Consolidation of both pension and sovereign wealth funds has continued over the past few years. This trend has several origins, including regulatory encouragement, a desire to achieve greater economies of scale, the opportunity to increase deal size and thereby gain access to better investment opportunities, and more effective governance and internal resourcing. At the macro level, the need for all investors to improve returns and for pensions to address increasing beneficiary lifespans can be key drivers. As investors continue the trend of more active and direct investing, we expect that fund consolidations will continue as larger funds tend to have greater internal capabilities to address the different asset classes and expanded geographic reach that may follow from a more active investment strategy.
It is important to understand the risks and challenges that come with consolidation. As with most significant changes, proper preparation allows funds to anticipate and plan for the challenges that are inherent in a consolidation. Consideration needs to be given to investment mandates and allocations, staffing, delegations of authority, governance, operations, systems, tax and accounting as well as the cultural aspects of the merger. Finally, the politics of achieving consolidation can be very challenging and draw considerable debate on national interests, control and market influence.
There have been a number of recent merger announcements in the SWF space, including OIF and SGRF in Oman, ADIC into Mubadala in the UAE (following the merger of IPIC into Mubadala the year prior). In the pension arena, merger activity has been seen in Denmark, the Netherlands and Australia. AustSafe Super and Sunsuper, two Australian superannuation funds based in Brisbane, citing the need for increased efficiencies, announced a merger in 2018 that is expected to close in April 2019. While fund mergers are initiated for different purposes, the pre and post-merger challenges are similar.
This article will discuss the potential benefits of fund consolidation as well the considerations and risks of these amalgamations.
Consolidations are never easy, can take various forms, and can take many years to realize the intended benefits. The challenges, which include cultural, political, technological, financial, tax, accounting and operational considerations, are significant and must be addressed beforehand.
As noted above, there are a myriad of possible drivers in favor of fund consolidation. In certain jurisdictions, such as the UK and the Netherlands, there is regulatory encouragement to reduce the number of pension funds. The number of pension funds in the Netherlands reduced from 800 in 2005 to roughly 300 in 20171. In December 2018, the UK Department for Work & Pensions published for public consultation a paper titled “Consolidation of Defined Benefit Pension Schemes” (See, e.g., KPMG in the UK’s Insight dated 7 September 2018 “What does consolidation mean for defined benefit pension plans?”). In the sovereign wealth fund space, mergers are often intended to create vehicles that have the size and capital to efficiently expand in terms of geographies and sectors. Whether or not the impetus is from a government initiative, the goals of the merger are often the same. Below we will discuss the many potential benefits and pitfalls associated with a merger of funds.
One often cited rationale for merging funds is to achieve greater economies of scale. The savings here can relate to administrative costs as well as external costs. In practice, these cost savings are not often realized, at least to the extent expected. Therefore, it is critical to have a clear plan well in advance of the merger one precisely where cost savings and efficiencies are expected to be achieved and over what timeframe. A full merger is far from a simple exercise; good planning is key to its success.
Former Australian treasurer Peter Costello believes the country’s industry super funds should be consolidated and run by a central government agency. “A bigger pool with economies of scale and access to the best managers would likely drive down costs and drive up returns,” Costello said. “There would be huge economies of scale.” Currently, industry super funds are managed by a mix of not-for-profit, for-profit organizations (primarily large commercial banks) and a growing number of self-managed funds.
Many argue that a larger fund can achieve a better governance model. The logic is that larger funds can attracts better talent and can more readily absorb the costs associated with a robust governance program, including an enterprise wide risk management program, internal controls and the hiring of experienced board members.
Another major potential benefit of a larger fund is on the investment side. Larger funds have access to more investment opportunities and also have the ability to write larger tickets. They also can negotiate more competitive fees with asset managers and external advisors. Finally, larger funds can afford more internal resources allowing them to expand their investment portfolio into new asset classes and jurisdictions.
For example, Canadian public pension funds are fragmented amongst the provinces and territories reflecting a resource-based economy prone to commodity booms and busts. Proponents for consolidating the provincial SWFs believe placing them under one investment institution will allow the consolidated fund to have a clear mandate, more transparent and autonomous governance, and ability to include more provinces and territories over time.
There are certainly other benefits beyond economies of scale, governance and greater investment opportunities, some of which are particular to the entities merging. Let us turn to the many challenges of a merger of funds.
Challenges of a merger of funds
- Culture is one of the larger issues that needs to be addressed early on in a merger. Funds each have their own culture developed over many years. Cultural clashes can prove a serious distraction, and worse, significantly reduce the perceived value of a merger. Human capital is a key asset of any fund; addressing cultural considerations should be a key component of merger planning.
- Technology is often a troublesome area in a merger. Each fund likely is reliant on a number of systems that handle everything from payroll to accounting. A clear plan must develop on how best to integrate these disparate systems and this plan cannot exist in a vacuum. IT systems are an enabler of key processes, procedures and controls. So the determination of how to proceed and select the appropriate IT systems for the merged entity must be aligned with the target operating model and a determination of the processes that the merged fund will adopt going forward.
Tax challenges are many and will vary by jurisdiction. Potential tax considerations of a merger are generally at the investment level and include capital gains and transfer taxes as well as change of control provisions that might restrict or eliminate the ability to use tax attributes such as net operating loss carryforwards. There also might be local notification requirements that need to be satisfied.
A review of each fund’s accounting policies as well as the potential impact of how investments are accounted for are important, especially where funds have common investments. A consolidated process for tracking investments and associated returns must be agreed upon. The process of fair valuing investments will need to align.
The merger trend is likely to continue given the challenges facing funds to improve returns, explore new assets classes and investments, enhance governance and all while reducing costs. While a merger is a tempting solution to addressing these challenges, there are important considerations to be addressed in advance to help ensure a successful merged fund.
Head of Sovereign Wealth & Pension Funds and Head of Asset Management
Managing Director, Tax
KPMG in the US
Managing Director and Financial Services Lead for Deal Advisory & Strategy
KPMG in the US
1 IP&E March 2017
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