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Impact Investing

IPE special report May 2018

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Slow start for ratings move

From last month Standard & Poor promised to rate UK pension funds to help trustees monitor the risks to the funding and investments.
But initial responses from pension funds, consultants and the industry trade body have been poor and even S&P, the US-owned independent research, ratings and indices provider, admits the increase in users is likely to be slow.
The S&P UK pension fund assessment service will provide information on the financial strength and management of defined benefit (DB) schemes. The three-part service will look at funding risks from the sponsor; investment performance risk; and the financial stability of the asset managers.
S&P’s Defined Benefit Assessment Service (DBAS) is a development from its work on the impact of DB schemes on their sponsors’ credit strength. The new service covers all companies, not just those with public debt rated by S&P, and is aimed at the funds’ trustees. The intention is to allow trustees to better negotiate with their sponsors about the contributions paid, particularly if a fund is in deficit, and balancing the interests of the sponsors’ other creditors and shareholders.
The DBAS has two elements: the credit strength of the employer (probability of it closing the scheme) and the consequence of such a closure on members’ interests, which varies depending on whether they are a pensioner, deferred or live participant. S&P uses a contributions/solvency model and qualitative assessments of the sponsor’s willingness to continue funding to maturity. S&P them gives the scheme a one to five star rating (with one showing an extremely weak scheme and five showing a currently and prospectively fully funded pension pot) and is designed to be used with the other two services.
The Pension Management Process Assessment (PMPA) looks at whether the investment objectives are likely to meet fund solvency requirements and at what risks, when compared to a AA discount equivalent bond portfolio, and how well the objectives are set and executed. S&P, along with State Street’s consultancy subsidiary, the WM Company, will carry out the assessment on an annual basis.
WM Company will also help S&P with the Asset Manager Assessment Service (AMAS). This service will analyse the asset manager’s stability, in terms of a credit rating; its corporate governance and ownership; and investment strengths for specific mandates. In total 30 to 40 categories are assessed to produce an academic, credit based report on an asset manager’s capability from a separate team to the one compiling the debt credit rating. AMAS will not, however, provide fund manager recommendations and is meant to be independent of consultants, as recommended by the Paul Myners’ review of institutional investment.
Unlike DBAS and PMPA, fund managers rather than the trustees pay for AMAS. Jim MacLachlan, managing director of Standard & Poor’s and head of European pension services, says the cost to asset managers would vary but at a minimum would be about £10,000 (e15,200) for the asset manager’s credit rating with two mandates assessed, but could be in the £100,000s for larger firms. Trustees would pay for DBAS and PMPA, and the cost would be less than 16 basis points (0.16%), MacLachlan adds.
He says there was no specific number of asset managers or number of pension schemes signed up to make S&P’s service viable. “We expect a slow ramp up of numbers, although we hope our other relationships [with firms, such as the funds and credit_ratings] will help. For example, when we started the credit rating of insurance companies 15 years ago it was slow but now nearly all are signed up.
“It is good governance for trustees to do this – the Pension Protection Fund (PPF) [a safety net being put in place by the UK government to compensate scheme members if a DB fund collapses while in_deficit] levy will consider the solvency of a scheme and probability of default when deciding its contributions level.” He adds that the PPF might look at the S&P system as it already maintained a credit risk tracker of about 300,000 companies with revenues above £100,000.
He said there had been “tremendous interest since March”, when the services’ details were first released, as trustees now have to assess the needs of the corporation to remain in business relative to any deficit. “What does the pension fund trustees do if the sponsoring company does not have a credit rating? How does the trustee made a decision on appropriate funding level? We assess impact of different contributions on scheme solvency and no other party does, thus, the use of the marginal pound, which is not a skill set the investment consultants have.”
MacLachlan emphatically denies that the services were competing with to the investment consultants but admitted it was unlikely they would sell the service to pension funds. He said: “We cannot expect them consultants to sell this service but it is not competitive to them – we do not provide advice. On investment performance strengths we do not recommend asset managers but collect information on governance, generic company strengths and specific mandates, which can be the same as collected by investment research department. It is a tool investment consultants can build on but written for trustees.”
George Urquhart, performance and investment consultant at WM Company, said it would be a conflict of interest for it to have provided fund manager recommendations for the S&P service as it was owned by State Street. But consultants were less convinced. Watson Wyatt declined to comment as it was “difficult”, while Mercer Investment Consulting said parts were competitive, although it needed more details.
And pension funds were also uncertain about S&P’s plans. John Birch, secretary to the trustees at the £9bn British Airways pension funds, said S&P had yet to discuss its plans with it but added that: “Members already have a lot of information, much of it contradictory, on fund values. I cannot think why members would need a rating.”
Andy Fleming, press officer at the National Association of Pension Funds, was more optimistic, but said the UK trade body was also uncertain as to S&P’s plans. He said: “S&P ratings could be a useful tool for some people, but I am sceptical if scheme members would need it, although there is a growing awareness of importance of good pension funds. More likely it will be an investment tool but, if so, people will need to think twice about it. Our reaction is to say ‘lets see how it works’, who forms the audience, for example? It has been more than one year since it was announced at our conference and we have been told nothing.”
MacLachlan says the consultants, pension funds and trade bodies had been consulted, and said he was surprised by their reactions. But in the month of launch such uncertainty is unusual and less than favourable for S&P.

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