Multinationals turn to pooling, but trust remains an obstacle

Emma Oakman explores the benefits that risk pooling can bring in an environment of heightened risk and governance awareness

The year 2008 will be a memorable year for anyone involved in pensions. Aggressive swings in asset values combined with rocketing inflation, as the banking crisis left no safe-haven untouched.

Unsurprisingly, risk has catapulted to the top of pension funds’ agendas. Schemes are increasingly looking for ways to protect themselves by improving governance and investment structures. Multinationals are recognising the benefits of asset pooling to flex bigger muscles at the negotiating table and get a better handle on overall exposures.

But trust is an ever rarer commodity in today’s uncertain market. Will trustees really be willing to let go of control? Could the risks of fiduciary responsibility undo the pooling market before it has really started?

“The current environment is raising the bar in terms of understanding risk,” says Kerry White, head of multinational business development at BNY Mellon Asset Servicing. “Pension managers are all confronted with the same challenges and are recognising the benefits of being able to manage downside risk on a more holistic basis.”

This argument has come to the fore in recent weeks as corporate sponsors try to get a grip on total exposures to particular counterparties, stocks, sectors or markets.

As Aaron Overy, business development manager for pooling at Northern Trust, notes: “Going out to pension managers in a number of different countries is going to be much more onerous than if the assets are pooled in one place.”

Unilever’s own pension plans are spread across 42 countries, 25 of which hold non-domestic assets, and Unilever was one of the first multinationals to create a Luxembourg-based Fonds Commun de Placement (FCP) in November 2005. ‘Univest’ was launched with €2.3bn in assets from their UK and Dutch plans and is now in talks with another 10 Unilever schemes.

Univest is expected to lower overall risk by providing a diversified external manager facility for the company’s plans worldwide.

According to Barry Mack, who heads up Mercer's task force on Pan-European pensions: “Central governance can help manage risks. For example, the expertise needed to understand some of the risks that have been highlighted by recent events is often underestimated.”

At individual country level, he says, it is less likely the necessary know-how exists across the board. By creating a global investment committee, all schemes benefit from dedicated resource and expertise.

White believes this is important for levelling the field between a multinational’s schemes: “Smaller plans are often disadvantaged in terms of getting access to asset classes and managers.”
Ensuring all schemes access the best quality managers is important to Unilever, whose plans range from €6bn to under €1million.

Overy says: “Asset pooling allows multinationals’ smallest plans to leverage the skills and efficiency that scale brings to access a wider range of asset types. Small funds have difficulty accessing hedge funds, for example, which is a lot easier if they are part of a $1bn fund.”

Picking the right hedge fund manager is crucial to success. “Scale can be critical to securing access to top managers,” Mack says. “By bringing the assets together, schemes have greater purchasing power and can potentially deliver benefits to members that would not otherwise have been possible.”

As the credit crunch rams home arguments around diversification and good governance, he believes these aspects of pooling will become more attractive and help drive the market forward.

Greater purchasing power has other key benefits.

Overy says: “More collateral also means schemes can negotiate bigger discounts. Every investment manager is a commercial business and we expect for an active equity mandate, schemes can save around 20 basis points a year by pooling assets.”

White notes that a major concern for schemes is being able to do more with less: “Schemes are trying to eke out better returns with less money. There are more schemes looking at their funded status and wanting to better manage costs, execution and access.”

As well as being in a better negotiating position, pooling may also create a more efficient way to manage corporate relationships with each manager. “Some multinationals may pay three sets of fees for the same product being used by different local plans. Being able to streamline that will create real governance value,” White says.

These vehicles are also more tax-efficient than other collective investment vehicles: Underlying schemes are taxed at their individual country level rather than at fund level.

According to Angela Docherty, senior corporate investment consultant at Unilever, Univest would not be possible if the authorities were not able to look through the pooling vehicle and tax all of the individual pension plans according to the rates that apply to their countries of origin. “Without this,” she says, “Schemes would lose the benefits of double taxation treaties and pooling would not be tax efficient.”

Overy argues these tax savings are effectively giving schemes money for free: “Over a 10 year period a $1bn tax-efficient fund invested in European equities would gain an extra $58m versus a collective investment vehicle.”

However, asking schemes to hand over control of a part of their assets requires a degree of trust that is currently lacking in financial markets.

In countries like Britain, where managing pensions carries a high degree of fiduciary responsibility, there may be resistance to this internal counterparty risk.

White says: “Getting around the trust issue is difficult. Trustees will always have a note of caution in how they approach ceding control to central bodies. It is crucial to ensure they know what is going on with the scheme and what decisions are being made. They also need to know that they have a clear get-out clause if conflicts arise.”

Clear two-way communication is crucial, according to Mack: “The last thing multinationals want is for local managers to decide to go their own way without telling Head Office. There needs to be a clear understanding of what local mangers can and cannot do and they have to be willing to disclose their decisions. Trust between the centre and local managers is a very important ingredient in this happening effectively.”

Overy stresses that pooling doesn’t mean trustees give up all their control: “They would be co-opted onto the investment committee and would therefore still be involved in asset allocation and manager selection.”

According to Docherty: “It is important to emphasise that this is a partnership with the trustees for individual plans. We firmly believe a primary responsibility of the trustees is strategy, and this is what really determines whether you can meet your pensions promise.

“Getting strategy right is 90% of the outcome – implementation, picking the managers, only 10%. We offer simplified implementation solutions carried out by Unilever investment professionals.”

Trust is, however, implicit and proven, robust structures are good news for the industry, says Overy.

Several other multinationals have now established similar structures: IBM was among the first, creating a Common Contractual Fund in Dublin at the end of 2005, with Nestle following suit in 2006. “These are tax-efficient structures that have been through the audit cycle and are understood by regulators and revenue authorities,” Overy says.

He expects to see further growth in this area, particularly as European regulators in Luxembourg, Ireland and Belgium are keen to push their jurisdictions.

“Liabilities are only going to increase,” Overy says. “In recent weeks, assets have been swinging wildly and multinationals need a platform to understand what their overall exposures are and to get access to best-in-class managers.

“We are on the upward gradient of the early adopter curve,” he adds. “There is no reason why the number of companies doing this wouldn’t increase.”

Written by Emma Oakman, a freelance journalist