Chief financial officers, representing the shareholder as the unifying management force in multinationals, need to enforce a global management structure for foreign pension plans.
Global financial management is a top priority for multinationals. Yet, while many have tightened supervision of cash and currency transactions, and while raising capital has become a global exercise, few multinationals have consolidated the management of their global pension plans. As foreign plans grow in size, and new legislation increases sponsors' retirement burdens, multinationals need to adopt a new model for managing their global pension obligations. If left unmanaged, many companies could be in for a dangerous surprise as these obligations snowball in the future. There is also an opportunity cost of managing these plans in a less than optimal way.
Foreign pension plans generally enjoy an autonomy unheard of in other areas of corporate financial management. Local schemes reflect local investment traditions and laws.
An example is the United Kingdom, where pension funds remain invested primarily in equities, despite the prospect for significantly increased linkage of investment results and corporate results. The social, fiscal and legal backdrops to investment strategies vary from country to country. German companies typically use a book reserve system for funding pension obligations, relying on future corporate growth to fund retirement obligations. Switzerland tightly controls the amount of pension reserves committed to equities. Japan continues to use book value accounting for the limited investment pool set aside for pension obligations, masking the dramatic swings in asset values experienced in that country in recent years. The Japanese government also strictly enforces the asset allocation policies of pension plans, establishing rules that dictate a minimum amount of fixed income and a maximum investment in domestic and foreign equities and property.
Local plan sponsors typically hesitate when asked to follow home office instructions to change pension investment policies based on corporate financial policies. They fall back on local laws and traditions as the reason to not adopt a corporate risk approach.
Some Canadian sponsors have used the derivatives markets to get around the dictates of local laws, which establish a maximum of 20% of the book value of plan assets invested in non-Canadian securities. These sponsors hold cash in Canadian short-term fixed-income securities and purchase futures contracts on non-Canadian market indexes. This practice results in fully hedged non-Canadian market exposures beyond the specified legal limits.
Local trustees typically demand autonomy when making decisions on local investments. Their legal obligations are to act in the interests of their beneficiaries, and they resist the input of their corporate parent. Many trustees have little experience analyzing the relationship between assets and liabilities, however. The corporate risk position is a little understood concept. Investing "like your neighbor" becomes commonplace; performing "ahead of the median plan" becomes a goal. This situation is suboptimal from the CFO's perspective of trying to maximize shareholder value.
Because most parent companies tacitly accept their role as guaranteeing the pension liabilities of foreign affiliates, CFOs have the authority and responsibility to impose a process on local subsidiaries for recognizing and evaluating pension investment risk. As U.S. companies are subject to unifying accounting standards established by Financial Accounting Standard 87 on their foreign plans, the pension expense impact of each pension program on the parent needs analysis. The funding requirements for each foreign subsidiary also need review within the context of the corporation's global funding policy.
The natural implementer of change is the parent pension officer. Doing it with the typical resources allocated to their staffs will be difficult, however. Also, these individuals frequently do not have the stated authority to implement change on foreign subsidiary financial policies, nor do they have an understanding of the local country financial situation. Both sides need to learn from each other, keeping the shareholder interests and the interests of all local participants at heart.
The first step in the rationalization process is to get a fix on the liability, the funded status and the investment position of each foreign subsidiary. Pension assets and liabilities need to be compared on an apples to apples basis. Once this corporate survey is complete, the process of rationalizing the investment structure can begin. Simply having parent personnel attend subsidiary trustee meetings is a good first step in getting this done.
Many issues arise beyond the initial understanding of funded status. Global custody, manager selection standards, performance measurement standards and benchmarking are only a few of the numerous issues any company attempting a global pension management system must face.
While the efforts of some multinational corporations to rationalize their foreign pension policies often are genuine, few can point to true successes in the area. Among the attempts:
In the dark: Multinationals typically have no real grasp of the subsidiary pension issues. They regard it as a "project for the coming year" that always seems to be delayed.
Ivory tower: Some multinationals have done significant thinking about solutions to global pension issues but have failed to implement a grand strategy due to the resistance of local trustees.
Cross-country trustees: One large multinational, which runs most of its pension assets in-house across the globe, has portfolio managers from local countries sit on the trustee boards of other local subsidiaries in order to cross-fertilize ideas. This situation has little applicability to most multinationals.
Creating a functioning global pension management system will take time, resources, diplomacy and political clout. A better level of understanding must be developed among both local trustees and parent staff on critical issues impacting the pension equation. Ultimately issues will arise that will not be solved through understanding, however. In these situations the CFO, representing the shareholder, will need to step in as the guiding force to implement change.
Signs of rising pension risk around the globe are appearing almost daily. State schemes in parts of Europe - notably France and Italy - are heading for bankruptcy with obvious liability implications for the private sector. The fast growing Asian economies will need properly structured pension plans sooner rather than later.
Setting up a rational investment program will be a priority. A new management paradigm will need to evolve in this environment of change for global pension plans.
Steven C. Case is a managing director and senior consultant at RogersCasey, Darien, Conn.