Who's for governance?
Corporate governance has been on the agenda for many years, but for most pension schemes the attention has been focused on the governance of the companies in which they invest rather than the governance of the pension fund itself.
Now, however, pension schemes and their governing boards are being subject to greater scrutiny and more pressures than ever before. Pension scheme trustees have traditionally been chosen from within the companies they serve, providing valuable liability knowledge but little investment expertise. Whether this model will last is now open to serious debate. This is increasingly apparent in the UK where amateur trustees find that they are struggling to stay on top of all of the information being thrown at them.
In the UK and elsewhere pensions governance is now really in the spotlight, legislation is on the increase and it appears heavier responsibilities are being placed on trustees. How will they cope?
The first problem is that no one really knows what good pension fund governance is. Most advisers have no idea whether we even need a code of best practice on trustee governance.
Pension fund governance is really quite a new science. In fact it was less than three years ago, in October 2002, that OECD governments got round to agreeing guidelines for the administration of their private pension funds designed “to help protect individuals’ retirement benefits from mismanagement and fraud”. Some commentators thought the UK got there a little earlier when in 2000 Paul Myners reviewed the investment industry for the government. He certainly started a debate but I feared most trustees looked at whether their schemes complied with his recommendations rather than whether their own governance of their schemes was up to scratch.
When it comes to corporate governance we are told that each corporate board must have a number of non executive directors and that after a period of time non executives stop being non executive because they have gotten to know management too well. Trustees go on record to vote off members of boards that do not accord with best practice and yet don’t even have a code of best practice for their own behaviour. This raises a number of questions. Very few trustee boards have policies which force members to resign after serving a number of years. Many member nominated trustee directors serve only for a few years but are usually free to stand again time after time. Is this right? If it is not, are we in danger of losing expertise just as it is built up? If independent directors are appointed should this only be for a limited period, for example for only as long as a sponsoring company non executive is considered non executive?
But the really interesting game is for trustees to try to measure their own success. To help trustees, we are now seeing a number of new initiatives in this area. Law Debenture, a respected independent corporate trustee has recently published, on its website, a very good contribution to the debate. This takes of the form of a pension trustee self assessment guide. Law Debenture describe trustee performance as effectiveness in ensuring that members receive their accurately calculated benefits promptly and that sufficient assets are available and contributions paid. There are 39 questions for members of boards to consider and 24 questions just for the chairman. It may be just a start but I can commend it to governing boards.
The Centre for Economic Policy Research and The Institute for Fiscal Studies issued an interesting paper in June 2003 comparing pension fund governance in the US and Europe in discussion paper no 3955. Authors Timothy Besley and Andrea Prat of the London School of Economics argue among other things for a strong board of trustees to monitor the performance of the pension fund. More controversially they argued that the effectiveness of such a board depends on the existence of a well-defined job market for trustees and of the independence between the trustees’decisions and fund performance. The authors argued that their core contribution was to establish a connection between the residual claim structure of a pension fund and its optimal control structure!
While progress continues strongly in the UK, pension fund governance in the Netherlands seems to have lapsed into a kind of limbo. After preparing an impressive draft code nearly a year ago under the chairmanship of Peter de Koning, the Dutch association for industry-wide pension funds (VB) eventually had to drop its plan to finalise the code following disagreement amongst its members, other funds and industry bodies. It appears the Dutch pension fund industry generally felt the VB’s proposals for a second supervisory board consisting of employers, employees, pensioners and deferred members were rather over the top.
Instead, following a study of Pension Fund Governance in The Netherlands commissioned by the ministry for social affairs and Employment and prepared by the legal firm Allen & Overy and the consultancy Boer & Croon, it is possible we might see legislation? I am told it was fear of government regulation that was a driving force behind the VB’s draft code. It would therefore be rather ironic if it was disagreement within the VB that ensures we do see regulation in this area.
Whatever happens, I am sure this story will be revisiting many more times.