For trustees and board members of pension funds in Europe, life has never been harder. A decade ago, things looked rosy. Pension funds were in surplus, and funding levels were not a concern. Pension schemes were posting strong double digit returns, allowing contribution holidays, and spending almost next to no time on investment decisions.
All this has changed, of course. A recent study from actuarial consultant Lane Clark & Peacock has shown that Germany, Spain, and the UK have the biggest pension deficits in Europe. According to the firm, the combined European pension deficit stands at €116bn. It was hardly surprising that after the technology bust and subsequent market downturn in 2001 to 2003, the whole asset management industry went through a period of navel gazing. But when it comes to the governance of pension funds, that navel gazing has only just begun, say industry participants.
“It’s a matter of trust,” explains Peter Borgdorff, director of Vereniging van Bedrijfstakpensioenfondsen (VB), the Dutch Association of Industry Wide Pension Funds. “After the problems with the stock market at the beginning of the century, there was a sort of breakdown of trust. Now we have to establish the trust of the participants in the pension schemes, and in society,” he says.
Borgdorff also points out that it was only a matter of time before governance became an issue for politicians and other organisations. “You see governance being discussed in relation to companies and all over society. You are seeing people working on governance codes for education, and healthcare, for example. It was a bit strange that pension funds, as large investors, are demanding that companies have good governance, but we’re not doing it ourselves.”
And the pressure is mounting for improved governance in the pensions industry. Earlier this year, a report released by London-based think tank AccountAbility and the World Economic Forum offered a damning view of pension funds’ lack of governance.
According to the report, Mainstreaming Responsible Investment, accountability and transparency fall short, with members rarely able to discover how their funds are managed, and with little say on how the funds operate or who makes the key decisions.
The report notes that corporate funds and employee stock plans in many jurisdictions are largely controlled by company management. And boards of trustees of pension funds generally do not operate as professional oversight bodies. It says that many trustees are not getting trained, they spend too little time on the job, do not communicate enough with members, and ignore shareholder activism and socially responsible investment.

It is no wonder that trustees are feeling the heat. In the UK, for example, the Pensions Act of 2004 imposes strict penalties on trustees who do not meet their obligations. The Pensions Regulator, which was created under the act, will have greater powers, and trustees risk fines is they neglect or refuse to provide information required by the regulator. They are also required to report any breaches of the act that they come across, and have less scope to claim they did not understand what was happening.
“Governance is crucial, because under the Pensions Act, the trustees have massively new and onerous obligations. The key is knowledge and understanding, and I think this is where trustees need all the help they can get,” says Chris Edge, chief executive of Epic Consulting in the UK.
Understandably, trustees complain that under the current system, their situation is close to impossible. They are managing increasingly difficult investment decisions and although they might be getting training and education, they are not all professionals and they carry the whole burden of responsibility on their shoulders.
“Many trustees are now stretched to their limit of their knowledge and understanding in a lot of areas,” says Kevin Carter, head of European operations at Watson Wyatt. “Also, the relationship between the sponsor and pension fund trustees has had more scrutiny in the last few years, and there is more potential for it to be a difficult relationship at times. The employee trustees have become increasingly conflicted, and if they happen to be important to the company as well, they become impossibly conflicted, because they have to serve too many masters.” It means that chief financial officers and other talented professionals often leave trustee boards, because of the conflicts of interest.
And pension funds are increasingly influencing the fates of their sponsoring companies. Last summer, for example, the trustees of UK retailer WH Smith blocked a £940m (e1,384m) takeover approach by Permira, the private equity house. Martin Taylor, chairman of the trustees and the former chief executive officer of Barclays Bank told Permira that any acquisition would have to have a guarantee that the pension funds would at least have priority with the banks in the case of a company collapse.
A survey of UK corporate pension scheme trustees conducted by Watson Wyatt, finds that trustees have, on average, 17 years of financial experience and nine years of experience of trustee matters. However, 25% of trustees have had less than five years’ financial experience and less than three years experience in trustee matters. The survey, which covered 131 funds worth approximately £137bn, and involved more than 400 trustees, reveals that the typical trustee body spends less than 24 hours per year discussing investment issues.

Some critics argue that trustees should take more responsibility. “Trustees need to have a far higher level of understanding of investment instruments and strategies than they currently have. They rely far too much on consultants and other intermediaries, and do not interact enough with fund managers or investment banks. I would like to see fund managers and trustees talk more frequently,” says Amin Rajan, chief executive of the Centre for Research in Employment and Technology in Europe (Create), the think tank.
Amin believes that the review completed by Paul Myners in 2001, which recommended that trustees be paid for their work, should be implemented. He also says that structures need to change. “You need a board of trustees, and under them, various investment committee that can be empowered to make a decision on a quarterly or monthly basis, depending on the instruments that they use.”
Such structural changes to improve governance are being introduced across Europe. The EU pensions directive came into effect in September 2005. On the issue of governance, it states that the board of directors, or decision making body of a pension fund, needs to be competent, responsible, and accountable. The board should be educated, and should be assisted by external advisers such as actuaries, money managers, and custodians, but will ultimately be responsible for administration and disclosure. Annual audited accounts should be presented to the sponsoring company and members, and pension funds must have a statement of investment principles that are reviewed every three years.
Similarly, the Organisation for Economic Co-operation and Development (OECD), is adding to the guidelines that it set out in 2002 to beef up international standards of pension fund governance. In a recent report on developments in governance, the OECD pointed out that there are several issues that still need to be addressed.These include the “lack of clear accountability and personal liability as a result of the involvement of multiple fiduciaries, a lack of sufficient knowledge of trustees, excessive reliance on external consultants, and a lack of clarity over the whistle blowing role of auditors and external managers”.

Earlier this year, the UK’s National Association of Pension Funds issued its own discussion paper and recommendations for governance, pointing out that in the first report of the Pensions Commission last year, the issue of governance did not even feature. In fact, since the Myners review highlighted the importance of the issue, there has been little thinking about the governance of trust boards themselves, according to the NAPF. Instead, recent regulatory initiatives have focused on the composition of scheme governing boards in so far as they represent members, rather than looking at governance as a whole.
The NAPF paper also argues that there is a governance vacuum in contract-based defined contribution workplace schemes. The schemes have grown in the last five years and are likely to continue to do so, “but there is no effective mechanism to promote represent the collective interests of the millions of workers in these schemes after the point of sale, effectively creating a ‘governance vaccum’”, according to the report.
The OECD says it is a problem that has relevance across Europe, where contract-based DC schemes are being developed without any kind of collective governance relationship.
It also has an impact on communications, points out Epic Consulting’s Edge. “DC is the forgotten part of the pension agenda. The trustees’ job is to look at everything, but the DC plan is last on the agenda. It is vital that trustees make sure that members have the wherewithal to understand the range of investment options that trustees make available to them. In most DC plans, members go for the default option, and whether or not it is a good one is besides the point. It indicates a level of very poor communication, and suggests that members believe the recommendation they need to go for is the default one.”
According to the OECD, it all comes back to the issue of the expertise of fiduciaries and trustees. Since there are no proper checks on fiduciaries nominated by the sponsoring company, conflicts of interest and suitability may not be fully addressed. In the UK, for example, there is little guidance on who should become a trustee and what sorts of expertise is needed, according to the report. The OECD also points out that it is a question of scale – 80% of UK schemes have less than 12 members, which make it difficult to manage the requirements of trusteeship.
The OECD has made a number of suggestions for tackling some of these issues. One is for pension funds to develop clarifying guidelines outlining the roles and responsibilities of each party, and to encourage pension funds to draw up and adopt a code themselves.
It has also suggested that there should be a requirement of training for all trustees, and the development of paid trustees, and independent trustees who act as non executive directors. A ‘two tiered’ internal governance structure, with an expert group advising, should also be considered, as should the introduction of pensions management committees for DC schemes.

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