Where does the buck stop?
Is there an optimal model of pension fund governance? If so, how should it be applied to Europe’s occupational pension plans?
These were the key questions at a discussion on pension fund governance organised by pension fund consultants Akkermans Stroobants & Partners in Antwerp recently, attended by pension fund managers, asset managers, financial supervisors and academics.
The keynote speaker, Keith Ambachtsheer, the founder of KPA Advisory Services in Toronto and author of the monthly Ambachtsheer Letter, has proposed a theory of pension fund management. This takes into account five key factors - investment belief (or portfolio theory), risk, financial engineering, governance and agency issues (who is in control).
“The first three factors are a re-formulation of Harry Markowitz’s ideas of the 1950s. The last two are the organisational ideas that he didn’t tackle – governance and agency issues. But if we don’t deal with the organisational issues, portfolio theory won’t save us,” says Ambachtsheer.
Confronting agency issues is crucial, he says. “The agency issues are who are the various stakeholders groups, what are their interests in their pensions arrangements, and whether you can align their interests well enough so that you get, in a game theory sense, a ‘win-win’ situation. Or is there a possibility that you will move to a win-lose situation where certain people win at the expense of other people.”
A pension fund needs a board to make this theory work, says Ambachtsheer, “The board is accountable for ensuring that work to further stakeholder interest gets done. But the board does not need to do this work itself. This is a huge pitfall that many pension funds fall into. They think that because they’re responsible they need to do the work.” Pension fund boards should choose a key manager - a CEO - to whom they can delegate, he says.
Ambachtsheer is critical of the 3.25% guarantee required from Belgian pension funds. He describes it as a put option that could create governance problems in the future. “I see that as a potential deal breaker some way down the road, because you have got to ask the question who owns those puts. Who has the capability of basically saying ‘I want my 3.25%.’?
“You also have to ask who is on the other side of that transaction. Who is underwriting that risk and is there fair compensation for whoever is underwriting that risk? Because if the answer is no you are setting up some serious agency issues.”
René Maatman is chief counsel at the Dutch pension fund ABP. Last year he completed his doctoral dissertation ‘Dutch pension funds, fiduciary duties and investing’. The perception in the Netherlands is that pension fund governance failing to meet present day demands, he says. “Criticism is targeted at the fairness of the pensions deal, the professionalism of the pension funds, and stakeholder participation.
“The question about effective governance has to be answered in the first instance in light of the objectives of the pension fund. Who is it doing what and why?
“A pension fund’s overriding objective is to satisfy the claims which the members can derive from the pensions contract. And to fulfil that objective a pension fund should be a professional service provider with sufficient expertise available to control its core activities - pension administration, providing information and asset management.
“Currently the governing boards of pension funds are in a difficult position. They are representatives of employers and employees, but they are not appointed primarily because of their specific expertise. They do not have an expertise on pensions law or pensions administration or asset management.
“Pension law in the Netherlands assumes that a management board can compensate this lack of expertise, by day-to-day management. But that is a weakness of the governance structure because the law of legal entities says that the governing board - the board of trustees – is tasked with the management, and can be held accountable for this.
“That is a weakness of the management structure in the Netherlands. Governing boards are responsible, but it is questionable whether they are able to fulfil their responsibility in practice.”
Maatman says there is a need for a new organisational structure for pension funds in the Netherlands which meets the current requirement for sound governance. It should be compliant with the EU pensions directive, securities law and the law of legal entities.
“What I promoted in my dissertation is a governing board of a pension fund consisting of professionals, and a stakeholders’ council to whom the governing board is held accountable - a stakeholders’ council consisting of three to 12 persons who appoint and dismiss the board and who also have the specific expertise to supervise the governing board. It should function something like a supervisory board with a corporation.”
The social partners in the Netherlands are not prepared currently to go that far, however, he concedes. “Employers and employees are currently responsible and in charge of the pension fund. They are directly involved in the negotiations on pensions. And they would lose power if they had to cede management responsibility to a professional governing board.”
An intermediate model would provide a compromise solution, he suggests. “One of these models is a one-tier board to function as a practical alternative, with professionals as executive members, responsible for the management of the fund, and representatives of employers and employees as non-executive members, serving together on the governing board.”
The debate about pension fund governance in the Netherlands is a sensitive issue, Maatman says. And he warns: “This sensitivity may easily result in doing nothing, and it is probable that inertia that will harm our pension fund system in the Netherlands most.”
Outsourcing asset management to external managers can cause conflicts of interest in pension fund governance, Lutgart Van den Berghe, a corporate governance expert at Vlerick Leuven Gent Management School suggests.
“If a pension fund has a long-term commitment of 30 to 40 years and they outsource their investments to organisations where the managers are rewarded for the short-term optimisation of the portfolio, you are bound to have conflict in terms of long-term continuity.”
The shift from defined benefit (DB) to defined contribution (DC) pension schemes is also likely to create conflicts of interest, she says. “It is in the interest of the pension fund to go from DB to DC. You don’t need to give any guarantees. But DC is a dangerous boomerang that will come back when people realise they don’t have the pension they assumed they had.
“From a governance perspective, there is a mismatch between the information professional have inside an organisation and your stakeholders have as to what the risk is and who carries the risk.
“If you set up a pension fund you should be transparent and accountable to your stakeholders and tell them clearly what risk they are taking on their shoulders.”
The new sector pension funds in Belgium will provide a clean slate for pension fund governance, Karel Stroobants, founder and partner of Akkermans Stroobants suggests.
“We will have pension institutions that will have a board. The unions will have to put members on the board. The employers will have to put members on the board. How will we ensure that we get it right? The Netherlands has had 25 years to get this issue right. We have only 25 months.”
Belgium’s lack of pension fund governance may be an advantage, says Henk Becquaert, special representative, supervision of complementary pensions at the CBFA, the supervisory authority for the Belgian financial sector. “Because we can start from almost nothing we can do what we like.”
The CBFA has set up a working group to consider pension fund governance “We will look at good practice in other countries. But it will be a difficult discussion and a difficult issue, taking into account the large number of small pension funds in Belgium.
“The consequence of a large number of small pension funds in Belgium is that there is a lot of outsourcing. We need to look at outsourcing and how it is organised. In practice, some pension funds do not make the right choice,” says Becquaert.
One of the main issues in Belgian pension funds is the distribution of risk, he suggests.“In Belgium pension funds are only a bag of money. Pension funds don’t bear risks on the liabilities side. That remains with the employer. On the other hand, they take do bear risks on the assets side.”
The effect of this is that some stakeholders are excluded from discussions about pension fund governance, he says.
“Employees in some pension funds are accepted and play an important role, but in a lot of pension funds its only employers that play a role, and at the end it is they who decide how to run and organise pension funds. There is some logic in that, because a pension is only a bag of money and the risk stays with the employers. We need to reflect on how we wish to go forward on this issue.”