Conflicts of interest
Written by Christine Senior
Trustees and finance directors in the UK have been battling with conflicts of interest for a number of years; so how does the rest of Europe compare? Christine Senior finds out
Conflicts of interest are a big issue for UK pension funds, and have got bigger as funding has become more problematic. It’s of particular concern for the UK Pensions Regulator which has issued guidance on where conflicts can arise and how they can be mitigated. Schemes are required to have a policy to deal with conflicts. In contrast, in continental Europe the structure of pension regimes makes conflicts less common.
The most significant conflict is probably faced by company finance directors (FDs) who also serve on the trustee board. Since funding levels have plummeted, with subsequent calls from trustee boards to their sponsors to plug funding gaps, directors find themselves in an impossible position of having to decide whether the company’s cash is best used for the benefit of the business or the pension fund. The upshot has been that it’s now rare for FDs to sit on the board of trustees of larger and listed companies.
This itself causes problems, says Mark Hodgkinson, director at Muse Advisory. “At the time when trustees need to negotiate funding they don’t have anyone on the board who has intimate knowledge of the corporate and its funding arrangements.”
Where the finance director remains a trustee, and negotiations over funding between trustees and company are under way, directors feel obliged to distance themselves from the debate, which again poses a problem for the trustee board.
“If you have a six person trustee board, for that most important trustee activity they are down to five, and have probably lost all their financial skills,” says Hodgkinson.
Any trustee who feels conflicted has choices to make, depending on the level of conflict. They may simply record they have a conflict and carry on as normal, contribute to debate at trustee meetings but refrain from voting, or stay out of both debate and vote, but in extreme cases resignation from the board is the only option. This loss of skills through the withdrawal of FDs is one reason behind the rise in use of independent trustees.
“We mitigate conflicts by being independent,” says Richard Butcher, MD of Pitmans Trustees. “If we are appointed to replace somebody who is conflicted, we get rid of the conflict of interest. If we join an existing board we dilute conflicts of interest.”
Another way of dealing with conflicts is through the appointment of a subcommittee to consider and take action on a particular issue where some trustees would be conflicted.
“It’s not that different necessarily from having a board of four where one says I have conflicts of interest, I will leave the room now,” says Butcher. “In creating a subcommittee they have to decide terms of reference. They may have different decision-making capabilities from the main trustee board.”
Another conflict which faces company-appointed trustees arises from trying to balance the demands of trusteeship and the duties of their day job. The increasingly heavy time demands on a trustee could take up to 20 days a year. But the company management may fail to register this and expect them to devote as much time as before to company duties.
“Employers are not as sympathetic as they might be, having put people in this position in the first place,” says Hodgkinson. “Enlightened companies recognise the issue and incorporate trustee duties within the key performance indicators on which performance for the year is assessed. But it doesn’t happen often enough.”
Another type of conflict revolves around the requirement that trustees should not benefit personally from their activities as a trustee. So if a decision was being taken to raise pensions for a particular group of pensioners, and a trustee was in that group, the potential for conflict of interest is there, or perceived to be there.
A rule of proportionality needs to apply, says Butcher. “If the proposal is to give all pensioners an extra 2% pension increase I don’t think they need to exclude themselves from that decision. If the decision is to give a small group of pensioners, of which this trustee is one, a significant increase they might feel it’s disproportionate to be involved in the discussion.”
In continental Europe conflicts of interest are less of an issue than in the UK. Pension boards are normally made up of half employer representatives and half representatives of the workforce.
“There shouldn't be a conflict of interest because the interests of all stakeholders in the pension scheme should always come first,” says Angélique Joosen, pension legal client manager at Aon Hewitt in the Netherlands. “A CFO who is also a member of the pension board should act as a member of the pension board when he is in a meeting of the pension board. But of course this will be very difficult.”
The same is true for Switzerland, where employer representatives must put aside their responsibilities to the employer in making decisions that are in the interests of the pension fund and its members.
“In Switzerland, board members have to act exclusively on behalf of and in the interest of the pension fund, whether they have been appointed by the employer or elected by the employees,” says Willi Thurnherr, head of retirement for Mercer in Switzerland. “If there is a real conflict between the interests of the pension fund and the interests of the employer, employer representatives may want to abstain from voting. They are legally required to indicate that. This goes for employee representatives too.”
Another reason why this kind of conflict is less of an issue in the Netherlands and in Switzerland is that underfunding is also less common. Pension funds have by law to be fully funded, underfunding was rare before the 2008 financial crisis, and when it does happen the solution is in the hands of both employers and scheme members. The burden falls less heavily on the sponsor to make good a deficit. On the one hand employers may be asked to pay contributions into the scheme, but at the same time scheme members can be asked to increase contributions, pensions indexing can be suspended or benefits reduced.
Regulation puts more constraints on how pension boards deal with underfunding, which limits the scope for conflicts. Ernst Schmandt, director of international consulting at Towers Watson in Germany, says: “In a highly regulated framework and limited discretion on behalf of the governing bodies of a pension fund, the likelihood that conflict of interests arise is much lower than in the UK.”
New governance measures proposed in the Netherlands would bring an element of external professional experience, more in line with the UK practice of bringing in an independent trustee to pension boards. The Dutch social affairs minister has suggested one of the options for a new pension board model should include external representatives in addition to the employer/employee representative board members.
But bringing in external experts brings its own problems. “It’s a very political issue,” says Joosen. “The social partners say these experts don’t have any feeling for the people for whom they are working. Unions and employers are afraid they will lose power if experts are brought in.”
Time will tell what the impact of this might be, but it is clear it is a real issue which needs to be addressed.
Written by Christine Senior, a freelance journalist