Shell Asset Management Company's decision to award a multinational pooling mandate to JPMorgan is expected to trigger more big deals. But Iain Morse finds there may be hurdles in the way
Outsourcing deals don't come much bigger than this. JPMorgan has won the Shell Asset Management Company (SAMCO) mandate for a single global custodian and fund administrator. It faced plenty of competition. "We won because we offer the best solution," claims Benjie Fraser, head of EMEA pensions and endowments at JPMorgan Investor Services (JPMIS). The quality of service offered by JPMorgan to Shell will set a benchmark for the industry.
"We have spent a lot of time and expertise developing technical support for complex pooled structures," adds Francis Jackson, head of EMEA business development and relationship management at JPMIS. Hitherto, administrative pooling has tended to be jurisdictional with too much patch and mend, but JPMorgan aims for a seamless, capital-intensive quality of service.
Shell's global pension assets are worth some €45bn. The deal is expected to inspire many more such deals, precipitating a wave of change among the largest European pension schemes. But we have been here before. Multinationals with significant pension assets should be pooling, yet have been reluctant to do so. "Progress has been slow," says Mark Walker, principal at Mercer Investment Consulting (UK). "The implementation of pooling is often more complex and potentially expensive than might first seem to be the case."
For a start, not that many schemes are sufficiently large, measured by their aggregate assets under management, and also sufficiently complex to justify pooling. "Those that meet both of these conditions will, no doubt, pool in time," adds Walker.
Shell's portfolio may be far better suited to pooling than others. Listed equities account for 60-67% of portfolio value, bonds for 30%, alternatives for 3-10%, and hedge funds for 8%. Cash can be negative, allowing the portfolio to stay within benchmark. The scheme is also fully hedged against currency risk. Shell is tight-lipped about the factors behind its decision to pool, but the new Dutch financial assessment framework (FTK) was undoubtedly a major factor .
The FTK has already led to other changes in the way the scheme is run. These include the establishment of an accountability council in addition to the existing board and members' council. The new council has six members equally representing the sponsor, employees and the pension fund's management team. The council is required to issue an opinion on the running of the scheme.
The pension fund, constituted as a separate legal entity, also concluded an administration agreement with Shell as employer. This relationship is also subject to annual inspection by a specially appointed committee of three independent experts who monitor all aspects of the pension fund's activities.
With this in mind, Shell has gone on record with some well polished quotes attributed to Peter Wit, the chief operations officer and finance manager of SAMCO. These emphasise the benefits of pooling as a set of economies of scale. Returns from asset pooling should be more optimally risk adjusted through better diversification, risk management, and cost savings from the simplification of operations. They also cite possible increases in revenue from centralised stocklending and cash management, not to mention the negotiation of lower asset management fees.
These are persuasive reasons for pooling but there may also be an important catalyst for further change from the US. Until recently it was accepted that US-domiciled pension scheme assets governed by the Employment Retirement Income Security Act (ERISA) could only be managed by a US-domiciled asset manager. But Walker says: "The fact is that we can get round this and pool cross-border assets as we can now get round many of the other impediments to cross-border asset pooling." As a consequence, US multinationals that moved abroad in the post-war period, setting up country-specific pension schemes in Europe and elsewhere, will now be in a position to consolidate and rationalise their pension assets and administration.
There are some 580 companies with pension assets of €1bn or more in Europe and around 50 of those may be potential candidates for pooling assets and their attendant custody and administrative requirements. JPMorgan is optimistic about the potential in this market. "Our target is far wider than just the top 50 schemes," says Fraser. "There are at least 200-300 defined benefit schemes in Europe that we believe we can help."
But these companies are a disparate group. Most still have a preponderance of defined or minimum return pension assets and liabilities. But quite a few EU member states, not to mention Switzerland, operate national regulations relating to asset allocation in the relevant pension funds. These amount to a form of prescriptive risk control but often oblige national schemes to hold a high level of bonds, which may be index linked. In countries like Belgium, schemes are obliged to guarantee a minimum rate of return. Many German schemes still have an element of direct promise, where assets are located on the employer's balance sheet.
"The European market is nuanced," says Fraser. "We recognise these nuances and local differences, but we are sure we can provide the same quality of service to all." The decision making process on major strategic issues such as pooling can also vary widely between pension schemes and countries.
In some countries, pension boards share power between employee and employer. In others, the employer has clear control. We know there has been plenty of resistance to the open selection of asset managers; bancassurers tend to bundle costs including those arising from administration and custody.
On the other hand, over the last 10 years, the way that sponsors view their defined benefit pension liabilities has changed. "Pension decisions used to be taken in the human resources departments, but now the main board, particularly the finance director, will want to be involved," says Walker. A whole new emphasis on cost saving and risk management has emerged as result and administrative pooling fits well with this.
But implementation remains a thorny issue for many sponsors. There are several different routes to pooling, some of which bring extra costs and complexity. Asset pooling needs all participating pension funds to agree on the use of a common taxtransparent pooling vehicle. Without this there is a risk of sacrificing optimal tax status, notably by incurring the withholding taxes levied in some European countries.
In practice, tax transparency is conferred by using one of a growing number of intermediary fund structures offered through financial centres. The best known examples are the Irish Common Contractual Fund (CCF), Luxembourg's Fund Commun de Placement (FCP) and the Dutch Fonds voor Gemene Rekeneng (FGR), which is used by Shell.
There are others are on offer, although as yet little employed, like the UK's Pension Fund Pooling Vehicle (PPFV). The tax savings from the use of these funds result from investing in equities rather than bonds. State Street estimates that they average 60 basis points on a US equity portfolio held by a European pension fund. This is before any savings which result from pooling asset administration.
So-called virtual pooling is another option. This is permitted under mutual fund regulation in both Ireland and Luxembourg. It offers a means to combine assets with the same investment management mandate while continuing to enable these assets to be legally, beneficially and directly owned by the separate pension funds participating in the asset pool. "It is really distinct from actual pooling," says Tim Caverley, executive vice-president, investor services, at State Street Global Advisors.
"Many sponsors find virtual pooling easier to take on and less traumatic than actual pooling," he says. A range of factors lie behind this. More asset managers are creating offshore investment products for the pension fund market and finding new ways of cost saving. That and the optimisation of revenue from asset portfolios are now subjects if interest to sponsors. "Decision takers are becoming more familiar with these ideas and looking to implement them if they feel there is no extra risk attached," adds Caverley.
The most potent and familiar arguments in favour of pooling are those that come with associated cost savings or revenue increases. But the most important single consequence of pooling may lie elsewhere. Asset pooling, whether actual or virtual, opens the way to more optimal portfolio management. Administrative pooling facilitates the use of risk management tools that will better allow the management of these diversified portfolios.
In the long run these will allow sponsors to manage their pension risk with greater efficiency. This, in turn, will facilitate more dynamic asset allocation and will have major consequences for the asset management industry that manages the relevant pension assets.