Should pension funds rotate service providers?
By Tilman Friedrich of Retirement Fund Solutions
Pension funds typically employ a whole array of different services from 3rd party providers. Certain service providers offer composite services while others are focusing on a limited range of closely related services.
Good corporate governance requires the regular review of service providers, does it not? In essence good corporate governance aims to manage risks and compliance. Rotating service providers for the sake of rotation certainly cannot be at the core of good corporate governance.
Assuming one is satisfied with the services provided by a service provider one would have to determine whether rotation reduces risk and/or strengthens compliance management, before this question can be answered conclusively.
What are the typical risks a fund faces vis-à-vis its service providers? Here are some that spring to mind immediately:
* The service provider overcharges, i.e. its costs are excessive relative to the value of the service provided. Costs can be benchmarked to the market, but to value the service provided is typically left to judgement.
* The service provider does not meet required standards of diligence such as inferior controls that lead to errors and omissions, loss or corruption of data and compliance failures; unqualified or inexperienced staff; high staff turnover and loss of corporate memory; insufficient indemnity and fidelity cover; inadequate succession planning; late, poor or defective reporting and potential of business failure due to defective or unsustainable business philosophy and policies.
* The service provider is not adequately supervised by another independent expert, particularly relevant to composite service providers.
Considering these key risks a service provider presents to a fund, it is quite evident that the risks referred to will not be addressed through rotation of service providers.
There are industries and situations where the rotation of service providers makes sense as it mitigates important risks. Rotation is typically employed in the security and asset protection industry or where highest standards of independence between client and service provider are required, such as in the audit profession.
In other industries rotation could in fact present additional risks. Personal services dependent on an acquired knowledge of the client or administration services relying on historic data going back over many years, such as typically relevant to the pensions industry are a points in case where rotation may present bigger risks than it might mitigate.