small company pension funds where this is seldom the case.

"Smaller pension funds have a governance handicap, as they tend to have higher management costs and more limited access to good trustees than larger funds, and may also have insufficient scale to establish fully-developed governance structures," explained Yermo and co-author Fiona Stewart, of the financial affairs division of the OECD.

They added small funds "may be more exposed to conflicts of interest and be at the mercy of consultants and external advisers who may lead them to make risky investments they may not fully understand".

This might also pose a problem when those funds select a fiduciary manager - defined by the authors as "a commercial provider taking care of not just the operational but also some key decisions of the fund such as strategic asset allocation and external manager selection and monitoring".

According to the OECD, the problem with this arrangement is "it is unclear whether commercial providers can manage the conflicts of interest inherent to such activities".

Yermo and Stewart see taking an equity stake in the manager, "as was recently done by a medium-sized pension fund in the Netherlands", as "one option to better align the incentives of the fiduciary manager".

That said, small funds might not profit from this option as such stakes need to be quite significant to have an impact.

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