Room at the halfway house

With pan-European pension vehicles a distant vision, simpler cross-border schemes may be the way ahead, finds Gail Moss

Asset pooling has grown in importance for pension funds,  as more of them consider setting up pan-European portfolios to support their schemes in individual countries. The logical extension of this trend would be to create pan-European platforms from which all aspects of pension funds in different countries could be managed.

However, in reality the arrival of a true pan-European pension vehicle, with all its necessary complexity, remains a distant vision.

But cross-border funds - run on a single platform but covering two or more different countries within the EU - are now becoming a popular halfway house for schemes whose ultimate aim is a pan-European model. Nestlé and Bosch are just two of the multinationals that are approaching pan-European schemes on a step-by-step basis, using cross-border funds.

But are these schemes indeed a stepping-stone to an all-embracing European design? Or do they represent the point at which further integration will hit the buffers?

"Cross-border pension funds are important because it is these funds, rather than pan-European vehicles, which may well be the future of the industry," says Paul Kelly, (pictured right) a principal at Towers Perrin, who specialises in this area. Towers Perrin is working on a number of these schemes for Fortune 500-type clients and has recently set up a scheme based in Ireland, covering the UK, Hungary, Poland and some non-EU countries.

"The events of the last few weeks, in terms of market turmoil, have shown that governance is an issue," says Kelly. "If you can't trust large institutions to remain solvent, then there is an argument for concentrating resources around a number of decisions rather than either devolving things to a lower level or concentrating provider risk across the continent in one giant vehicle."

But he does agree that cross-border vehicles can have advantages over separate pension funds in several different countries, as long as there is a genuine business need.

"Cross-border funds can create more risk control," he says. "They can also reduce the control that works councils, which represent employees, sometimes maintain over investing. Businesses like to increase their own control in this area, but it doesn't always work on a country-by-country basis across Europe. It may therefore be easier to do this using a cross-border scheme."

Kelly says that some jurisdictions, more than others, favour greater employer influence over investment policy, as they are the ultimate sponsors of the fund. "In this case, it is easier for businesses to exert influence via one pension fund based in a more favourable jurisdiction, than over funds throughout Europe," he says.

The exception to this argument is the UK, where it is the pension scheme trustees, rather than the sponsors, who have total control over investment policy.

Kelly says a subsidiary motive for companies setting up a cross-border vehicle is to control and reduce costs, although this is more a gain for the employee than for the employer for defined contribution (DC) schemes.

And this type of fund is also a useful vehicle for internally mobile employees. "If you're a multinational employer, and your employees move into a new country, such as Rumania, you either set up a new scheme there or put the employees into an existing one elsewhere," he says. "It might be easier to do the latter than create a new scheme in a country where you have to deal with new providers, and possibly less choice of investment funds."

At present, however, he says that creating cross-border schemes is necessarily a step-by-step process, not least because not every country in Europe has so far gone through the process of allowing them. Even so, as cross-border schemes have become more common, some EU countries have moulded themselves into hosts for these vehicles.

There is now growing competition between the UK, Ireland and the Benelux countries that are tailoring their regulatory regimes to attract cross-border business and create jobs, while building up their investment strength and reputation as financial centres.

According to Kelly, Ireland attracts schemes for companies with employees in the UK and Ireland and non-EU countries, while Belgium attracts schemes covering its own nationals, eastern Europe and smaller countries such as Cyprus and Malta.

However, the UK presents something of an obstacle in the form of its trust law regime, which governs pension schemes. "UK trust law doesn't fit well with a cross-border pension schemes, because such schemes need to reflect the social and labour laws of the countries where scheme members are working, covering such things as member nomination of trustees," says Kelly. "Other countries' laws are specifically constituted to deal with that issue, whereas historically, UK trust law hasn't been able to accommodate that fully, which has led to some problems."

Kelly says that cross-border schemes need the flexibility to deal with differences in local laws, while the same administration platform is used for the whole fund. Schemes must also allow for different national rules for members' involvement. "In Ireland, for instance, it is common to give employees an investment choice, whereas in Spain everybody has to be treated equally," Kelly says. "But they can still use the same investment manager."

While a scheme's assets do not have to be run in the country where the scheme is based, Kelly notes that there is a natural inclination to do so, especially since that country is where the board sits.

In terms of asset management, pension funds from the constituent countries can be run alongside each other, investing in the same funds but in different proportions, depending on the specific investment policy for each country's segment.

Cross-border schemes tend to be DC arrangements that can provide increased benefits to employees without affecting the volatility of the profit and loss account. However, Kelly says: "We are also aware of a number of DB [defined benefit] schemes where money is proposed to go into Belgium and Luxembourg."

According to Kelly, the industry sectors where companies are most keen to set up schemes are high-tech, pharmaceuticals, oil and financial services. "I think it will become the norm for multinationals in these sectors to have cross-border pension solutions within two or three years," he says.

But he is sceptical about the chances of further integration. "I don't think pan-European schemes will ever happen. National differences make it difficult enough to combine a number of schemes on a cross-border basis, and it is going to be difficult to find a business need that would justify the extra work to include every scheme."

Barry Mack, (pictured left) head of pan-European pensions at Mercer, agrees that in the short term the pan-European pension fund is likely to prove more of a mirage than a concrete reality. But he does think they will arrive and be here to stay in the longer term.

Mack is co-author of a study published last month of pan-European pension schemes carried out by Mercer. "There are around 60 to 100 cross-border plans in Europe, but it is difficult to tell if there are any true pan-European plans in existence," he says. "It is unlikely that there's ever going to be a pan-European vehicle that can accommodate all 27 member states. Instead, companies should look at countries which could be grouped together."

Mack says there are two reasons why companies initially look to pan-European pension plans. "First, they want to create a central platform, to reduce costs," he says. "Second, they want to manage and reduce risk. However, it's more about good governance than central control. In any case, multinationals should be asking themselves if there are cheaper or better ways of getting control. So will cross-border funds give them better value from a cost perspective?"

Once companies decide to cluster small groups of funds rather than go pan-European, Mack says there is more than one way to skin the proverbial cross-border cat.

Besides the obvious geographical or cultural groupings such as central and eastern Europe, the Benelux and the Nordic countries, companies could choose other criteria for clustering schemes - for example, the similarities in pensions regimes between different countries. With DC schemes some countries provide for guaranteed returns, whereas UK funds, in contrast, pass all risk to the participant.

Yet another approach is to create funds for specific sets of employees - for example, expatriates or highly paid executives.

However, Mack says that a pan-European ideal is useful to give organisations something to aim at. "We are suggesting to organisations they should look at pan-European pension funds because if they see that as a target, it helps to define the journey and achieve solutions," he says. "Then they should progress step by step, checking what business value they're getting from each step before they take it."

Mack says that these steps comprise three levels. "The first level is to find out exactly what pension schemes they already have - you would be surprised at the number of companies who don't know that," he says. "They then need to decide on the policies they want to action in terms of benefits, which providers to use, and so on."

The next level is to get consistency between the schemes in the same grouping, which can include deciding whether to pool assets or risk benefits, choosing a preferred provider network and co-ordinating any move from DB to DC.

 "Level three is, simply, Nirvana - a single platform with centralised management information allowing companies to reap economies of scale. This platform would also provide uniformity of communication to employees, via web portals which have the same look and feel whichever country the user is in."

According to Mack, the key to successful cross-border integration is to take these steps, while constantly checking their business value. "If you think there is no further business value in integrating schemes from more countries, you should stop at that point," he says. "But that means a multinational can go further towards that ideal in some countries than in others."

Chris Erwin, investment principal at Aon Consulting, is also cautious about the prospects for pan-European pension funds. "From time to time, there is a lot of interest in pan-European vehicles shown by new corporate treasurers of global companies based in the US," he says. "They don't understand that there are problems. They think it's just the Europeans being difficult."

For European pension funds themselves, Erwin says there are two particular barriers to the ultimate pan-European vehicle. "First, different countries have different legal systems and do not recognise the pensions vehicles of other countries," he says, echoing Kelly's remarks.

"For example, in the UK and Ireland, the vehicle for occupational pension funds is a trust, but Roman law in continental countries does not recognise that particular concept. So UK pension funds cannot apply to the Netherlands, for instance."

He adds: "In this context, regionalised funds make sense, to a degree. So you could have one vehicle for the UK and Ireland, say, and another for the Benelux countries."

There is, however, a second and more serious obstacle to creating a Europe-wide fund, according to Erwin. "The EU pensions directive directs that all pension funds of all countries in the EU shall be fully-funded at all times," he notes. "While a lower level of funding is permitted for schemes where all members are domiciled in the same country, with a recovery plan to full funding, as soon as you go cross-border you have to go to full funding immediately."

In this scenario, the average UK fund, which is only 70-80% funded, would need to put in 100% more money to achieve full funding, depending on the scheme's situation and the definition of full funding, Erwin says. In contrast, Dutch funds have to be 110% funded at all times.

However, this issue could also affect the growth of cross-border vehicles as well. "A cheaper way to do things would be for schemes to buy out individual members living or domiciled abroad," he says.

"Just before the legislation came into effect, there was a huge move by funds to buy out odd members here and there whose inclusion would have meant schemes were classified as cross-border vehicles."

Erwin recalls one UK pension fund client that had exclusively British members, apart from one individual with Irish domicile. The fund bought him out to avoid paying the estimated £500m (€626m) cost of raising funding to the minimum levels required for a cross-border scheme.

And Erwin says he cannot see any way for pension funds to get round this. "Some schemes operate via insurance companies, which make it easier to operate in different countries," he says. "So if you have a smaller scheme done through life assurance policies, it possibly could be extended on a pan-European basis. But the costs of operating via life assurance policies tend to be higher."

He concludes: "These arrangements would only work for small pension schemes, because otherwise the cost of pooling would be enormous, although there are some exceptions."

Erwin does not see an answer to the problem coming from Brussels. "Even if they wanted to solve the funding rule problem, I am not sure they could get every country in Europe to agree on a suitable level for full funding as, currently, the rules of individual countries vary enormously."