Edition: Jun - Aug 2014
McCarthy . . . mammoth task
Principles are all well and good, but the devils are in the detail if established practices are to change. Governance of umbrellas is being watched.
“We know the problems,” admits Dave McCarthy, main author of National Treasury's retirement-reform papers. "Help us to find solutions".
He was referring, rather forlornly, to the conflicts of interest rife in the retirement-fund industry. They're easier to identify than to resolve. Indeed, the 11-page Budget update on reforms – released by Treasury in March – highlights conflicts on no fewer than eight occasions.
Were it only that they be untangled simply by disclosure and regulation. That's already prescribed in the Financial Advisory & Intermediaries Services Act and the Pension Funds Act.
Conflicts go to the to the guts of retirement-fund governance because they're systemic. Profit maximisation is as much a valid objective of service providers as the avoidance of abuse is to their clients. The tension is in getting their interests to align, and this in turn relies primarily on the development of trust relationships. A service provider that fails to engender trust with clients deserves not to retain them.
To regulate against conflicts is limited for effectiveness. Since one size doesn't fit all, they evade all-embracing definition.
They can be nominal and positive when they result in lower costs to the client (inclusive of retirement funds), for instance by discounts that a service provider offers to incentivise the use of numerous in-house products and skills. They're objectionable and negative when the opposite applies, for instance by the service provider making secret profits or miss-selling products to the client's detriment.
At bottom, what matters most is not attempting to regulate conflicts out of the equation but ensuring that they're recognised and managed for optimal client advantage. Recognition implies that they be disclosed, but disclosed how and to whom?
Only if the disclosures are made in ways that affect decision-making, as opposed to formalistic declarations obscured in wads of documents, will they serve a purpose. And only if conflicts are managed in such a way that they are seen by clients to be to their advantage or at least not to their disadvantage -- for example, through cross-pollination of ideas through different divisions in the same firm -- can they possibly be more beneficial than engagement of outsiders starting afresh.
The obligation is not only on service providers to make the proper disclosures. It's also on trustees to ask the right questions.
Independence is an ideal, but in practice its permutations of are loaded. What comprises independence to one might be conflicts to another. They can be endemic, as in the one-stop marketing concept; or oblique, as in relationships created over rounds of golf. But if trust is the litmus test in the sale of financial products and services, then openings are created in a cut-throat environment for service providers against competitors who compromise it.
There are shades of grey. A "weakness", specified by Treasury, relates to "non-disclosure of all grants and payments made to related parties including to trustee conferences and workshops arranged by stakeholders". It says that "some of these practices may also need to be prohibited from a governance perspective to prevent conflicts of interest or dependence on key stakeholders".
Careful, guys, because it particularly impacts on trustees who act without remuneration. Their acts of altruism are sweetened by perks ostensibly to relieve fund members from paying for attendance at workshops and the like, not without the implicit message that pervades all corporate hospitality. Also, blanket prohibition can knock the bottom from industry bun-fights such as the Institute of Retirement Funds annual conference.
This is an area where the inputs of Batseta, which represents droves of shop-stewards who're unpaid trustees, will be especially welcome to draw lines between acceptable and unacceptable practice. Batseta wants to turn its back on sponsorship reliance (see article elsewhere in this TT edition), with consequences yet to be foreseen. Note that there are already provisions in the FSB's good-governance circular PF130, a guidance yet to become law, for the giving of gifts to be disclosed and contained.
More topical and significant, with the rapid consolidation of standalone retirement funds into umbrella arrangements, Treasury intends to address the "governance challenges" of multi-employer schemes. Some of these commercial umbrellas, it says, have rules that "constitute an impediment to sound fund governance because they tie the funds to particular service providers".
Good governance of pension funds depends primarily on good trustees. What are the criteria for good trustees? Not only are there "fit and proper" standards that regulation will require. There's also independence of mind, and the unconstrained capacity to exercise this independence, that no regulation can enforce.
Commercial umbrellas are still a work in progress. As they evolve, the assertions of their trustees' independence will be scrutinised. The extent to which the trustees act independently of their funds' institutional sponsors will be a critical component in assessing how well the umbrellas are governed.
The jury is out on whether good governance will be more pervasive in substance than in form. The hurdle to overcome is structural conflicts:
It needn't be argued that both objectives are entirely justifiable. The issue is how they're to be reconciled. In theory, it seems akin to mixing oil with water. In practice, the starting point must be for institutions not to exploit their dual role as sponsor and service provider.
This might be easier said than done. It depends on how the sponsor will make its profit, and the channels for boards' accountability:
There are ways to address such issues, perhaps by contract between the sponsor and the fund. For instance:
Sponsors should have no more than a first-mover advantage in the offer of services. For trustees to make selections requires some form of standardisation for comparability. Then trustees won't be seen to be asserting their independence simply for the sake of it.
Cat amongst the pigeons is Batseta, the trustee-only body formed by the three major trade-union federations and the Principal Officers Association. Because its ethos has to do with investment of "workers' capital", it will almost certainly seek union representation on the boards of commercial umbrellas (TT March-May).
This is likely to make less cosy the present arrangements that can ignore such a body, purportedly to speak for members:
But it isn't yet clear that mancos will be made mandatory. Neither is it clear whether they'd encompass geographic regions or specified industries (to accommodate lots of small employers), or one manco per large employer, or offer employers the option. Either way, they'll help to mitigate the governance defect of remoteness from members and beneficiaries.
In a society that attempts to promote inclusiveness, it seems contradictory that umbrellas are permitted to controvert an intention of the 1996 amendment to the Pension Funds Act. Under trade-union pressure, it introduced the principle of equal employer and member representation on trustee boards. Should umbrellas' sponsors not address its challenges with the union federations, quick to notice when rights are averted, they could invite disruption.
Treasury is explicit that it and the FSB will "initiate a consultation process with umbrella-fund providers in order to improve the governance, design and portability of these schemes in order to further protect the interests of members who are enrolled in them."
That process must soon come to a head, surely not only with fund providers but with credible representatives of fund members too. The governance principles for commercial umbrellas are no different from the industrial or bargaining council funds that many union leaders prefer.
A particular concern of Treasury is in payments to intermediaries. Unlike independence of retirement-fund trustees, potential conflicts at the advisor level are simpler to identify.
"The current system of financial intermediation has the unintended consequence of raising both the complexity of retirement-fund designs and their cost," Treasury says. "Further, the quality of financial advice may be adversely affected by conflicts between the duties of those advisors to their clients and their own interests. This is because remuneration structures are often designed to incentivise advisors to direct client business to providers which offer the advisors the greatest rewards rather than those that provide the best 'value for money' to their clients."
For all its logic, the argument won't go unchallenged. Any number of advisors, even those openly aligned to particular providers, will present any number of examples where they offer ranges of out-house products and disclose their respective fee structures. But then they would deny malpractice, wouldn't they?
Nothing except inertia prevents clients from shopping around. Advisors are licensed and therefore, by regulatory implication, to be trusted.