Managing conflicts of interest
Written by Peter Davy
July / August 2010
Those expecting that the recession would lead to a surge in conflict of interest disputes in pensions will have been largely disappointed. Notwith-standing squabbles over the BA pension before Christmas and the scandal engulfing the Canton of Zurich civil servants fund (BVK) in Switzerland, schemes seem to have managed their way through the crisis relatively unscathed, and high profile cases remain rare. Indeed, even before the UK limped into recovery in the new year, the UK Pensions Regulator was finding encouraging signs: its governance survey showed an increase in the proportion of schemes that felt the trustee board had appropriate processes in place to manage potential conflicts.
The UK’s National Association of Pension Funds (NAPF) is also cautiously optimistic as there’s little evidence from its members that the economic crisis has led to signifi-cant problems with conflicts.
That’s possibly because the dangers are now well recognised. In the context of the wider governance process there has been an increas-ing focus on the issue in recent years, says Clive Gilchrist, director at BESTrustees. Look at both trustee and company board meetings nowadays, he points out, and the agenda will invariably kick off with the question of whether anybody has a conflict of interest. You can also probably take the increased use of independent trustees as an indication that practice is improving. At Pitmans Trustees, managing director Richard Butcher argues that the main benefits independent trustees bring are the expertise and understanding of the market. Nevertheless, conflicts are the driving force for many, if not most, trustee boards that consider them.
“The first thing they generally say is that they think they are conflicted and need somebody else to help mitigate that,” he says.
Elsewhere in Europe it’s a similar picture. The Irish Association of Pension Funds (IAPF), for instance, notes an increase in independents, while in Switzerland, pension fund association ASIP hopes to introduce a governance charter for pensions that will address conflicts (among other things). However, director Hanspeter Konrad says the voluntary code is more about providing reassurance, promoting confidence and seeing off proposals for heavy-handed government regulation than about correcting poor practice.
“I think trustee boards actually handle the issue pretty well,” he maintains.
Not everyone is so sure, however. Looking back to the UK Pensions Regulator’s survey and it’s not all good news. Yes, there was a significant increase in the number of boards with appropriate processes in place to manage conflicts, but only up to 60 per cent. The other 40 per cent still weren’t confident they did. Furthermore, only half maintain a register of trustee interests. At least one in ten, therefore, feel this unnecessary in order to manage potential conflicts.
The Regulator’s findings are all the more significant when you consider the number of sponsors’ directors sitting and even chairing scheme boards. At the end of last year, the Occupational Pensions Alliance (OPA) published a survey showing that 60 per cent of trustee boards contained directors of the sponsoring company.
Of course, that’s not necessarily a problem; as Butcher puts it, “It’s not conflicts of interest that make bad trustees; it’s the failure to identify and manage them”. However, the problem is that it’s impossible to know if they are being identified and managed, according to OPA executive officer Roger Turner. Despite the Regulator’s “serious concern” that funds must be confident members’ company positions do not make them less diligent, it doesn’t record the number of schemes in such a position, he points out. Nor does it note what steps schemes take to mitigate potential conflicts.
There is another reason why conflicts of interest remain a real issue, though: they are unavoidable – even in countries where concerns are not focussed on trustees.
“Conflicts of interest will always be there,” says Karel Stroobants,
an independent director and past president of the Belgian Pension Fund Organisation. “You have them in every model, and you have to tackle them.”
In Belgium, for instance, Stroobants is scathing about the management of most pension funds. Conflicts arising from directors or other employees on the board are not usually an issue, he remarks, but only because too many boards are barely engaged in the running of the fund. In at least two thirds of cases, he says, funds are entirely in the hands of an asset manager or consultant. Boards too often have neither the expertise nor interest to seriously question them.
“When we try to prompt them to consider the risk in the fund or define their investment beliefs the typical answer you get from board members is that it is all too compli-cated for them,” says Stroobants. “My answer to that is to say, ‘Sorry, but if it is too complicated then you should be not sitting on this board’.”
And leaving control almost entirely to the fund manager without proper oversight is inherently dangerous. The fund manager’s time horizons, as a listed company, are invariably short-term; the scheme members’, long-term.
That, of course, leads onto the issue of fiduciary management.
Here the potential conflicts in the model are, admittedly, not a new issue. However, as with conflicts on trustee boards, that it hasn’t come to a head should give only so much reassurance, say some. In the UK, for instance, it’s probably as much because few people are using it, says Gilchrist.
“It hasn’t really been an issue because the UK [fiduciary manage-ment] market has not grown that much. It only becomes a real issue when people are doing it, and that is only really starting to happen.”
It’s a similar story in Ireland and Germany.
However, that’s not an argument you can apply to Holland, where as many as three quarters of pension scheme assets lie with a fiduciary manager. But what about the per-ceived conflicts? The reality, says Gerard Roelofs, head of investment consulting for continental Europe at Towers Watson, is that in the majority of cases the responsibility for strategy is in fact shared by a consultant and fiduciary manager together to prevent any conflicts from being a problem.
“In practice there are not too many conflicts,” he says. Where the fiduciary manager is to monitor itself, however, then there’s an issue. And even in Holland, questions are being asked. Firstly, about whether trustees have given too much control away by relying on fiduciary man-agers, following criticism by the committees set up by social affairs and labour minister Piet Hein Donner. This has led to a period of intro-spection on the part of pension scheme board members as to whether they have the right skills and expertise to properly manage the funds and evaluate the risks, says Roelofs.
Secondly, questions are being asked as to who pension funds can trust their money with. Some point to the decision in April of the €6bn Dutch transport pension fund, Pensioenfonds Vervoer, to drop Goldman Sachs as the fund’s fiduciary manager, although it said the decision was not con-nected to fraud charges the bank faces in the US. However, Leny van der Heiden-Antjes, deputy director of the Dutch association for industry pension funds (VB), says funds are looking hard at the issue.
Nor is it just in Holland. Roelofs’ col-league in Germany, Nigel Cresswell, notes that at the recent congressional hearing one of the big questions posed to Goldman Sachs executives was the extent to which they had a duty to act in the best interests of their clients. It’s a question that should be considered of providers more widely.
“One of the things we all should have learnt from the credit crunch is that you shouldn’t assume that the provider is acting necessarily in your best interests,” he says. If a company is selling a product, it is – by definition – partially conflicted, he adds. Just as within the board, it’s ultimately up to those responsible for the fund to look out for those conflicts and make sure they manage them.