Benjie Fraser, global pensions executive for J.P. Morgan’s Investor Services, has seen the needs of pension funds evolve, and the next few years will continue to be marked by change in terms of regulation, technology and the structure of funds. While the landscape will be altered, Fraser thinks custodians still have ample and exciting opportunities to serve these funds, particularly from a data perspective. And while pension funds vary greatly across the world, these differences also create unique opportunities region by region.
How are the needs of pension funds changing, and what are custodians doing to meet those needs?
BF: Obviously, a major development will be how pension funds address regulation. Year on year, they are looking at exemption from cleared trades around derivatives, but how long will that exemption go on for, and what’s that exemption worth to them in market cost? Regulation, from a global view—Dodd-Frank and EMIR—are affecting the global world of pensions. If I just localize it a bit, I’d say under that regulatory heading is the impact of Solvency II. As well, in the EMEA region, a more localized potential impact is the Financial Transaction Tax. These are just examples that could affect pensions from a regulatory point of view.
In terms of what actually the market impact will be on pensions—will this lead to greater costs for them? Will they have to use some of their hard scarce cash to help with the collateralization of some of these areas? Yes, possibly. And a lot of this regulation is really a multi-year phenomenon. In the U.S. they’re beginning to think how this will affect them over the course of 2014 and 2015 as you begin to see the first cleared trades in the derivatives area. Custodians are responding by being the organization that [pension funds] can plug into for knowledge that otherwise they might find difficult to collate.
Are custodians helping with any cost savings in regards to regulation or just helping them be compliant?
BF: Custodians are helping pension funds to understand what the cost implications are so certainly there could be cost savings. There is analysis that we provide them that has been very valuable. The other thing is as most pension funds don’t have particularly big back offices, J.P. Morgan’s ability to collect certain data on behalf of pension funds is becoming more prominent. The need to aggregate information to work with advisors or actuaries is becoming a more of a priority, particularly leading into next year.
Pension funds are looking for custodians to help them with a data, platform, and technology strategy. What I mean is that traditionally the custodian industry has been very good at focusing on, quite rightly, technology and data and platform as regards to making it more efficient in the processing of securities and the whole securities movement and control aspect. But you’ve got to remember, for a pension fund, a lot of that goes on and they never see it. It is just the infrastructure.
The new shift is now to apply a similar strategy to the actual way clients touch the J.P. Morgan Markets platform.
Another big change is, in Europe or Asia, big pension funds potentially taking money in-house. We’re seeing trending towards self-management in Australia and in the U.K., and a close look at self-management by some of the Asia funds. Now that’s not agreed globally. A lot of the U.S. funds, such as the big public funds, are pretty comfortable having their money run out-house. They say “Cost is higher, but I like the flexibility. I like the fact that I have a very transparent relationship with my money managers, whereas if they were in-house it would be less transparent, and that may be something that caused me difficulties if something went wrong.” But consistently outside the U.S., particularly with public funds, people are looking to get the same returns at a lower cost by taking money in-house. You’re going to see custodians providing simpler—a middle-office-lite—services, so to become more integrated with the pension fund.
What will emerge quite rapidly is client technology. In some places, technology is very important to pension funds. In other places, some funds are not sure how much use to make of their desktop. Around regulation, we could turn that on its head and say that pension funds are looking to their custodian to provide more thought leadership around operational intelligence. So we’re not looking to replace the advisors, but we’re looking to provide our data to the pension funds and their advisors, because we have a lot of really good data around these things.
How is the business model changing with funds taking money in-house? How do custodians make up those fees?
BF: It is the early days. Everything is connected. In Australia, the industry is consolidating; the super funds are consolidating. There is a connection between self-management and sizing up. For a custodian, what they are going to do is have opportunities to service bigger asset pools. There will be winners and losers certainly in terms of the custodians that will be successful. The type of custodians a pension fund may to work with may include a qualification that they understand the depth of the derivatives markets.
How much are funds using derivatives? Is that something that’s growing?
BF: The big change is the use of big macro trades on the liability side for DB plans. We’re seeing particularly in the U.K. and Denmark and Netherlands, where they know they have to make future payments, they will want to de-risk the value of that money by—as a for instance—taking out a hedge against interest rate fluctuations or inflation. These aren’t, necessarily, multiple derivative trades; these are big trades they’re doing to help them immunize future payments to pensioners.
How much are funds becoming more comfortable investing with hedge funds and in private equity?
BF: Pension funds are continuing to educate themselves on the alternatives asset class utilizing their trade associations and the hedge fund industry. The interesting thing for hedge funds is that the alternative asset class has expanded. You’ve got infrastructure, property is sometimes viewed as an alternative asset class, and you have got private equity. Hedge funds recognize that although the allocation hasn’t necessarily gotten significantly bigger that fast, the actual number of investment options a pension fund could look at has grown.
Are there any trends you think will develop that have not emerged yet?
BF: The big thing that has not emerged, but could emerge—and this is being touched on in the U.S. and is generally being talked about in Europe, but there’s no sign yet how this will work— is that a lot of DC may move out of employer-based arrangements to multi-employer-based arrangements, super trusts, as they have done in Australia and the rest of Asia.