As the framework for the UK's first authorised fund regime for tax-transparent contractual vehicles takes shape, Aaron Overy examines the impact for the UK pensions industry
The development of a UK authorised tax-transparent fund (TTF) vehicle, which will allow UK pension funds to pool their assets, is set to change the pensions landscape in the UK.
Planned to be introduced by next summer (2012), it will broaden the opportunities for UK pension stakeholders to benefit from the growing momentum for pooling. This 'pooling push' is being driven by numerous factors including regulatory developments such as the Undertakings for Collective Investment in Transferable Securities (UCITS) IV Directive as well as pension funds' broader focus on achieving economies of scale, tax efficiencies and enhanced governance.
UK pension schemes, particularly smaller ones, often strive to invest alongside each other to achieve scale efficiencies and access to best-in-class managers. Indeed, the Association of Member Nominated Trustees (AMNT) recently announced they are to investigate how smaller schemes can pool assets in such a fashion. In addition, Local Government Pension Schemes (LGPS) are looking to framework agreements to procure and invest alongside each other to achieve similar cost efficiencies.
Large schemes, with hundreds of millions of pounds to invest, have the power and leverage to negotiate with investment houses on fees, whereas smaller schemes generally do not possess such influence. Often smaller schemes experience a ‘take it or leave it’ attitude, with investment houses automatically charging higher rates for smaller sums invested, challenging the cost efficiencies benefit.
In addition, some pooled funds are not tax-efficient, particularly in terms of withholding tax (WHT) on equity investments, thus impacting performance of the fund. Pooled funds are also seen as having low levels of transparency in terms of securities lending risk.
Hence there is demand for a UK focused tax-transparent pooling fund that can be established by groups of UK pension funds or offered to them by insurance companies and investment managers. The development of a UK TTF vehicle will hopefully fill this need.
The UK government is currently undertaking a consultation programme with the industry on the design, technical, legal and tax aspects and any legislative changes that may be required for a new regime. Draft regulations will be presented in late 2011. The government aims to implement the new legislation and have the TTF vehicle come into effect by the summer of 2012.
The government's main objective is to ensure the UK can benefit from pan-European asset pooling, such as master feeder structures under UCTIS IV.
The master feeder fund structure is highly suited to a TTF vehicle, as it will permit feeder funds in different domiciles to invest in the same master vehicle allowing the feeder fund to maintain the correct WHT position. Therefore funds from across Europe can be moved into a centrally managed pooling model to benefit from a consistent management strategy and operating cost efficiencies whilst still gleaning tax advantages.
Numerous further critical drivers for the introduction of a UK based TTF vehicle exist. For example, the new Solvency II framework, similar to the Basel II banking regime, aims to facilitate the development of a single market in insurance services, whilst securing an adequate level of consumer protection. Under this proposal, additional regulatory capital would likely be required to be held on balance sheets, prompting EU life and pension reinsurers to move from a policy holder to unit holder model to mitigate this capital adequacy requirement.
Due to their scale, insurance sector funds are already operating on a cross-border basis. Therefore, undertaking the change to distributing funds where the fund owns the assets rather than the insurance company, and in order to preserve the WHT treatment for their investors, the new fund will have to be tax-transparent.
Furthermore, in the post-financial crisis environment, tighter cost and risk management is encouraging multinationals, insurance companies and fund managers to rationalise their portfolios. Legacy funds inherited via mergers and acquisitions are also being closely examined and consolidated to achieve maximum synergies while re-domiciliation is an ongoing consideration for investment managers.
Grouping pension funds and other assets into a cross-border pooling fund allows for significant cost efficiencies in various areas such as investment management, administration, custody, audit and service fees. A centralised pool of assets also enables a streamlined approach to asset monitoring and plan oversight and a consistent global investment strategy to support regional variations. Ultimately, a better performance can be attained.
Finally, US regulations such as the Dodd-Frank Act and the Foreign Account Tax Compliance Act (FATCA) will potentially impact investment managers with US clients and highlight the advantages of achieving greater oversight and tax-transparency over assets.
Benefit for UK pensions industry When contemplating where to domicile a cross-border pooling vehicle, tax treatment is a key consideration for a fund manager. A domicile that can be the tax-transparent master for feeder funds from around Europe is a huge draw compared to domiciles that do not possess this capability.
Such master fund structures already exist in Ireland, Luxembourg and the Netherlands, therefore the development of a new UK TTF vehicle will ensure the UK's competitiveness as a fund domicile to the benefit of UK plc.
Marketed well and structured advantageously, a UK TTF vehicle could become the natural choice for asset managers that already operate large UK fund ranges. It is also anticipated the vehicle will allow legacy defined benefit assets to be co-invested alongside new defined contribution plans to achieve common investment platforms, as is currently possible in Ireland, Luxembourg and the Netherlands. Demand is also expected from outside the UK as an option for European, Asian and US based asset managers who are looking to operate a central platform for their global fund distribution needs.
The benefits of a domestic TTF vehicle to the UK pension fund industry are numerous and include:
l Multinational master feeder funds will have the option to be based in the UK rather than in competing European tax-transparent domiciles.
l UK pension funds will also be able to pool all their assets in the UK while life companies will be able to mitigate the effects of the Solvency II directive.
l Local government pension funds will be able to set up a framework agreement whereby different funds can share common procurement, management and other costs leading to higher returns for investors.
l Government pension schemes across the UK currently undertake a large amount of repetitive work so achieving economies of scale will become increasingly critical as austerity measures continue to be implemented.
The future is bright for pooling At Northern Trust we have seen the industry for tax-transparent cross-border pooling grow exponentially since we supported the launch of the industry's first tax-transparent cross-border pooling solutions for multinationals through vehicles based in Ireland and Luxembourg six years ago. As a measure of industry growth we now service tax-transparent cross-border pooling funds with assets in excess of US$55.5 billion (as at 31 March 2011) for leading global multinationals, insurers and investment managers.
After lobbying for the introduction of a UK TTF contractual vehicle and being contributors to the ongoing governmental consultation process, Northern Trust eagerly awaits the implementation in 2012.
Looking forward we expect the continued combination of regulatory developments, jurisdiction competition and broader pension fund trends will trigger further significant innovations and expansion.
This represents a significant opportunity for UK pension stakeholders, with the ultimate winners being the retirees.
Written by Aaron Overy, vice president at Northern Trust