While multinationals have spent considerable time and effort in creating efficiencies in their manufacturing and distributions processes to try to produce the best possible product at the lowest cost, most have not yet applied their skills to the management of their worldwide pension assets. Now, there finally might be a solution for multinationals to create economies of scale and efficiencies in pooling of their various pension plans around the world.
Until now, many multinationals have spent considerable time and money to create an effective multicountry pooling vehicle but have frequently been confronted with insurmountable tax and regulatory issues. Problems arise from foreign tax jurisdictions that view most pooling vehicles as taxable entities themselves, making them less effective than direct security investment. Multinationals and investment managers, including those based in the United States, might have found a solution in the new pension fund pooling vehicle regulations that have been put forward by the United Kingdom's Inland Revenue.
This development could be the first step toward true global management of pension assets. Pension fund pooling vehicles are one approach to help multinationals save money that could be used for other corporate purposes or to increase plan benefits.
The costs benefit of these vehicles is substantial on a global basis. One could expect a multinational with $1 billion of assets to save approximately $2.5 million a year through the use of pension fund pooling vehicles. Broken down, some 20% of the savings would come from lower overall investment management fees; 20% of the saving would come from lower custodial and transactional fees; 30% on administrative benefits, such as time spent on investment manager oversight, investment performance reporting and tax reclaim issues; and, finally, 30% from improved investment returns based upon asset allocation and the ability of subsidiary plans to use superior investment management firms.
With pension fund pooling vehicles, the concept of pooling multinational assets is now less of a dream and more of a reality. Multinational funds finally have a tool to enable them to manage their pension investments much like they have been organizing their manufacturing and distribution processes.
There are essentially four types of benefits pension fund pooling vehicles provide to a multinational. These are structural benefits, operational benefits, organizational benefits and cost benefits.
In addition to the structural benefit of actually pooling assets, multinationals can use pension fund pooling vehicles to pool money managers as well; this will create economies of scale in structuring their global equity and fixed-income mandates. The structure of these vehicles also might be applicable for defined contribution plans. A multinational could structure numerous pooling vehicles that could then be used by defined contribution plans of the headquarters and subsidiary companies. Another structural benefit is that it allows local pension plans to have access to high-quality global investment management firms to which they might not otherwise have access because of their size.
Operationally, pension fund pooling vehicles create advantages in that the multinational can reduce paperwork and increase the efficiency of the billing process through one coordinated invoice for investment management fees, custodial fees, etc.
The multinational will have better coordination of performance results by being able to move efficiently and to quickly compile the investment returns of their subsidiary pension plans. This information on investment performance and asset allocation will ease implementation of the asset allocation structure.
One of the issues facing multinationals is the vast difference in asset allocation between one country pension plan and another country pension plan. These asset allocation differences affect the cost of funding a defined benefit plan. In higher expected rate of return plans, the benefit provided will cost less and therefore, the subsidiary can use the savings for increased profits, increased compensation levels, increased benefits, etc. The advantage of these vehicles is they can be used to effect changes in asset allocation structure more quickly and efficiently.
There already have been a number of organizational benefits to the multinational structure, even though no vehicles to date have been funded. These benefits come about because headquarters and subsidiaries have talked about the issue of investment pooling and this promotes a discussion on global investment policy. Discussion of this concept induces cooperation among all of the subsidiary plans and it paves the way for more global communication concerning pension issues within the company.
Pension fund pooling paves the way for multinationals to establish a global pension committee. We are aware of situations where the multinational has appointed a person at headquarters to oversee assets on a global basis, and we have seen other companies that periodically bring in to headquarters all of their personnel around the globe responsible for pension issues to talk about investment policy in a more cooperative manner.
These operational benefits translate into monetary savings for the subsidiary and the parent. The subsidiary receives access to better investment managers, an increase of their knowledge on institutional investing and possibly an increase in their allocation to equities. These benefits should produce higher rates of return, which can translate into lower pension contributions and, ultimately, lower labor costs in the subsidiary plan.
The pension fund pooling vehicle is a form of the United Kingdom's unit trust, with a number of significant alterations. The first is the trust will not be viewed as an entity for capital gains purposes. The second is the trust itself will not be taxed on the income generated by the investments. These are extremely important distinctions from alternative approaches and it is hoped they will satisfy foreign tax jurisdictions to view these vehicles as being transparent for double tax treaty purposes.
Essentially, a pooled vehicle is considered transparent if the investor pays the same rate of tax on income participant in the pool as if he had invested in the security directly. Therefore to be successful, a multinational pooling vehicle must not be subject to tax itself and must have all income and capital gains belong directly to the investors and not the trust.
Why is this important? When a U.S. pension fund invests in a non-U.S. security, one has to apply the tax treaty, if available, between those two countries to assess the withholding amounts that are due and those that can be reclaimed. The double tax treaty issues are compounded when you have multiple country plans investing in multiple country securities.
In the search for vehicles that could possibly fill this role, a number of multinationals had examined limited partnerships and other similar vehicles for the pooling of multinational pension assets. The problems with most of these vehicles include either an inability to structure the vehicle as transparent from the perspective of foreign tax jurisdictions or the tax problems that arise when pooled vehicles allow both taxable and tax-exempt investors to become participants in the pool.
The pension fund pooling vehicle regulations issued by the Inland Revenue require all investors must be exempt-approved pension plans. It is hoped this restriction will make it easier for foreign tax jurisdictions to view these vehicles as transparent. That these vehicles are U.K.-based should not affect their use by U.S. multinationals.
Another accommodation by the Inland Revenue is the ability to structure the money manager contracts to enable non-European Community schemes that participate in a pension fund pooling vehicle to rightfully avoid the value-added tax charges typically levied to participants in U.K. pooled trusts. Likewise the Inland Revenue has eliminated the 0.50% stamp duty on in-kind contributions and distributions of securities into or out of a pension fund pooling vehicle.
While this is an exciting development for both the sponsors of multinational pension plans and the managers of pension assets, there still is a lot of work to be done before these vehicles are accepted outside the United Kingdom. There are ongoing efforts to contact both overseas pension authorities, to ensure there are no restrictions or regulations that might prohibit foreign pension funds to invest in this vehicle, and foreign tax jurisdictions, to receive agreement that the pension fund pooling vehicle is viewed as transparent. The efforts also will require support from multinationals which can be extremely influential in pushing this process forward.
Mark Scott is a senior consultant at Watson Wyatt Partners, Reigate, England.