Thumbs up for central control

This month’s Off The Record poll focused on derivatives, operational risk and custody. Some 61% of respondents felt it was positive that measures in Brussels and the US would force pension funds to clear derivatives using a central counterparty. “Central banks need to be able to control markets in extremis, as we saw two years ago. The only beneficiaries of off-exchange derivatives are investment banks. End users of derivatives should be happy to see them go to central clearers,” said a UK fund. Another UK fund added: “Being transparent will be important”.

However, not all respondents were positive on the issue. A Danish fund commented: “Monopoly is always dangerous and may lead to various inefficiencies”, while a UK fund argued: “Although it may seem desirable at first sight, it will cause the costs to rise dramatically for pension funds”.

The majority of respondents (64.5%) believed that clearing derivatives contracts through a central counterparty would increase costs for their pension fund, for example through higher margin postings. “It seems like yet another mandatory institution will increase costs”, a Dutch fund said.

Just a third of respondents (33.5%) said their funds conduct securities lending, with only 11% believing securities lending income to be important to their pension fund.

Over half of respondents (55.5%) have restrictions regarding securities lending. “We only accept certain government bonds as collateral, and not cash,” said a UK fund. Another specified its restrictions as “counterparty limits, warranties from service provider, restrictions on securities taken in exchange, [and] appropriate haircuts”. Over 90% of respondents said their fund’s restrictions had not changed in the past 12 months.

Some 78% of respondents had one custodian bank relationship, with 16.5% having two and 5.5% with none. Respondents gave varying reviews of their most important custodian relationship when rating its performance over the past 12 months. The majority felt that they had received a good service, although one UK fund’s response suggested it had not been without its problems: “Performance has improved, prompted by more rigorous monitoring after a patchy period”. Another UK fund stated that the performance was “fine on the surface, but we are drilling down further now to question the exchange and interest rates received from them”.

Although mainly satisfied with the current service provided by custodian banks to their pension fund, respondents suggested various improvements. “All services could be improved - for example, quicker tax reclaims, [and] fewer failed trades”, a UK fund commented. Another UK fund added that it would like to see “systems improvements, integration of derivatives including OTCs, [and] better ‘future proofing’ of systems architecture”. Other respondents were interested in more general improvements. A Dutch fund wanted custodian banks to be “more pro-active with new services”, while a Danish fund felt they should demonstrate “more flexibility in daily operations”.

With regard to the importance of operational issues such as counterparty exposure when selecting and monitoring asset managers, 66.5% of respondents felt that operational robustness was integral to investment ability, not a separate issue. Some 39% felt it was as important as investment ability, and 50% added that it was more important than it was two years ago. Just 11% felt it was less important than investment ability. A UK fund stated that it depends on the type of manager or asset class, and commented: “[The] scheme should [have] control, not [the] individual mandate manager.”

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