The Canadian Source Of Employee Pension Fund Investment And Benefits Plan Management

Back Issues

Custodians Adapt To Meet Sponsor Needs

By: Joe Hornyak

Adaptation has long been the name of the game for service providers in the financial services industry. Anticipating the products and services that pension plan sponsors need remains a consistent challenge as the landscape is constantly changing, says Doreen Rigsby, of State Street.

custodians adapt

That landscape is now changing in Canada as lower return expectations for certain asset classes and concern about meeting funding liabilities have fostered a search for higher risk/return opportunities, the creation of more complex investment vehicles, and investment in new asset classes.

One change in the landscape is last year’s elimination of the foreign property rule (FPR). Removing barriers to foreign investment is a significant issue. “It provides pension plan sponsors greater latitude to invest freely, improving their prospects of meeting their pension funding obligations,” says Tom McMillan, of CIBC Mellon.

Jeff Conover, of The Northern Trust Company, Canada; says Canadian pension plans are expected to increase direct allocations to global securities and foreign fixed income funds. As well, the removal of the FPR has allowed Canadian pension plans to reduce investment in equity derivatives and synthetic products.

This has changed the role of the custodian. Before the elimination of the rule, clients had a need for expertise in the accounting and valuation of derivatives used to circumvent the 30 per cent cap, and also for compliance tools to help ensure clients’ remained within limits. “Although the elimination of the cap has not changed our products, it has changed the demand to a different set of products,” says Rigsby. For example, with greater exposure to foreign currencies, capabilities in currency overlay strategies become a critical tool in helping clients’ manage their risk.

McMillan does not expect the removal of the FPR to have an impact on the way custodians do business. “When clients are ready to make a change in their percentage of foreign ownership, they will find we already have all the systems, products, and procedures in place to support … their current and evolving needs. However, as plan sponsors consider expanding their foreign holdings, due diligence and fund governance in this area will become more important and plan sponsors need to know that custodial service providers can support their needs.”

New Environment

In this new environment, plan sponsors and their investment managers need to better understand the risks and operational requirements of foreign markets. “Online access to depository risk analysis and guides to market settlement, income collection, and documentation requirements for each new market are prime examples of the custodial support needed,” says McMillan.

As well, once a fund enters a new market or expands its existing investment, plan sponsors need to ensure the fund is in compliance with its statement of investment policies and procedures. At a minimum, custodial service providers must supply sophisticated performance measurement and investment analytics with global market benchmarks. They will need automated, customized, daily compliance measurement tools and “dashboard” reporting to alert them and their investment managers to situations that require further review. “These are critical oversight tools,” says McMillan.

Conover says providers can also be relied on to monitor and administer alternative asset holdings through integrated accounting and reporting packages, performance analysis, and risk management services.

Globally, alternative assets are experiencing tremendous growth. He cites Hennessee Group LLC Hedge Fund Research which shows from 1990 to 2004 worldwide hedge fund assets under management grew from C$29 billion to C$1.1 trillion. “Private equity investments have also been popular,” he says with Pricewaterhouse Coopers and Ageos Research showing more than C$700 billion in cumulative funds raised from North America for private equity investments between 1998 and 2003.

“The lifting of restrictions on foreign investments and the continuing quest for alpha from non-traditional investments will see Canadian plans turning to alternatives, says Conover.

However, alternative investment strategies – such as hedge funds, private equity, and real estate – have precipitated an increasing need for more robust reporting, enhanced performance measurement, and compliance tools, says Rigsby. Sophisticated risk management and reporting capabilities have become a critical component of clients’ requirements, as they delve into more risky asset classes and have a need to accurately assess the level of risk they are willing to undertake on behalf of their beneficiaries. As well, as investment mandates shift, cost continues to be an issue. Here is where being a global custodian is a major factor. “Global custody is a business built on scale,” says McMillan. “We believe that to support the breadth of products and services required by the $700+ billion pension plan industry would be a challenge for a custodial service provider without adequate scale.


“Globalization of the Canadian marketplace offers significant benefits to Canadian plan sponsors. If we look back to the early 1990s, there were about 10 custodial services suppliers in Canada. The number of suppliers may have given the appearance of a competitive marketplace, but their capabilities were strained to meet the needs of plan sponsors.”

custodians adapt

Today, three custodial service suppliers account for 90 per cent of the pension and mutual/pooled assets in Canada, but the level of service and sophistication of the products available today is beyond the dreams of those suppliers of the early 1990s.

The focus on cost control remains strong as institutions continue to look for ways to lower costs across the enterprise, including the management of benefit plans, says Conover. Cost reduction efforts involve focusing on core competencies and seeking the lowest cost options to perform functions. As a result, plan sponsors are left with fewer internal resources as some inhouse activities are shifted to vendors.

Expertise in transition management is another critical tool in the pension sponsor’s toolbox. This enables clients to mitigate the risks and reduce the costs of implementing changes to their investment manager lineup, says Rigsby.

Asset servicing providers have the economies of scale to efficiently process asset transactions, says Conover. Costs incurred due to regulatory or industry standard changes are spread across a large asset base. By outsourcing these non-core functions, pension plans have the ability to lower their cost and focus on what matters most to the plan and the parent company or institution.

Cost Control Benefits

Asset servicing providers are also developing innovative solutions that offer cost control benefits, while helping plans achieve their goals. For example, crossborder pension pooling solutions are being implemented for large multinational corporations with pension plans around the world. Pooling assets from country plans with common investment mandates can improve governance and risk management of pension assets worldwide without requiring additional internal resources. Also, these larger pooled asset pools can provide greater leverage with investment managers.

One major trend that will have an impact on Canadian pensions is that demographics in Canada are shifting (see Exhibit 1). Conover says more people are retired or preparing to retire than in years past. An estimated 32 per cent of the population will be 55 or older in 2021, compared to 23 per cent in 2001. Census data helps explain this phenomenon. Canada’s population increased by almost 60 per cent from 1941 to 1961, and now the oldest members of that boom generation are entering their retirement years. This creates two issues for plan sponsors.

Pension liabilities are growing while assets are depleting as the number of retirees collecting pension payments increases and there are fewer active workers per retiree. With more employees near retirement age, plans are required to maintain higher funding levels to meet future obligations.

Talented individuals with intimate knowledge of how their pension plans operate are retiring and are not being replaced, as companies focus on core competencies and devote fewer resources to pensions and benefit oversight.

External Corporate Memory

In the event of senior staff retirements, the asset servicing provider can become an external corporate memory. Custodians have the technology to maintain data on accounting, settlement, performance, risk monitoring, corporate actions, fund valuation and shareholder reporting in a single data repository, and generate a host of reports related to the plan’s assets to satisfy the needs of the parent company and its partners. These factors, combined with increasing regulatory and transparency requirements, evolving investment vehicles and higher than ever service expectations have led to greater demand for more robust information.

Clients are more often requesting tools and capabilities for measuring performance more accurately (and more often); ensuring compliance to regulations and investment goals; assessing risk within portfolios; and facilitating investment decisions.

Today, financial service partners are able to offer more products of greater breadth to help manage risk and enhance returns more than ever before. The definition of ‘core services’ has expanded to include those which at one time were differentiators and considered ‘value-added’ services. For example, securities lending, performance and analytics, and compliance, to name a few, are now considered more mainstream offerings for many institutions.

In today’s competitive marketplace, organizations are well aware that they must offer highly developed technology to meet their clients’ ever-growing and sophisticated needs. And, as technology enables faster information delivery, the demand for customized products and services that can be specifically tailored to meet a client’s unique business requirements have become more common, says Rigsby. The obvious example is automation of manual functions, but offering customized solutions for data feeds, or data warehousing solutions, or integrated reporting at the micro and macro level to help clients’ better manage their organization is becoming more commonplace.

Advances in Technology

Certainly, advances in technology have made delivering on these expectations easier, and in many cases, helped to exceed the client’s needs. Technology investment has facilitated the delivery of more robust information through improved processing, faster delivery mechanisms, and innovative and more nimble tools to model and manipulate data, as well as assist with adherence to regulatory changes and implementation of industry best practices.

The financial investment required to develop and maintain the necessary technology and enhancements is costly, and few organizations have the resources to dedicate to keeping pace. Add to this the speed at which the servicing requirements change, and the ‘new’ technology becomes ‘legacy,’ and investment in cutting edge technology becomes increasingly prohibitive.

Custodians are committing as much as 20 to 25 per cent of their annual operating expense budget to technology every year. The focus is to deploy timely, cost-effective and superior business solutions that deliver maximum value for clients.

Being able to consistently satisfy clients and implement the necessary changes to process, technology, or expertise is the challenge for today’s financial service partner, says Rigsby, and is perhaps the one constant in our evolutionary investment environment.

Joe Hornyak is executive editor of Benefits and Pensions Monitor.

- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -

Subscribe to Daily News Alerts

Subscribe now to receive industry news delivered to your inbox every business day.

Interactive issue now onlineSubscribe to our magazinePrivate Wealth Online