Pension Funds Online

Code of Best Practice for Transition Managers - The T-Charter

In 2007, a code of best practice for transition managers, ‘The T-Charter’, was launched with most transition management service providers signing-up to its high-level principles. However, on that same day, three of the signatory firms issued a joint press release expressing the view that the code had fallen short in its objective to protect clients. The launch of the T-Charter and the perceived attack on the document by the ‘dissenting three’ received a fair degree of press coverage. Trustees may well wonder whether the T-Charter is a good thing or a false security. This article provides the background to the T-Charter, sets out its key provisions, and responds to those who believe its measures do not go far enough.

Background

From time to time pension funds need to make significant changes to their investment arrangements; these asset restructurings may be prompted by performance issues, actuarial advice, sponsor changes, new regulatory requirements or new investment opportunities. To implement the required changes it has become increasingly commonplace to employ the services of a specialist manager. This ‘transition manager’ reduces costs, controls risks, and provides efficient project management.

The number of transition management service providers has grown rapidly as asset managers, investment banks, custodians and investment advisers compete for these restructuring assignments. Trustees and their investment advisers have found it difficult to compare services, cost estimates, fee quotations and performance results of the competing transition managers due to the fundamental differences in their business models and dealing practices.

At an investment conference in December 2004, the transition management industry was accused of poor practice and a lack of standards. Six weeks later, the leading transition management firms came together to discuss the issues. These were the first tentative steps towards an industry code of best practice. This code, known as the “T-Charter”, was finally launched on the 22nd October 2007, with seventeen firms agreeing to abide by its principles.

The T-Charter

The initial discussions of the transition managers were heated, but the debate became more constructive when it began to focus on the standards of service and behaviour that should be expected of a transition manager whether acting as fund manager, investment bank, custodian or investment adviser. The objective was to raise standards and allow clients to compare the proposals and results of transition managers. The T-Charter has ten straightforward principles:

Disclosure and Conflicts of Interest

The transition manager structures their business to put the client’s interest first and minimise and manage conflicts of interest. They prepare a disclosure document detailing actual and potential conflicts of interest and the measures taken to manage them. This document is submitted in all proposals and legal agreements.

Client Confidentiality

The transition manager has procedures and systems in place to protect client confidentiality. Market sensitive information is safeguarded from other operating areas of the firm and from external parties.

Resources

The transition manager has available the appropriate resources to support and efficiently manage the transition process to meet the client’s objectives.

Systems and Processes

The transition manager maintains a clear audit trail of transition activity and ensures that the reporting systems that support the transition process are provided with accurate and timely data. All business procedures and work flows are documented and appropriate business continuity procedures have been put in place.

Cost Estimation

The transition manager provides cost estimates that are unbiased and presented in a common format so that clients can compare the forecasts of competing providers. All assumptions are realistic and clearly stated.

Remuneration

The transition manager fully discloses all the sources of client remuneration received by the manager and/or its affiliates, whether paid explicitly in fees or other charges or earned implicitly through income sharing, rebates or trading revenue. Alternative remuneration structures are presented in a fair manner.

Dealing Strategy and Practices

The transition manager proposes strategies that are fair, appropriate and relevant whether dealing as principal or as agent. The dealing strategy adopted and all trading activity is reasonably expected to obtain the best implementation shortfall result taking into account the potential volatility of the shortfall result and the transition objectives agreed with the client. The transition manager acts in the client’s interest, in good faith, and with due skill and care, and in accordance with best execution rules. The transition Manager agrees to the following requirements if pre-hedging transactions are contemplated:

• Discuss clearly and fairly with the client and their advisers the implications of pre-hedging

• Disclose in the proposals and the legal agreements that pre-hedging has been agreed

• Confirm the extent to which the profit or loss is shared between the client and the Transition Manager

• Ensure that performance measurement starts in advance (previous day’s market close) of the first pre-hedging transaction

• Detail the pre-hedging transactions undertaken

• Report on the performance impact due to this pre-hedging activity in the implementation report

Evaluation

The transition manager calculates and reports performance results as implementation shortfall as defined by the T-Standard. All charges, fees and costs are included in the calculation. The realised result is compared to the cost estimate and any differences are clearly explained.

Errors

The transition manager reports errors involving material financial loss during the transition as soon as is practicable to the client and, if applicable, their advisers.

Compliance

The transition manager confirms that their business is subject to oversight and review by the Compliance function. The transition manager, upon request, confirms adherence to the T-Charter.

Does the T-Charter Go Far Enough?

The press release from the three transition managers did not ‘slam’ the T-Charter as claimed by one newspaper headline but it did warn clients that the code may not provide a sufficient level of protection or comfort to clients. Their concerns can be summarised as follows:

• The T-Charter implies all providers are equal; they are not

• Pre-hedging should have been banned

• The value, not just the sources, of remuneration should be disclosed

• The T-Charter lacks enforceability

These three managers did not propose alternative drafting for their peers to consider and all of these issues were discussed in detail before the T-Charter was launched. My response to these four criticisms is set out below:

1.    The T-Charter does not claim that all transition managers are the same in the same way that the Highway Code does not state that all drivers have equal expertise. To suggest the T-Charter fails because most transition managers have agreed to its measures may imply an agenda to exclude some providers and limit client choice.

2.    The T-Charter stance on pre-hedging (more transparency and greater disclosure) was guided by:

• Pre-hedging is allowed under market regulations; it would be inappropriate for a voluntary code to overrule the market Regulator (the FSA)

• Some transition managers, in certain circumstances, believe pre-hedging can be beneficial to clients

• Some sophisticated clients allow their transition manager to pre-hedge and do not believe the T-Charter should limit their choice

• If trustees are suspicious of pre-hedging, they can and should prohibit the use of pre-hedging in the transition management agreement (TMA).

3.    The ‘dissenting three’ always act as ‘agent’ in carrying out their duties as transition manager; other transition managers can act as ‘principal’. The agent provider receives remuneration from buying and selling assets on your behalf but the risk (profit or loss) of asset price movements during transition remains with your fund; disclosure of the value of remuneration is therefore straightforward. The principal provider receives remuneration from buying and selling assets but the risk (profit or loss) of asset price movements during transition remains with the provider; disclosure of the value of remuneration is not straightforward. When challenged on this issue, the agent providers were unwilling to provide the same level of profit and loss disclosure when undertaking principal (risk) transactions on their clients’ behalf. The T-Charter has to treat all providers equally.

4.    The T-Charter is a voluntary code but if the obligation to abide by the T-Charter is included in the TMA the measures becomes legally contractual. The ‘dissenting three’ can deal with their enforceability concerns by including the T-Charter within their legal agreements.

T-Charter Support

Many pension schemes and their investment advisers are already using the T-Charter in their selection and evaluation of transition managers. It defines the high level of service and behaviour that all transition management clients deserve. It will be unfortunate if the mixed message at its launch has undermined the code before a proper evaluation by the users of transition management services. My belief is that the T-Charter will find widespread support because:

• It protects clients not providers

• It has been widely accepted by the transition management providers

• It promotes greater disclosure and transparency

• If it needs to be enhanced or strengthened it can and will be

• It is already being used by pension funds

• The ‘cost estimation template’ allows direct comparison of the cost estimates of the competing providers

• The ‘disclosure document’ provides clarity on conflicts of interest and remuneration

• It brings greater disclosure and transparency to pre-hedging activity

• It provides disclosure on all the sources of remuneration

• It delivers an agreed performance measurement methodology

Transition Management – The Future

Competition is generally good for clients as it brings about better products, wider choice and lower prices. Pension fund restructuring costs have already fallen markedly. In the early 1990s, the WM Company, a pension fund performance measurer, estimated these costs to be 2.7% of the assets in transfer. Today, many pension funds are able to make the equivalent changes to their schemes for less than 0.5%. The increasing use of transition management is responsible for some of this cost saving. In the future, clients will want to see these costs fall even further.

The T-Charter will exert an influence on the market. Transition managers will begin to compete on disclosure and transparency. It will be much easier to compare and differentiate the services and results of one transition manager against another. This will be particularly important in the area of transition manager remuneration where clients will demand greater disclosure and transparency of fees.

Transition management did not really exist sixteen years ago. Today, most pension fund restructurings will call upon the services of a transition management specialist. Transition managers have delivered better risk management, lower restructuring costs, accountability, and better project management. This is a success story within the pensions industry that looks set to continue.