S E R V I C E l E X P E R T I S E l I N T E G R I T Y NORTHERN TRUST A YEAR IN REVIEW: 2008 CROSS-BORDER PENSION/ASSET POOLING Service Expertise Integrity P R I N C I P L E S T H A T E N D U R E Over the past 12 months Northern Trust has continued to make an exceptional contribution to the expansion of the European cross-border pension asset pooling industry through its: Ground breaking work with governments and regulators In 2008 Northern Trust secured a milestone advisory opinion from the US Department of Labor that provided clarity for US pension plans wishing to participate in a European cross-border pension pooling vehicle. Expanding product capabilities Northern Trust has enhanced its asset servicing solutions to support taxtransparency around certain short extension funds such as 130/30 strategies alongside its long-only and alternatives capabilities in the hedge fund, private equity and real estate sectors. Tools for assessing the merits of taxtransparent pooling A highly detailed feasibility study has been developed to guide plan sponsors. Support for market demand We have developed our platform in response to market demand from various segments including hedge funds. Continued investor base expansion We continue to take on new investors and work with our existing client base to add substantial pension funds to their pooling vehicles. Single, European pension plan Northern Trust is moving closer to the ability to support a single pan-european pension plan which would provide multinationals and their employees with ultimate flexibility for pensions management and staff movement. Industry thought-leadership We are actively engaged in raising awareness about the cross-border pension pooling industry through our research, tailored workshops and conference participation.
KEY ASPECTS OF SERVICE PROVISION Innovative pooling capabilities Northern Trust is a global provider of asset servicing and asset management solutions, with a key focus on providing sophisticated services to support our extensive pension client base. Our cross-border pension asset pooling solutions are an integral part of this strategy. Our proprietary pooling system supports large, complex investors with multiple countries of investment and multiple countries of investor for both tax-transparent and non-tax transparent vehicles domiciled in Luxembourg, Ireland or the Netherlands. As part of our pooling capabilities we provide fund administration including fund accounting and transfer agency, global custody, securities lending, tax reclaim, investor and regulatory reporting and management company services. Clients benefit from local servicing from Dublin, Luxembourg and the Netherlands and global servicing from the United States and United Kingdom. Asset management capabilities are available, through Northern Trust Global Investments (NTGI), the asset management arm of Northern Trust. As at December 31, 2008, Northern Trust had US$15.7 billion in tax-transparent and non taxtransparent pooling assets under administration for leading, global multinational companies and investment managers. SCALEABLE ASSET SERVICING SOLUTIONS Northern Trust s pooling solution supports our objectives to help our clients to maximise the performance and fiduciary oversight of their plans through efficient and scaleable solutions. Supporting Your Objectives Northern Trust s proprietary pooling solution provides institutional pension plans with: The potential for a consistent, global investment strategy. Access to best-in-class managers and specialised investment mandates. Enhanced governance and risk management through a centralised pool of assets and the ability to more effectively monitor manager performance. Consolidated reporting through a single, global custodian. Economies of scale through the potential for significant cost reductions in many areas including investment management, administration, custody, audit and service fees. The tax-transparent fund structures that Northern Trust can support also offer the advantages of: A look through vehicle which enables tax authorities within the investment jurisdictions to determine withholding rates based on the tax status of the underlying investors. The elimination of tax drag when compared with a traditional pooled vehicle may offer 30 basis points or more of additional return for equity portfolios with pension plan investors. Driving the industry forward in 2008/2009 Northern Trust has been actively building on its position as a European market leader in the area of cross-border pension pooling over the past 12 months. Building on our pioneering development in this field, we continue to actively expand the market for cross-border pension vehicles through our work with regulators and governments; product developments; research and engagement with the European pensions industry. Our leadership reflects our eight-years pioneering work in the industry and our work to develop taxtransparent vehicles which has effectively removed the road blocks to the expansion of the European pension pooling industry. In 2001 Northern Trust joined a client-led research consortium including two multi-nationals. As a result we implemented the first practical solution for multinational cross-border pooling in 2002 and in 2005 the first tax-transparent cross-border pooling solutions for multinationals through vehicles domiciled in Dublin and Luxembourg.
LOBBYING GOVERNMENTS TO EXPAND INVESTOR PARTICIPANTS As a prime example of our leadership in the global pension markets, Northern Trust secured a significant advisory opinion in 2008 from the US Department of Labor that provided clarity for US pension plans wishing to participate in a European cross-border pension pooling vehicle. The advisory opinion clarified that the use of pooled offshore vehicles to hold the assets of the US pension plans and non-us pension plans of multinational corporations administered by Northern Trust in the manner described in the advisory opinion would not violate certain requirements of the Employee Retirement Income Security Act (ERISA) that relate to the holding of currencies or securities offshore. As a leader in asset servicing for ERISA plans, Northern Trust worked with clients and outside counsel to request the advisory opinion from the US Department of Labor. With this Department of Labor advisory opinion, we expect more multinational companies to capitalise on the benefits of bringing cross-border assets together for investment management purposes. We are currently working with one of our major multinational clients to launch a tax-transparent Irish CCF which will incorporate a US investor. This will be one of the first examples of a US ERISA plan investing in a tax-transparent European domiciled cross-border pension pooling vehicle. BROADENING THE INVESTMENT TYPES Northern Trust has enhanced its asset servicing solutions for tax-transparent pooled vehicles to support certain short extension funds offered by investment managers. Our latest pooling innovation preserves tax benefits that allow investors to achieve increased returns from their investment strategy, and is available via three pooling vehicles: the Common Contractual Fund (CCF), in Ireland; the Fonds voor Gemene Rekening (FGR) in the Netherlands; and the Fonds Commun de Placement (FCP) in Luxembourg. In addition to removing tax drag, Northern Trust s proprietary pooling solution provides two key benefits for investment managers using short extension strategies. Northern Trust has enhanced its fund accounting platform to allocate short positions, maintained by prime brokers, to each of the underlying investors in a pooled fund, thereby enhancing reporting and valuation. Short extension strategies, such as 130/30, have increased in popularity, but of key concern for our clients was the issue of withholding tax, which can greatly cut into alpha. Northern Trust s tax transparent pooling infrastructure provides a solution to this issue, enabling the tax benefits created for pension investors to be preserved. Northern Trust already supports long-only and alternative strategies including hedge, private equity, and real estate funds. GROWING OUR BUSINESS As at December 31, 2008, Northern Trust had US$15.7 billion in tax-transparent and non taxtransparent pooling assets under administration for some of the most sophisticated multinational companies and investment managers, around the globe. Of these US$7.3 billion were tax-transparent. As of the same date Northern Trust had an additional US$20 billion tax-transparent FGR assets under custody for leading fiduciary managers in the Netherlands. After adding 10 new tax-transparent pooling institutional investors in 2008, the pooling vehicles we administer now have 37 institutional investors from 12 countries. New business included a mandate from a significant European based multi-national company and a major Dutch insurance company. We also worked closely with our existing client base to add substantial pension funds to their pooling vehicles. We have leveraged off our significant expertise in implementing, operating and servicing cross-border pooling vehicles in Luxembourg and Dublin to support the growing demand for the FGR. We are working with a number of asset managers to transfer their opaque pooling structures into a taxtransparent CCF structure, encompassing a range of strategies including real estate investment funds in addition to equities.
HELPING PLAN SPONSORS ASSESS THE MERITS OF CROSS-BORDER POOLING To assist plan sponsors in reviewing the potential impact of cross-border pooling, in 2008 Northern Trust developed a formal, feasibility study framework. The study aims to help the plan sponsor to identify, measure and summarise the costs and benefits of establishing and utilizing a cross-border, tax-transparent vehicle. The study, conducted by a team of Northern Trust experts, uses a series of financial models. In addition to confirming whether this form of pooling is an attractive solution for the plan sponsor, it also lays the foundation for gaining the support of constituents, for example, the trustees of different country pension plans. VIRTUAL POOLING DEVELOPMENTS Northern Trust has continued to develop a sophisticated support structure in response to the growing demand for virtual pooling solutions. Virtual pooling is a custody and fund accounting solution that provides efficiencies for investment managers and advisors. Features include the pooling of assets from multiple funds together in one or more portfolios with each portfolio managed by a single portfolio investment manager and specialised in one geographical sector or investment product. The funds, which maintain ownership of the securities within the portfolios, allocate a percentage of their assets to the underlying portfolios according to the investment policy of the fund. In essence, it achieves product flexibility without sacrificing scale by using common portfolios to assemble different fund offerings. In September 2008, Navigant Consulting (formerly Morse Consulting) completed a review of Northern Trust s systems and capabilities to support virtual pooling. Navigant confirmed that Northern Trust's current custody and fund accounting platform was very sophisticated and will support virtual pooling clients, provided that gaps identified during the review are addressed. While virtual pooling is not yet widely accepted by securities regulators worldwide, regulators in Luxembourg, Ireland and the United Kingdom have each approved instances of intra-pooling. Under an intra-pooling structure all of the sub-funds are established within a single entity (a vehicle or umbrella fund) and do not have their own legal status: the entity maintains the legal status. It is hoped Northern Trust s work in this area will support the development of this option for investment managers. PAN EUROPEAN PENSION PLAN Greater acceptance for the cross-border pooling of pension scheme assets is encouraging multinationals to consider not simply pooling assets across multiple schemes but establishing a single pan-european pension plan. Northern Trust is focused on adapting its proprietary pooling solutions to support this interest. A pan European pension plan would be domiciled in one EU country but would be subject to participation by employees across Europe. The plan would be underpinned with a single pool of assets and a centralised mechanism for managing both the assets and the liabilities. Steps are being taken to support this interest. Specifically the use of a cross-border IORP (Institution for Occupational Retirement Provision) structure is being explored. Rather than pool solely the assets of Defined Benefit (DB) plans, the IORP allows pooling of contributions and liabilities (subject to some conditions) allowing a multinational to provide a single point of pension excellence for their employees across Europe and beyond. Northern Trust anticipates the use of an Irish Master Trust IORP (with DB and Defined Contribution sections) investing via an Irish CCF alongside direct investment in that CCF by plans which do not want to use the IORP to pool assets and processes (perhaps US DB plans). INDUSTRY THOUGHT LEADERSHIP Northern Trust is proactively engaged in raising awareness about the benefits of using cross-border pooling structures through research, client conferences and tailored client forums.
Research Northern Trust undertook a detailed analysis model to quantify the benefits of moving to a taxtransparent structure for pooled pension products. The model, published in Finance Week, provided a simulated analysis of the impact of using a taxtransparent pooled vehicle on a 1 billion investment in a MSCI Euro index fund. It demonstrated that a UK corporate pension investor who invested this amount in 1997 via a tax-transparent Irish CCF would have earned an additional 57.5 million over 10 years when compared to the same investment via an Irish Variable Capital Company (VCC), which is "look at" rather than "look through" for tax purposes. While the CCF was not introduced until 2003 (so it would not have been possible to replicate this in reality), the results of the model are a powerful illustration of the benefits of removing tax drag. The 57.5 million figure was based on a fund manager performing the same as the index. If they outperformed, the numbers would be even better. A comparison between tax-transparent and non-tax transparent Luxembourg or Dutch fund vehicles could easily have been substituted for the Irish vehicles chosen for this model. *Model produced August 2008. Tax rates were verified by Northern Trust's Tax Technical Team and the Dividend Yield information was provided by Northern Trust's Risk and Performance Team.Tax rates may be subject to change. Column two shows the weighting of the investment in the different countries included in the MSCI Euro Index and column three comprises the average yield of equity investments in each country as of 31 March, 2008. In column four, the weighted yield for each country is calculated and summed to produce a gross dividend yield for the Euro equity index. An investor in a MSCI Euro index fund can expect an annual gross dividend yield of 3.64%. In column five the withholding tax rates applied to a dividend paid to a variable capital company vehicle are displayed. Column seven includes the withholding tax rates applied to a UK pension investor for dividend payments from the same countries. This analysis assumes that tax transparency is achieved in each jurisdiction so the rates available via double tax treaties to the investor are achieved when investing via the CCF in each case. Next, column six calculates the year one withholding tax amount (assuming the 1 billion initial investment) from each country for the VCC and column eight performs the same calculation for the CCF.
Conference attendance Northern Trust presented at four industry conferences in 2008, including the IIR Asset Pooling conference in the Netherlands on 29 June 2008, and the CIEBA (Committee on Investment of Employee Benefit Assets for corporate pension plans) and its International Plan Committee on 12 June 2008. RECOGNISED BY THE INDUSTRY Northern Trust s achievements in the cross-border pooling arena were recognised with the presentation of the Pension Pooling Award of the Year at the European Pensions Awards 2008. Pooling workshops and client briefings In 2008 Northern Trust business development executive Gwyn Koepke (left) hosted two forums in New York and Chicago to share Northern Trust s views on the US Department of Labor decision and its impact on ERISA funds. The forums provided a broad overview of cross border pension pooling, including goals and objectives of a global pension pooling strategy, and an in-depth look at Northern Trust's experience and how we service these types of vehicles. The forums also gave guidelines on how to approach a business case for pension pooling, as well as implementation and execution of a pooling program. In 2009 Northern Trust hosted a forum in New York focused on the tax advantages of asset pooling, Luxembourg tax efficient fund structures, and Northern Trust s tax drag analysis. Further forums are being planned in 2009. Contact gwyn_koepke@ntrs.com for further details. In the United Kingdom, multinationals and investment managers attended Northern Trust s pooling briefing on 22 October 2008 at the Naval and Military Club in London. Pooling briefings will be held in Frankfurt, Switzerland, Edinburgh and London in 2009. IN SUMMARY As a pioneer in this field, Northern Trust is leveraging its extensive experience to give our clients a competitive edge through the use of our innovative pooling product. As European pension plans face unprecedented pressure to have greater oversight of their plans and manage their liabilities, we believe our sophisticated, industry award winning cross-border pension pooling product is making a significant contribution to the European pensions industry. FOR MORE INFORMATON Martin Campbell Product Management +1 312 557 3692 martin_campbell@ntrs.com Gwyn E. Koepke Business Development +1 312 557 7331 gwyn_koepke@ntrs.com In the Netherlands delegates at Northern Trust s Annual Dutch conference were briefed about latest pooling developments, including the FGR.
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