Most multinationals' global pension programs consist of a grab bag of investment plans stretching across dozens of countries, each with its own rules. Managing such a crazy quilt is both an administrative nightmare and a drain on costs.
Thus companies have sought for years to pool their pension funds across borders -- not only to cut expenses but also to increase oversight and better execute their fiduciary responsibilities. But regulatory restrictions and tax laws have always frustrated such sensible consolidation.
The chief obstacle: withholding taxes on pension fund gains and income. Bilateral tax treaties between the U.S. and other developed countries, notably Canada, Japan, the Netherlands, Switzerland and the U.K., provide reduced rates of withholding taxes on pension fund gains and income. Pooling separate pension funds into a single intermediate vehicle may jeopardize the favorable tax treatment afforded each fund and subject the pooled vehicle to taxes in the jurisdiction that governs it. For pooling to achieve its potential economies, the vehicle must be considered tax transparent -- that is, the tax status of its constituent funds remains unchanged -- by the tax authority of the pension fund's home jurisdiction; the tax authority of any country that imposes withholding taxes on pension fund gains or income; and the tax authority of the country sponsoring the pooled vehicle.
Sensing a business opportunity, Ireland and Luxembourg have amended their tax regulations to encourage pooling by creating or modifying investment vehicles that neither country intends to tax and that several large countries have indicated they would regard as tax transparent.
Early adopters of the new vehicles are International Business Machines Corp., which registered with Dublin in October to create what the Irish have dubbed a "common contractual fund" (CCF) and Unilever, which in December said that its Dutch and U.K. funds would pool E1 billion ($1.18 billion) each in Luxembourg in a vehicle known as a "fonds commun de placement" (FCP).
Both companies are clients of Northern Trust Corp. Since 2001 the Chicago firm has been working with Goldman Sachs Asset Management, Mercer Investment Consulting, Deloitte & Touche USA and U.S. law firm Clifford Chance to find a pooling approach that would satisfy regulators and plan trustees concerned about the integrity of fund assets.
Finding a way to retain the favorable withholding tax treatment was the big challenge, says Kathy Dugan, vice president and product manager for pooling at Northern Trust.
"We weren't sure we could find a solution," admits Dugan, who has been with the project since its inception. "It has taken a while to get the necessary tax rulings."
In late June, Ireland's Investment Funds, Companies and Miscellaneous Provisions Act took effect, permitting the creation of CCFs. The vehicles are essentially contractual arrangements like partnerships. PricewaterhouseCoopers, which has closely studied pooling, says that most OECD tax authorities will consider the CCF tax transparent.
Sean Langdon, business development manager for corporate financial services at Ireland's Investment and Development Agency, says the rule's passage underscores his nation's determination to attract "high-end businesses," adding that he will "cooperate with anybody who can bring that business to Ireland." Langdon reports considerable interest on the part of big custodians and fund administrators in creating pooling arrangements.
State Street Corp. and Deutsche Asset Management have already teamed up to open a CCF in Dublin for U.K.-based institutional assets invested in the U.S. Alisdair Reid, who heads State Street's Asset Owner Group for northern Europe, says there has been interest among pension funds but "not much action yet."
"Pension funds like to take a considered approach before they do anything dramatically different from a structure that has been in place for ten or 20 years," notes Reid. Nevertheless, the appeal of CCFs appears to be strong: Reid estimates that pension funds can save 20 to 30 basis points annually through pooling.
Anouk Agnes, an official in Luxembourg's Treasury Ministry, says that since June 2004 the country's FCPs, which already were exempt from income taxes and stamp duties if used for pension pooling, are also exempted from a 1 basis point "subscription" tax. The change makes Luxembourg's FCP the functional equivalent of Ireland's CCF.
Unilever, whose pooled funds will be run by Northern Trust Luxembourg Management Co., has dubbed its FCP vehicle Univest. Philip Lambert, head of Unilever corporate pensions and chairman of its investment committee, believes that Univest will provide greater economies of scale than the current scattered system and also will lower overall risk and improve the consistency of asset management by centralizing decision making.
Unilever's pooling structure is complex, however -- demonstrating the difficulty that plan sponsors and custodians face in assembling pension assets under one roof, even with the more accommodating regulations.
Within Univest, each Unilever pension fund retains full ownership of its assets and liabilities. The funds are run by 14 managers who oversee 22 mandates in six separate regional equity subfunds; these are segregated from one another, so that each pension fund can continue to define its own geographical investment strategy. Investments in bonds and hedge funds are expected to come later.
Once other Unilever pension plans join the British and Dutch plans, Univest expects to have total assets of E3 billion to E5 billion. Unilever has 98 separate plans with a total of about E16 billion in assets.
Northern Trust's Dugan calls pooling a vast improvement over traditional country-by-country pensions.
"A multinational may have 25 plans, although we have clients with as many as 100 plans," she says. "In the past, each subsidiary made its own decisions. A firm will typically have significant sums in two or three places, and the rest [of its pension funds] will have small amounts. If everyone is making investment decisions independently, you are making the decision 25 times."
Dugan posits a not entirely hypothetical situation in which a company's pension plan in one country fires an investment manager while its plan in another country hires that same manager.
"That raises concerns about fiduciary risk," she points out. "You can't put forth the same diligence on a $200 million portfolio as you can on a $10 billion portfolio, but if something blows up, you are in trouble no matter what the size of the portfolio. Pooling brings the assets together so you can focus your expertise on a single vehicle that pools the assets but not the liabilities."
But in addition to the recent enabling legislation, multinationals will need sophisticated technology at the custodian level to make pooling work. Northern Trust enhanced its operating platform to track income, capital gains and withholding taxes at the investor level so that investors with different tax rates could join the pool. Like Northern Trust, State Street has spent heavily on its platform to contend with the complex reporting that pooling requires, says Reid.
"It makes life much simpler and more efficient for someone like State Street to provide services, since we start with one global operating platform that holds our custody records, investment accounting and performance management," he says.
Apart from the benefits of pooling itself, consolidating custodial arrangements can offer specific returns in the form of fewer portfolios to oversee, reduced transaction fees and the potential to net trades.
Explains Dugan: "If you have 23 plans that are tiny, they are spending a lot of money on investment management and custody. In addition, they can't participate in securities lending and commission recapture."
Dugan and Reid, who expect other custodians to enter the pooling market, anticipate that more multinational pension funds will adopt a pooled structure. Regulations in some countries requiring companies to report pension underfundings on their balance sheets and to make up pension liabilities are combining with poor investment returns to focus corporate treasurers on improving efficiency. Pooling has become a viable way to do just that.
