Why pension pooling is a reality
As a panelist at a recent IPE conference, I was asked: “For all the talk about cross-border pension pooling, is anyone actually doing it?” A fair question, because so much pooling-related activity in recent years has gone on behind the scenes. The design and implementation of a first generation of pooled funds and the building of the legal, tax and technology framework necessary to create a new generation of tax-transparent vehicles were all accomplished in relative obscurity. Now, with that framework in place, implementation will move to the forefront as this new generation of funds makes pooling attractive and worthwhile to multinationals with global investment mandates and funded pension plans in multiple jurisdictions.
The new reality of pooling came fully into view late in 2005 with Unilever’s launch of Univest, a Luxembourg-based vehicle funded with $2.8bn (€2.3bn) in assets from the corporation’s partners in the initiative, the UK and Dutch pension schemes. Unilever, one of the world’s largest consumer goods companies, with retirement plans in 42 countries, sees pension asset pooling as a key element in a strategy to improve efficiency and risk management across the organisation. Univest is ready to meet the challenge: the fund is expected to grow to as much as €5bn in assets and the possibility exists to expand beyond the current 14 fund managers and six equity mandates into bonds and alternative investments. Most importantly, tax-transparent pooling enables participating plans to take advantage of favourable withholding tax treaty rates. Traditional, non-tax-transparent pooled vehicles frequently prevent pension plans from accessing withholding tax concessions they receive when investing directly in the market.
Now there is no question that tax-transparent, cross-border pension pooling can be done. It is being done, and not just by Unilever. Our group, which provides custody and fund administration services to Univest, also administers an Irish-domiciled tax-transparent fund launched earlier in 2005 for a US-based multinational corporation, as well as a Luxembourg fund for an investment manager. We are implementing programmes for several more clients and have received serious inquiries from a number of corporations interested in pooling pension assets. From our perspective, pooling is in full swing.
Why now? The ‘tax drag’ from investing in pooled vehicles had been a significant barrier to cross-border pension pooling for many multinational corporations. For example, UK, Dutch, Swiss, and Canadian pension plans that invest through pooled vehicles are normally subject to withholding tax on US dividends, but these plans pay no tax if they invest directly. The negative tax effect undermined the benefits - enhanced governance and risk management, diversified investments and administrative efficiencies - of pooling assets from multiple subsidiary pension plans. Now that Univest and other first movers have demonstrated the feasibility of a tax-transparent solution, other multinationals are already taking steps to implement pooling programmes.
Working to obtain tax rulings from authorities in multiple countries, we have helped to pioneer the development of multinational pension pooling and the use of two tax-transparent pooling vehicles – the Luxembourg-domiciled Fonds Commun de Placement (FCP) and the Dublin-domiciled Common Contractual Fund (CCF). Multinationals can choose either jurisdiction to offer their individual, underlying country pension plans an opportunity to access a broad array of pooled investment options, including global equity mandates. The FCP and CCF are transparent in that tax authorities ‘look through’ the fund so that each participating plan pays the same tax rate as they would when investing individually.
Taxes are not the only barrier to pooling, however. For multinational corporations, cross-border pooling can mark a change in the traditional investment decision structure. Independent local subsidiaries and autonomous pension trustees need to understand the advantages of pooling before they will buy in to the solution. Local trustees decide how much of their funds will be invested in the pooled vehicle, and in which asset classes and strategies, while a separate investment committee for the pooled vehicle (often including representatives of local plans) determines investment mandates to be offered, investment policies and investment manager selection and monitoring.
Enhanced investment options and stronger due diligence on investment managers are important potential benefits to local pension funds that participate in a pooled vehicle. Smaller funds can benefit from economies of scale and reduced risk due to greater diversification. Pooling pension assets gives plans access to best-in-class managers and specialised investment mandates. Fiduciary risk is a related concern, especially from a corporate perspective; with a proliferation of funds it is difficult to perform the same level of due diligence on a $200m (e165m) portfolio as on a $5bn portfolio. The ability to manage a single large pool of assets, rather than a number of smaller separate accounts, also yields significant cost efficiencies in investment management, trading, back office support, and custody. Larger asset pools can also benefit from revenue enhancements such as securities
If the goal of gaining greater control over global pensions through cross-border pooling seems daunting for a corporation, two lesser steps - multinational headquarter reporting and global custodial services - can help multinational corporations gradually increase corporate oversight at a time of increasing regulatory scrutiny. A common approach is to appoint a single global custodian for plans of significant size and complexity, and rely on headquarter reporting for smaller plans. Each country plan will likely conduct a formal review of the global custodian recommended by corporates so the respective trustee boards can become comfortable and make independent decisions. Subsidiaries will want to understand the benefits of high quality local custody services, consistent reports, performance analysis and risk management across countries, as well as any potential cost savings of working with the same provider globally.
The ultimate decision on any service provider change lies with the trustees. If the corporation adopts a continuum of services approach, headquarter reporting and global custody services would be followed by the ultimate step, cross-border pension pooling, to ensure consistent investment strategy, economies of scale and reduction in administrative cost.
Investment managers are developing an alternative cross-border pooling solution for multinational corporations that lack the scale to establish their own pooling programme. We are now working with investment managers in Europe to establish multi-mandate, multi-manager offerings through either the Irish CCF or Luxembourg FCP. The new funds are intended to provide a cost-effective cross-border investment solution for smaller companies, offering tax efficiencies for pension funds in countries where pooled vehicles experience tax drag.
For many corporations and regulators, pan-European pensions remain the ideal. Such a plan would allow multinational corporations to create a single European pension plan that pools assets and liabilities. The necessity for a new regulatory regime is not in dispute.
The European Parliament has established the legal framework for pan-European pensions. Nevertheless, many legal, tax and infrastructure issues related to pooling of liabilities have yet to be resolved. While pan-European pensions remain far from reality, however, cross-border pooling brings the assets together and so can provide many of the economies of scale necessary to European funds. Moreover, cross-border pension pooling builds cooperation among subsidiaries, an important first step toward pan-European pensions.
There are significant differences between pan-European pensions and cross-border pooling. Cross-border pension pooling involves commingling some of the assets of pension plans worldwide, while pan-European pensions would be confined to Europe. Pooling maintains the independence of the local plans, while a pan-European pension plan eliminates local plans altogether, replacing them with a single European pension plan with members from different countries. Addressing liabilities on a pan-European basis also presents a difficult challenge, so it may be some time before pan-European pensions become a reality, especially for large multinationals with well established local plans. In the meantime, multinationals can implement a solution that will improve pension fund oversight and risk management, generate efficiencies and strengthen performance. Tax-transparent, cross-border pension pooling is a reality – today.