In taking out a patent for its cross-border pooling solution, Northern Trust (NT) has demonstrated its belief that the cross-border pooling market is set for considerable growth. The efforts of multinational companies to create global investment platforms to manage their pension assets in plans throughout the world has too often stalled when it comes to withholding tax. NT believes its tax transparent solution - which has been developed since 2005 - is unique enough to warrant patent protection.

"We believe there is a big market among large pension plans for tax transparent cross-border pooling," says Kathleen Dugan, cross-border pooling product manager at Northern Trust. She cites research undertaken by Deloitte and Touche at the end of 2005 that indicated 80% of multinational corporations surveyed were considering pension pooling.

A typical multinational may have up to 25 different pension plans, some large, some quite small. "Individually managing all of these plans is inefficient and prone to risk. The same processes are repeated for each plan; it is a very clumsy process for a multinational to deal with," says Dugan. "By pooling plans, a corporate will get better governance and risk management through tighter controls. They'll also get economies of scale because generally smaller plans will be paying a lot of fees and won't have as much diversification as the larger plans."

But equity investments present a significant challenge to the concept of cross-border pooling. Pension plans from many countries, including the UK and the Netherlands, will not pay withholding tax on dividends from US stocks when the investment is made directly in the US market. But if the investment is made through a pooled fund, withholding tax up to 30% can be imposed on these dividends.

In developing its solution, NT worked in a consortium with two large, unnamed multinational clients, Goldman Sachs AM and Mercer Investment Consulting. Deloitte & Touche were engaged as tax and accounting advisers and Clifford Chance as legal advisers. "We spent a lot of time looking at the tax and regulatory requirements before we started to code the system. In the years I have worked in custody, products are usually 90% systems and 10% legal, sometimes the opposite. This product is split 50-50 between the two. The ability to bring together all the tax and regulatory expertise and apply that before coding the system was a big achievement."

Dugan says key to NT's solution is its ability to support pooling vehicles with multiple countries of investors and multiple countries of investments in a tax efficient manner. "Providing custody and fund accounting for a single country is not particularly difficult, because all investors are taxed at the same rate. But when it comes to cross-border investments, you need a very sophisticated system in order to enable investors to take advantage of different tax treaties. Our solution proves that the administrative problems with pooling are being overcome."

Reporting is also important, she says. "Regulators in different countries require different types of
reporting from institutional investors. Our process maintains detailed information at the investor level and provides great flexibility in reporting to meet the regulatory requirements of a broad array of countries."

On the custody system, securities are held in a master account, but each investor's income is segregated. NT's global securities lending system determines lending availability. The fund accounting system shows a consolidated record for the entire fund and then each holding is split among individual accounts, according to the proportional share of each investor. Dugan says it is at both the custody and fund accounting levels where NT's solution differs from the treatment of standard funds. "We can create a separate accounting record for each investor in the tax transparent fund, which is something truly unique. The market is there for this type of capability."

The solution automatically processes withholding tax for relief at source and tax reclaim markets and provides accurate capital gains calculations in markets that require tax transparency for capital gains. The solution also derives a suggested securities lending rate based on the calculation of a blended tax rate, enabling investors to benefit from securities lending.

In September 2005, the bank launched the first global equity common contractual fund (CCF) in Ireland for a multinational client, and then in December launched the first global equity Fonds Commun de Placement (FCP) in Luxembourg for a multinational client. As of 31 December 2006, NT supported six tax transparent vehicles for both multinationals and investment managers, which totalled $10bn (€7.5bn) in assets and covered nine investor countries for six clients.

Of these clients, half are investment managers and half multinationals, half are in the US and the remainder in Europe, and half are existing clients and half new clients.

"This has been a very strategic development for Northern Trust," says Dugan. "We believe we have developed a process that is uniquely suited to servicing tax transparent vehicles and we are developing proprietary services around that. We have expanded the solution to include emerging markets and plan to add alternative investment types."

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