The slow pace of development of defined contribution (DC) pension plans across Europe – whether at the national or pan-European level – has frustrated the growth plans of the investment management industry.
While many of the political and social factors impeding DC plans are outside the direct control of the industry, one frequently overlooked topic resides within the industry’s own capability: administrative efficiency. Properly designed and implemented, it could prove to be a critical component in achieving broad support for DC programmes and maximising their chances for success. Growth prospects for DC will be much more positive if the following capabilities are in place:
q Ability to maintain DC plans at low administrative cost, with appropriate control of investment operating risks, demonstrating efficiency to legislators, regulators and employers.
q Open choice of investment options, good reporting and easy-to-understand decision tools, creating appeal to employees, younger employees especially.
q Cost-effective support for open architecture of plans, with the ability to use existing retail investment funds in the open architecture mix, thereby enabling investment managers to participate fully in DC plans without needing to add significantly to their existing operations.
q Efficient and low-cost interfaces for pension administrators, who will need to make a fair return on investment in a low-fee environment.
q Connectivity and compatibility with the insurance industry, which will and should have a major role in DC solutions both as administrators as well as product providers.
These demands are challenging at the national level, and even more so if a true pan-European DC open pension market is to emerge. They can be met, however, through business solutions that provide market participants with both freedom of choice and efficiency.
The diagram represents a generic DC value chain. It shows the three critical links that need to be in place in order to achieve efficiency across the value chain.
q Link 1 connects the entity creating a DC pension plan (the plan sponsor, which may be a corporation, a labour union, a multi-company industry group, a government agency, etc) to its chosen administrator.
DC administration is a specialised skill, frequently outsourced via a commercial contract by plan sponsors to their chosen independent administrators. Once the administrative contract is in place, the most important interaction between the sponsoring entity and the administrator is a payroll interface: each pay period, both employee contributions and employer contributions must be reported in a timely manner to the administrator. As part of this reporting, any changes in employee status (retirement, resignation, new salary, etc) must also be communicated timely and accurately.
Common standards and protocols for communicating payroll data and employee status – from sponsoring entities to administrators – are essential for administrative efficiency. These standards and protocols may emerge in some markets as part of competitive differentiation between payroll processors. In Australia, the DC market is developing industry-wide standards for this critical link in order to balance overall efficiency with open competition.
q Link 2 is the connection between employees and their DC plans. Employees in any open choice system may wish to change their level of participation, their investment selections or the re-allocation of assets already accumulated. Employees may also require access to information and support to enable them to make appropriate personal decisions, a trend that has led to the development in the US of ‘advice engines’. In addition, depending on the legislative/regulatory environment and the overall governance provided by the sponsoring entity, there may be specifics of the plan (for example, investment minimums or maximums) that the administrator would build into its compliance, employee information and decision support tools.
Existing call centre and internet technology works very effectively to establish the link to employees. In a mature DC market such as the US, very few employers maintain their own employee support services, finding it far more efficient to direct employee inquiries to the third-party administrator.
q Link 3 is the most complex part of the administrative puzzle. In an open choice environment of third-party administrators (in many cases with an unaffiliated bank acting as a trustee/fiduciary for the plan to provide oversight as well as control of cash movements), interacting with a multiplicity of investment funds (or their transfer agents) and insurance companies can be a daunting process. In the absence of an administrative solution, communications will be handled via fax and phone, and, as a result, they will be labour-intensive, error-prone and expensive. Cash settlement will similarly operate at a high level of operational risk.

In the US, we have resolved the problems in this complex link through a single central servicing hub that:
o operates for the benefit of the entire industry as a neutral entity – that is, not owned or controlled by any other single provider
o operates as a message hub linking administrators with funds and insurance companies. This message hub employs:
l standardised business practices;
l standard message types and message formats, which may embed certain business practices;
l common reference data, used to enrich messages, and
l common rules of the game, neutrally enforced.
o operates as an information hub for post-trade reporting from funds and insurance companies back to the administrators. For funds, information includes net asset values (NAVs) and dividends;
o operates as a cash settlement hub, linking administrators and their banks, with funds and insurance companies and their banks. This cash settlement hub includes:
l determining settlement obligations and settlement dates bilaterally;
l communicating settlement obligations and settlement dates to relevant parties, including the banks responsible for settlement;
l initiating cash movement between settling parties;
l monitoring and communicating to all parties any settlement delays, and the causes for them, and
l administering common rules of the game for consequences of any settlement delays or failures.
In the US, this central servicing hub evolved from DTCC’s subsidiary National Securities Clearing Corporation as the Defined Contribution Clearing and Settlement (DCC&S) service, which broadened the application within an existing servicing hub for the US retail mutual fund market, a service known as Fund/SERV. DCC&S was introduced in 1998 with the express purpose of linking the triple parties in the DC transaction – the independent pension administrators and (where applicable) the bank trustees of DC plans to the providers of the DC product.
In 2002, DCC&S processed over 18m transactions across Link 3 of the value chain, serving as a cash settlement hub as well as a message hub for all of these transactions. In a manual environment such as prevails in Europe today, third-party transactions may cost e20–40 each, depending on the source of the costing estimate. In the US via DCC&S the cost to the industry is $0.35 a transaction. A comparable (and hypothetical) 18m transactions in Europe at e30 each would cost the industry (and ultimately employees) e530m more annually than in the US market. In an era of diminished expectations for portfolio returns, this translates to a financial burden that may not be acceptable socially or politically. Yet if DC is a serious possibility for Europe, transaction volume on a scale comparable to the US must be anticipated and planned for.
Who will drive administrative efficiency in Europe? Beyond exploring what needs to be accomplished in order to create administrative efficiency for DC plans in Europe, and why such efficiency is critical in order to meet the political, social and market needs for DC plans, there remain other questions: who will drive such an effort; and how will the resources be mobilised to bring administrative efficiency to reality.
If the investment management industry chooses to undertake an effort to create administrative efficiency for DC plans, it should not be hindered by concern over technological feasibility. Technology can be solved, and has been solved in other markets. Rather, the challenge is how to align the interests of different stakeholders in the markets to create a commercially sensible, ‘win-win’ solution at each link in the DC administrative process.
Peter Marshall is with the Depositary Trust & Clearing Corporation in New York

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