Pension Funds: New Plumbing and STP Success
I couldn’t get into my office the other day. The road was being dug up in order to lay new water mains – the old Victorian infrastructure has worn out and needs to be replaced. Last week I was delayed for nine hours returning to London on the train. The roof blew off the railway station in high winds and the fire brigade said the falling roof would cause injury. These events underlined for me how far our modern world is dependant on the legacy of Victorian infrastructures left to us by the industrial giants of the 19th century (even if it is now falling apart in life threatening ways).
At Idea Group, we are very aware of the importance of a solid reliable infrastructure. We are currently involved in the construction of a new electronic trading infrastructure for the corporate pensions industry that is going to transform the way the industry does its business, not just in the UK but also potentially across the globe. So what is the technical breakthrough that has made this advance possible? ISO20022 UNIFI messaging and the SWIFTNet Funds messaging infrastructure.
There is an ever more complicated balancing act to satisfy client expectation and the needs of the financial institutions to provide profits for its shareholders. Over recent years, we have witnessed the decline of the defined benefit pension scheme in favour of the defined contribution scheme. The defined contribution scheme puts the pension scheme member in a much more exposed position – no longer do they have the warm comforting feeling that their pension will be based on the level of their final salary, instead their pension will be based on the success of a series of investments made in their name by their pension scheme trustees – there are no guarantees any more. Consequently, wise pension scheme members are demanding a lot more information about the value of their pension pot and more say about how their money is invested.
There is an ever-growing demand from pension clients for enhanced levels of client reporting, better returns and lower risk – all at lower costs. How will the pension product providers cope? The defined contribution pension business produces more than 12 times as many more order processing transactions per million pounds of funds under management than the equivalent defined benefit business. Managers may not be able to guarantee fund performance but they can be confident that their existing order processing systems will not be able to cope with the growth of defined contribution pension business. What’s more, the expense of running these high transaction levels drives administration costs up and can make defined contribution pension products unprofitable for fund managers.
Another feature of the wealth management process has been the attempt to reduce costs and risks by contracting out processing steps to companies offering the most cost-effective solution. We have a world where the management of one financial instrument can involve a complex series of exchanges between clients, trustees, third party administrators, fund managers, transfer agents, custodians and others. If you attempt to draw a map of these processes with arrows showing data passing between the institutions it very quickly resembles a scene from a Robin Hood movie: arrows everywhere! Often these links between institutions are manual. They may be relying on faxes or e-mail attachments to move instructions and data between counterparties. Each data transfer introduces costs and nasty risks, particularly where data is being re-keyed.
Wealth management is hard. Somehow a balance must be struck between risk and return: management charges to the clients and a decent return to the fund management companies shareholders. This is not an easy task, which is why we have to make sure we don’t mess up the easy stuff. We must continue to look for the opportunities for automation and straight-through processing (STP) wherever we can find them. I don’t apologise for bringing all this stuff up again. There are many parts of the financial industry where there is a high level of automation and financial instruments are traded automatically. But there are still many areas, including corporate pensions, where the job still needs to be done.
The current STP initiative in the corporate pensions industry focuses on the space between pension administration companies and pension product providers. This is the part of the business where pension contributions calculated during the payroll run in the business are sent as subscriptions into the corporate pension scheme. These can be extremely high value transactions and the consequences of an error in processing an investment funds order can be very expensive. Before 2005, there was no consensus on how the job should be tackled. But, in fact, a consensus was actually quite easy to achieve – all it required was the opportunity to get key players in the same room and a good point to start from. That starting point was ISO20022.
In 2004, Legal & General Investment Management invited Idea Group to help them to set up a discussion forum – The Investment Managers Straight-through Processing Development Group (IMSDG). This organisation grew quickly and now has members from over 50 companies and institutions. The group reviewed the available messaging standards and the various ways that a standard means of achieving STP could be achieved.
The group agreed that they would start a pilot project based on the ISO20022 UNIFI message set transmitted via the SWIFTNet Funds service from SWIFT. Thanks to the business process focused design on the UNIFI messages, the group was confident that it could support all its order processing functions using the messages straight off the shelf. But it needed to prove this. A group of key players in the market agreed to participate in the pilot project: Barclays Global Investors and Legal & General Investment Management from the product provider side and Capita Hartshead, Mercers Human Resource Consulting and Watson Wyatt Worldwide from the third party corporate pension administrator side. A remarkable group – not least because they are competitors who have allowed themselves to co-operate in this very specific area to build an STP infrastructure for this industry where no infrastructure has existed before.
Experience has shown in previous STP projects that a standard message set is all very well but without an agreed set of market practice rules a simple standardised approach to STP is very difficult. It was seen as a vital part of the project that a set of business requirements should be agreed. Starting on 3 February 2006, the participating companies met on a weekly basis to agree a standardised approach to the use of ISO20022 UNIFI to achieve STP in the corporate pensions industry. That standard requirements document was signed off on 11 April 2006 and has become known as the ViaNova project.
The ViaNova group has not just been addressing market practice issues. We have also been considering the legal implications of introducing STP into the space between third party administrator and product provider. Would we need to introduce a new contract to support electronic trading? At present there is no contract between the third party administrator and fund manager; the actual relationship exists between the fund manager and the pension scheme trustees, and between the pension scheme trustees and the third party administrators. After considerable investigation, a solution has presented itself based on small changes to client mandates allowing the inclusion of ISO20022 and the SWIFTNet Funds service as a valid means of transmitting an order. The group is happy to share its results with anyone intending to introduce STP in this area.
It has been quite a year since that initial meeting. There is not enough space in this article to provide details of how each company built its business case or how SWIFT has worked in this new area to enable these smaller institutions (from SWIFT’s point of view) access to the network. However, to summarize, it works. We have built a fully automated STP order-processing standard that is performing well under test conditions. Watch out for our go live announcement.
Idea Group has continued to facilitate the ViaNova project and has constructed a fully automated STP interface for Legal & General Investment Management. The standard approach for STP in the corporate pensions industry in the UK is indeed based on ISO20022. We start phase 2 in February 2007 on the anniversary of phase 1 with more fund managers, third party administrator and software vendors committing to the standard approach. In many ways we are lucky – to find a green field site for an STP project at a time when a new standard was available to do the job enabled us to shift the log jam of uncertainty and get the job done.
The hole that prevented me from getting into my office has been filled in and the new water infrastructure for the City of London is a step nearer completion. The job didn’t take long. The same is true of this STP project – it doesn’t have to take long or cost a fortune. Take a decent open standard as a starting point and use agreed market practice. Then it’s just a question of spending a predictable amount of money for a predictable outcome – reduction of risk and reduction of costs and improved efficiency of the business.
With the change to defined contribution pensions, individual pension scheme members need to be much more focused on what’s happening to their fund. Trustees must take a much more member focused approach. The third party administrators, product providers and fund managers have to get it right first time if they are to have a hope of making any money running defined contribution pension products. STP is essential to get the job done.