LONDON - The British government has opened the door to a proposal that would require U.K. pension plans to hire outside custodians.
With some reluctance, government officials said they would consider a mandatory custody amendment now being advanced in the House of Lords' debate on the U.K. pensions bill. If adopted, the custody amendment would provide additional protection for plan participants and could open the market for bank-provided custody services.
In addition, Labour-affiliated lords proposed scrapping the bill's minimum solvency requirement. Instead, they urged the government to create a fund similar to the U.S. Pension Benefit Guaranty Corp. to cover losses in small pension funds.
Many pension experts believe the lack of independent custody contributed greatly to the late Robert Maxwell's looting of company pension funds. They argue the Goode Committee made a major mistake when it failed to recommend mandatory custody.
Lord Mackay, secretary of state for social security, told the House of Lords he does not have "a totally closed mind on the issue." But he said the amendment's supporters must clearly define what constitutes a custodian and how custodians would be regulated before the government would accept the amendment.
In other issues connected with the pensions bill:
Investment in real estate might be discouraged. Experts warn trustees would not be able to share fiduciary liability with managers that are not regulated by the Financial Services Act.
Trustees of pension plans with assets commingled in common investment funds may not be able to share fiduciary responsibility with their external money managers. Such vehicles are common among employers who maintain multiple plans because the common investment funds provide greater investment efficiencies and lower administrative costs.
The government rejected attempts to force pension funds and their money managers to vote their shares. Lord Mackay said voting should be voluntary, saying mandatory voting doesn't ensure it will be done prudently. He also questioned why pension funds should be singled out.
The government also spurned an amendment that would have incorporated the prudent man rule into the bill. Lord Mackay said such a standard already exists under case law and to codify the rule "carries the danger that the law would become fossilized."
The House of Lords defeated a Labour Party amendment that would have given plan participants at least half of the seats on boards of trustees. Another provision requiring that retirees be allocated a seat on trustee boards also was defeated.
The House of Lords is considering amendments to the pensions bill through Feb. 21. After amendments are accepted, the government in mid-March will return with a report incorporating revisions. A third and final reading of the bill is expected to occur before Easter.
The bill then will be taken up by the House of Commons.
Requiring independent custody
Baroness Dean, who proposed the custody amendment, argued independent custody would provide additional safeguards at a minimal cost, between one-tenth and one-twentieth of 1%.
She agreed with the government's view that independent custody might not have prevented Mr. Maxwell from plundering his pension funds, but added: "it would have made him think twice."
Echoed the Earl of Buckinghamshire: "It would be an additional barrier to anybody attempting to commit fraud."
Geoff Lindey, chairman of the National Association of Pension Fund's investment committee, which supports the amendment, said "making it harder to steal is a good idea." Under current law, trustees can keep securities in their own safe, although only a tiny minority do, he said.
The biggest sticking point in making outside custody mandatory might be coming up with a satisfactory regulatory scheme.
The amendment would permit trustees to continue obtaining custody services from their money managers, as is general practice in Britain.
But those services would have to be "adequately differentiated" from investment services provided by the manager.
Still, experts believe the amendment would force trustees to consider custody of pension assets more seriously. Traditionally, trustees have given relatively little thought to custody issues.
Creating a separate evaluation and hiring process for custodians likely would lead to additional hires of banks as custodians, a trend that has emerged among major U.K. pension funds but has not yet reached midsize and small pension funds, said Alex Over, vice president of global institutional services at Bankers Trust Co., London.
But Sue Douse, a senior consultant at Watsons Investment Consultancy, Reigate, England, believes internally managed funds that provide their own custody would be most affected.
PBGC-like fund eyed
In another major development, a coalition of Labour peers urged replacing the bill's minimum solvency requirement with a "central discontinuous fund."
Lord Eatwell said the minimum solvency requirement had been watered down by the government. "The minimum solvency requirement does not guarantee solvency, and it is fundamentally misleading to suggest that it does," he said.
He also warned the proposed requirement would cause pension schemes to lower their equity holdings and to boost bond holdings.
Instead, he urged the government to study the model of the PBGC. He said large schemes of bankrupt companies could be maintained by running them as closed funds. Smaller ones would be pooled into the discontinuous fund; the pool would be funded by a small levy on existing pension schemes.
Lord Mackay said the Goode Committee rejected a PBGC-type solution. He said such a fund would be complicated to operate and would require government guarantees or could place a burden on on-going pension funds.
Trouble for property?
Some experts warn the bill might discourage pension funds from investing in real estate, especially direct real estate investments. U.K. pension funds have about (pounds) 24 billion ($37.4 billion) invested in property.
The bill permits trustees to delegate investment decisions to managers covered by the Financial Services Act.
(The bill was clarified to ensure that money managers who handle overseas securities investments are included.)
The problem is that real estate managers are not covered by the act. That means trustees who invest in real estate might get stuck with liability for any actions taken by their property managers, explained Chris Lewin, head of group pensions at Guinness PLC, Edinburgh.
Real estate managers might only be able to act in an advisory capacity, requiring trustees to make decisions on investing in individual properties.
The real problem, said Iain Reid, chief executive of Barclays de Zoete Wedd Property Investment Management Ltd., London, could occur if the bill were strictly interpreted and trustees were forced to approve minor decisions such subleases or rent reviews.
The issue also might affect some real estate pools, depending on how they are structured, added Tony Thurnham, a partner at the London law firm of Linklaters & Paines.
A similar issue affects common investment funds. In those situations, trustees delegate investment decision-making authority to the fund, which rarely is managed by individuals covered by the Financial Services Act.
