NSFM on pension fund governance reforms

Six months on (!!) and some of the thinking around pension fund reforms is finally trickling through the system. A few months back Frank Jan de Graaf and Keith Johnson, two leading members of the Network for Sustainable Financial Markets (NSFM), released a paper on “Modernizing Pension Fund Legal Standards for the 21st Century”. The recommendations it contained were picked up by the OECD and included in the drafting of its revised guidance on Pension Funds Governance.

Frank Jan and Keith argue that not only are pension funds in need of reforms, they represent huge pools of capital and have a considerable influence on the financial markets. Their investment decisions can have a big impact on the real economy and their success in meeting their liabilities depends on the ability of companies they invest in to create value in a sustainable way. So any reform needs to go beyond fixing the current problems (e.g. improving risk management processes) and consider ways to integrate long-term considerations in pension funds’ incentive mechanisms, governance structures and investment processes.

As mentioned in the paper, a study published in the Rotman International Journal of Pension Management found that better governed pension funds outperformed poorly governed funds by 2.4 percent per annum during the four years ending December 2003.

One of the ongoing problems it clearly identifies under the current arrangement is the conflict of interest between pension fund participants / beneficiaries and their agents in the service provider chain. As Professor Amin Rajan highlighted in a recent study on “DC and DB plans: Strenghtening their delivery”, “There is a widespread perception in the pension world that the investment industry is perverse in one crucial sense: its food chain operates in reverse, with service providers at the top and clients at the bottom.  Agents fare better than principals.”

With that in mind, Frank Jan and Keith offer a series of recommendations, ranging from developing a “fit for purpose” qualifications for pension fund board of trustees to publishing a statement of  investment beliefs and mission and minimising conflicts of interest through appropriate compensation structures and audited policies on managing conflicts of interest.

As mentioned earlier some of these recommendations have been incorporated in the revised OECD guidance on pension form governance. Change won’t happen overnight but this is certainly a good step in the right direction.

Many thanks to all NSFM members who provided ideas, feedback and support in drafting and disseminating this paper.

Building Sustainable Financial Markets

Also at RIAA’s International Responsible Investment conference was Raj Thamotheram, one of the founders and driving force of the Network for Sustainable Financial Markets (NSFM). Raj presented the NSFM slideshow to an audience of fund managers, investment consultants, asset owners and other service providers.

Just days after the collapse of Lehman Brothers, this was a powerful reminder of the need to make markets work for the long-term. Given the interdependence of financial markets and the real economy, the slideshow suggests that there is a pressing need to rethink the notion of “market efficiency” to ensure that all aspects of social, economical and environmental well-being are taken into account in investment decisions and that markets mechanisms are geared towards delivering value for the long run. Just how much regulations vs. volontary industry initiatives is needed remains an open question – and the focus of the debate.

In this slideshow “premiere”, the NSFM sheds some light on issues ranging from fiduciary duty to climate change and executive remuneration. You can watch the video of Raj addressing the conference delegates, and you should also take a look at the pdf document (nsfm_riaa-melbourne_september-24-20082) if you actually want to see the slides Raj is talking to.

I have been incredibly privileged to work with NSFM coordinators to put this slideshow presentation together and make a meaningful contribution to today’s discussions. Louise O’Halloran has also been a great source of inspiration throughout this process. In the spirit of Al Gore’s Inconvenient Truth and Louise’s Enlightened Self-Interest, individuals who share these beliefs are welcome to use the slideshow to deliver its message to other audiences. All they need to do is fill out a License to Present form on the NSFM website (link to come).

And of course, all your thoughts / comments / reactions are welcome!

Is there light at the end of the tunnel?

After a marathon weekend to rescue the banking system from complete meltdown, the various headlines of today’s FT seem to point to some convergence of thinking (finally). Here are some of the highlights:

“There was a strong sense that a serious regulatory backlash was coming and that the best the sector could do was to get ahead of the game and promise to clean up its own act”. According to an article in today’s FT, this was the dominating perception amongst finance practitioners attending the Institute for International Finance’s dinner in Washington last night.

Josef Ackermann, Deutsche Bank chief executive and Chairman of the Institute, unequivocally stressed that “we want to be one of the frontrunners in improving our industry before we get asked by the regulators and governments to do so”.

Meanwhile, also in today’s FT, George Soros offers a detailed plan to recapitalise the banking system using the US$ 700bn bail-out package agreed by Congress. He also warns that “time if of the essence” and that “only by promptly announcing a comprehensive set of measures and executing them vigorously can the situation be brought under control”.

Clive Crook, in his article, puts forward an idea promoted by Pr. Avinash Persaud, Chairman of Intelligence Capital Limited and a member of the Network for Sustainable Financial Markets, to introduce “contra-cyclical capital requirements” which would “force banks to build up capital faster when their lending is expanding most rapidly.. [effectively] taxing the expansion of credit and building a bigger cushion for any bust”.

Finally, the FTfm dedicated a section to global pensions and published an article highlighting the fact that 3/4 of UK pension funds had a responsible investment strategy (according to a survey conducted by the UK Social Investment Forum). In the case of Barclays UK Retirement Fund, this strategy may have paid off; the emphasis on good governance has helped the fund win important mandates, according to its fund manager Mark Hyde Marrison (watch the video here).

Similarly the UK Environment Agency (a pension fund with £1.5bn AUM) has also announced that “it would only hire UNPRI signatories for future mandates”. This anecdotal evidence is encouraging because it suggests that the principles that underscore sustainability investing can have a material impact, not only on investment returns, but also on asset managers’ ability to attract new clients.

Whilst this starts to provide a systemic approach to the industry, we have yet to hear more concerted voices from the responsible investment community on other industry-wide issues that require collaborative efforts with a view to improve financial market mechanisms for the long-run.

Soul searching at times of turmoil

Yesterday we pointed to the fact that there was relatively little analysis and self-criticism coming out of the ESG/SRI community or the broader financial community with regard to the current crisis. So it was refreshing to see an article from the WBCSD President Bjorn Stigson, in today’s FT Sustainable Business section, on the parallels between the climate change negotiations and the financial crisis.

Stigson sees the current financial crisis “as the result of unsustainable business models in the finance sector.” In his opinion, “the finance industry has lagged behind in addressing sustainability issues” and “the current financial crisis is shedding light on the flaws of the current business models in the finance sector and the enormous extend to which public trust has been damaged”.

He goes on to say that “to regain this trust, the finance industry will need to revisit its role in society and deliver updated business models that consider current societal expectations of open and transparents businesses that demonstrably deliver value to society”.

Whilst some of this rings true, it fails to capture the complexity of the finance industry and financial services. Do fund managers share the same responsibility as hedge funds, investment bankers, traders, mortgage lenders or credit rating agencies? As Hendrik du Troit, CEO of Investec Asset Management, pointed out recently in the FT “the attack on Wall Street is indiscriminate”. Yet he also admits that “we’ve been part of pushing banks to make more profits instead of making sure they were building more stable businesses.”

So there is a need for a little more soul searching in the industry. And this also present a significant opportunity for the SRI/ESG community to assess the robustness of their research model and investment philosophy. Surely there are some lessons to be learned for all of us involved.

Your say on the crisis

At a time of unprecedented crisis in the financial markets, where the US Treasury Secretary Hank Paulson goes as far as saying that “we have a regulatory system that is broken, outdated and which doesn’t fit the world we live in”, it is surprising that we are hearing so little from the finance community itself about what’s gone wrong and how it can be fixed. I’m sure a lot of people who work in the financial markets have great insights that we could all learn from. If they do not actively engage in the debate, we run the risk that politicians will step in under public pressure and support the type of regulations that might offer “quick fix” solutions, but which fails to address the root causes of the current crisis and provide long-term solutions.

In an effort to stimulate this debate, AQ Research – an independent research agency – has developed a survey which seeks to explore what investment professionals really think about the crisis, and possible ways forward. It’s short but it really forces you to think about the big picture.

Anyone who works in this field should take this opportunity to share their views (and to circulate the survey widely) so that we can all benefit from the collective wisdom. We need to bridge this gap of understanding between practictioners on the one hand – and regulators and the general public on the other hand. If this is about restoring trust and confidence in the markets, then we absolutely need to foster that dialogue. And only then will we be able to come to the right decisions about the reforms that are needed to build a healthy financial system that is adapted to the realities of the 21st century.

I look forward to sharing the results back with you, which will of course be anonymised and aggregated.

More on the Network for Sustainable Financial Markets (NSFM)

To get a sense of what the Network for Sustainable Financial Markets (NSFM) focuses its energy on, check out its Open Letter, published on the Responsible Investor website last Friday.

This quote sums it up pretty well: “The Network for Sustainable Financial Markets maintains that the financial system failed because insufficient attention has been paid to sustainable wealth creation. [It] seeks to interject in the debate the views of long-term investors who, of all the players in the financial system, best reflect the needs of ordinary savers”.

For instance, at a pragmatic level, the Network is providing guidance to the OECD on the necessary reforms in pension fund governance. Although the Network points to some inherent flaws in the current system (e.g. executive remuneration, conflict of interests, short-term vs. long-termism… ), its fundamental belief is that the financial markets, if they are designed appropriately, can deliver sustainable solutions and sources of value creation. So this is what the reform agenda should focus on: creating the mechanisms that will in the long-run make the financial system as a whole more accountable, more efficient and more sustainable.

Time to take stock

We have seen a serious rollercoaster in the financial markets since I joined this industry about 2 years ago – from the peak of the bull market to a major financial meltdown with seemingly no end in sight. One part of the industry (arguably the only one) that is benefiting from the current situation are the reporters and commentators. The internet and blogsphere is awash with analysis of the crisis and opinions about ways forward. It’s all pretty overwhelming.

It is a steep learning curve for all of us inside (and outside) the industry, and because we all have limited time on our hands, I simply want to flag some of the best analytical overviews I’ve come across in the past few days. All of them take a big-picture / long-term view of the industry and seek to address some of the systemic issues that have recently (re)surfaced.

What is the major take-away in my view? Most people now agree that we need a fundamental rethink of the primary role of the financial markets (i.e. to allocate resources efficiently) and that we need to design financial markets mechanisms that will fulfill that role. The paradigm shift is that the 21st century notion of “efficiency” is (finally) being updated and upgraded to reflect the realities of a much more complex and inderdependent world, where the impacts on the real economy, on people’s livehoods and on nature’s eco-systems have to be accounted for in every investment decision. This is the only way markets can help create real sustainable value. It could also improve the sustainability of the financial sytem itself as a result, and make it less prone to booms and busts.

Where opinions continue to diverge is on the need for reforms and regulations. The following also make some great contributions to the pros and cons of strengthening regulatory frameworks. Over to the experts:

1/ The Economist’s Leader Editorial on 18 sept 2008

2/ FT Chief Economist Commentator Martin Wolf’s podcast on 9 sept 2008

3/ Financial Markets Historian Peter Bernstein’s FT video interview on 10 feb 2008