UK Pensions Industry disapproves of IFRS accounting proposals

From Global Pensions

Just a quarter of the UK pensions industry supports plans to make all schemes compliant with International Financial Reporting Standards, a poll shows.

A poll - conducted by Deloitte - revealed 75% of trustees, administrators and accountants did not support the Accounting Standards Board's plans to classify pension schemes as ‘publicly accountable' entities to comply with IFRS.

The poll of 80 respondents also showed a further 43% said pension schemes' financial reporting requirements did not need changing at all.

Deloitte audit partner Sue Barratt said: "We are surprised that all pension schemes are being proposed as publicly accountable entities, given that there are many small schemes with few members.
"It is doubtful whether such schemes hold assets for a ‘broad group of outsiders', which is part of the ASB's definition of ‘publicly accountable'."

Under the proposals, pension schemes would be classified as tier 1 in the ASB tier structure, putting them on par with a listed company in their accounting requirements.

The survey also found 29% thought accounting standards needed changing, with 28% saying they were unsure.

A concern expressed by many respondents was that the potential administrative burden and expense of changing existing frameworks may not lead to a greater understanding of pension scheme accounts by members.

Barratt added: "While the ASB has indicated minimal changes in reporting by pension schemes, examples from other countries that have adopted the equivalent IFRSs for pension scheme accounts have led to significant, additional disclosures in financial statements.

"Considering this, there is likely to be more debate as to which accounting standards would be most relevant for pension schemes, in advance of the ASB's consultation period closing on 30 April."

Sovereign Investor:   The great majority of UK trustees, administrators and accountants believes that managing money on behalf of others does not make them publicly accountable.  It seems worth exploring the possible reasons why, because the same principles may apply - in a more general way - to sovereign funds.

The Chartered Accountants in Canada have this definition of 'publicly accountable':

A publicly accountable enterprise is an entity, other than a not-for-profit organization, or a government or other entity in the public sector, that:

• has issued, or is in the process of issuing, debt or equity instruments that are, or will be, outstanding and traded in a public market (a domestic or foreign stock exchange or an over-the-counter market, including local and regional markets); or  

• holds assets in a fiduciary capacity for a broad group of outsiders as one of its primary businesses. 

In the United Kingdom, the definition provided by the Financial Reporting Council is very similar:

An entity has public accountability if:

• (a) at its reporting date, its debt or equity instruments are traded in a public market or it is in the process of issuing such instruments for trading in a public market (a domestic or foreign stock exchange or an over‐the‐counter market, including local or regional markets); or
• (b) as one of its primary businesses, it holds assets in a fiduciary capacity for a broad group of outsiders and/or is a deposit taking entity for a broad group of outsiders. This is typically the case for banks, credit unions, insurance companies, securities brokers/dealers, mutual funds and investment banks.

In both cases, the holding of assets in a fiduciary capacity for a group of outsiders is expressly included in the definition of public accountability, and so it ought to be.  The Sovereign Investor wonders, then, whether the trustees have a problem with IFRS per se or, whether having taken hold of their members' money, they regard the funds as somehow being their own property, at least for the time being.


They wouldn't understand more comprehensive reporting, anyway

The argument that more comprehensive reporting may not be understood by members is an old chestnut.  In many countries sovereign funds hold assets on behalf of people who may not even be literate, and this should make them more accountable, if anything.  The fact that not everyone is financially literate merely provides an excuse for the trustees and their colleagues to try and avoid accountability to those members, other stakeholders and industry commentators, who do understand these matters.  In finance, as we know and was proved during the GFC, the devil is always in the details. 

Yes, IFRS reporting can be bulky.  It's just as well that in December 2010 the International Accounting Standards Board issued a Practice Statement about having a management commentary.  The Practice Statement provides a broad, non-binding framework for the presentation of management commentary that relates to financial statements prepared in accordance with IFRS.

Management commentary is a narrative report that provides a context within which to interpret the financial position, financial performance and cash flows of an entity. It also provides management with an opportunity to explain its objectives and its strategies for achieving those objectives. Management commentary encompasses reporting that jurisdictions may describe as management’s discussion and analysis (MD&A), operating and financial review (OFR), or management’s report.

We don't have to understand the technicalities of air bags, advanced braking systems and other safety features before being allowed to drive our cars.  The Sovereign Investor would, however, like to think that its ignorance on these matters shouldn't be used as an excuse by car manufacturers to avoid accountability to the relevant authorities for compliance at a technical level with safety standards.

Linaburg-Maduell Transparency Index Ratings - Q1Y2011

For the record.  

 

(Click for full sized image)

For more information on the Linaberg-Maduell Index, see the SWF Institute.

Proxy firms move to centre stage

From the Financial Times

Annual meeting season is in full swing on both sides of the Atlantic. This year, a new player is being dragged onstage to perform alongside traditional characters such as the generously-paid-off former executive and the lone campaigning investor. The proxy adviser’s moment is here.

Proxy firms’ reluctant move from their behind-the-scenes role has two causes.

In the US, it stems from reaction to the first annual meetings to be subject to advisory “say on pay” votes. As shareholders have persuaded some companies to change pay policies and voted against the remuneration reports of a handful who were not listening hard enough, attention has shifted to the firms such as ISS and Glass Lewis & Co which advise institutional investors how to vote.

In Europe, meanwhile, regulators have started looking at proxy firms because institutional shareholders are becoming more dependent on them. This reliance comes as investors must respond to criticism that they were too dozy during the financial crisis, while managing widely diversified portfolios: Norges Bank Investment Management, the Norwegian state fund manager, has holdings in more than 8,000 companies, for example.

Sovereign Investor: Only the beginning of the FT's article on proxy voting companies has been reproduced here.  Email ftsales.support@ft.com to buy additional rights or use this link to reference the original FT article - http://www.ft.com/cms/s/0/976fd594-6e89-11e0-a13b-00144feabdc0.html#ixzz1KVhxoMSZ

The primary issue with transparent sovereign funds, and Norway is an example, is that the funds' voting records may be published.  Relying on proxy advisors is a useful administrative measure for sovereign investors, but efforts would seem to be justified in understanding the published policies of the proxy advisors (see, for example, the ISS policies) to be sure that stakeholders understand the reasons for the voting record.  Note that these policies, again looking to ISS for example, are subject to an annual consultation process and perhaps those institutions who rely on proxy voting companies should consider advising stakeholders to participate in that process.  

Reflecting on Ghana's new Sovereign Funds

By Ashby Monk, from Oxford SWF Project

Back in March, Ghana’s Parliament passed the Petroleum Revenue Management Act, formally creating two new Ghanaian sovereign funds: the Ghana Heritage Fund and the Ghana Stabilization Fund. I’ve finally had the time to read the Act in its entirety, and I found it rather interesting. Given Ghana’s consistent high scores for good governance, you won’t be surprised to learn that the Act has many of the ‘best principles’ of design and governance. Still, there were a few aspects of the Act that have caused controversy. But before I get into that, let me catch you up.

As their names imply, the Stabilization Fund will help smooth petroleum revenues, while the Heritage Fund will be an inter-generational savings fund. The Minister of Finance will be responsible for overall management of the funds, but the Central Bank will be responsible for the day-to-day operations. If this setup sounds familiar, it’s because this is pretty much a carbon copy of the Norwegian design: the NBIM manages the money (Central Bank) and the GPF-G has oversight for policy (Ministry of Finance).

In Ghana’s case, the Central Bank will be constrained in its investment options. Basically, the new SWFs can only invest the assets in investment grade fixed income securities (although the Act does offer quite a bit more detail as to what that actually means). This reminds me of the approach adopted by Timor-Leste, which decided to start slow (with fixed income) and diversify over time (which it is doing now). It’s a sensible way to go about things, as top notch institutional investors do not emerge overnight.

And yet, while the Act is quite sophisticated and solid, it has not been without controversy. For example, there is a provision that allows the government to borrow against the oil assets in the funds. That’s not something I would have included because it reduces the disciplining effect the funds should have on politicians’ spending habits. In short, while the Act does a good job of defining what the fiscal rules are for fund contributions and withdrawals, the ability to borrow unconstrained money (even if it is backed by a highly constrained, rule-bound SWF) undermines the power of the SWF’s rules and governance practices.

In addition, many were against the Heritage Fund, on the grounds that the country faces serious developmental challenges that require capital investment today. And it’s a fair point. I’ve noted before that (setting aside capacity constraints and Dutch Disease) there is a very good case to spend the money on domestic infrastructure with lasting economic benefits for developing countries.

Whatever the case, all credit to Ghana for taking some initial steps to prevent the resource curse. But there are many more steps to come. Next up on the agenda: implementation and operation.

Sovereign Investor:  It is interesting to compare the new Ghana Act with the equivalent law in Timor-Leste, on which the Ghana Act appears to have drawn heavily.  Both provide strong division of duties between the investment policy role (Ghana's Advisory Committee and Timor-Leste's Investment Advisory Board), the overall management (Ministry of Finance), and the operational management (central bank).  This structure has the effect of removing (as far as possible) political influence in both the setting of the investment policy (by the Advisory Board) and the implementation of the investment objectives (by the central bank).  Both laws have transparency as a fundamental principle.  Both countries have a committee (Ghana - Accountability Committee; Timor-Leste - Consultative Council) that assists parliament and the population monitor compliance with the relevant laws.  Both countries require the detailed publication of who has paid into the fund - Ghana requires quarterly publication, Timor-Leste requires the information to be published annually.  There are a number of other parallels too. 

By adopting robust governance structures and transparency, both countries appear committed to avoiding the inevitable risks associated with a large fund being solely and opaquely under the influence of a single person or ministry, and have instead adopted a system of institutional checks and balances at the highest level as an effective means of overall governance.  

The Characteristics of Factor Portfolios

From MSCI Factor and Risk Modelling Insights

Research from MSCI's Jose Menchero was recently published in The Journal of Performance Measurement. This paper provides an intuitive foundation for understanding and interpreting factor models. It shows every factor can be represented by a factor-mimicking portfolio, whose return exactly replicates the payoff to the factor. Pure factors provide a way of placing surgical bets and disentangling the often confounding effects of multi-collinearity. Read this paper.

Abstract:

 A key to deeper understanding of factor models lies in the concept of factor-mimicking portfolios, whose returns exactly replicate the payoffs to the factors. Factor-mimicking portfolios can be used to generate real-time factor returns and in principle could serve as the basis for exchange traded funds for capturing passive alpha or hedging risk. Simple factor portfolios are obtained by considering each factor in isolation, whereas pure factor portfolios are constructed by treating all factors jointly. In this paper, we derive the holdings of simple factor portfolios for the World factor, as well as for countries, industries, and styles. We also discuss the characteristics of pure factor portfolios and how differences between simple and pure factor portfolios arise due to collinearity between factors.

We introduce several intuitive measures of collinearity in factor models and present their empirical distributions in the context of a global equity model. Finally, we describe how collinearity can be reduced through factor rotation and discuss the interpretation of such factors.