Operational considerations for transferring assets
Dan Hardiman, Rothesay
Here we highlight some of the key operational considerations that a pension scheme should think about in order to manage its risks and obligations in satisfying the delivery of assets as payment of a premium.
Each scheme will be subtly different and assets for payment will likely fall into three buckets; bonds (gilts and/or corporates), derivatives (swaps), and cash. For any assets that will be transferred to the insurer to satisfy the premium due it is key that all parties - the scheme, its custodian/bank and the insurer - have the same view of the assets and that this is checked regularly. We list the key considerations by asset class below. Separate considerations are needed for investors in pooled funds.
1. Custody relationship
As a starting point, the scheme should ensure it has an easy way of getting sight of the assets held by its custodian. This may sound obvious but its importance should not be overlooked.
If the scheme does not have the technology in place to view its assets directly, for example through a custodian portal, it should arrange to be able to do so as it contemplates the buy-out. There should be no additional cost to the scheme of having this access and it will make the bond and cash reconciliations much easier as the frequency increases. In addition, the scheme should ensure it has a senior relationship contact at the custodian who understands the transaction and can help the scheme with the technical questions an insurer may have – for example designing and delivering any reports that you may need and helping with specific settlement details with the insurer in the run-up to inception of the bulk annuity.
The reconciliation and delivery of the bonds should be a relatively pain free exercise but there are some subtle points to watch out for.
- Notional – ensure you are reconciling the face notional (the actual position you hold in custody and that which will be delivered to the insurer) and amortised notional where relevant (bonds which have repaid part of its principal balance through the life of the bond). There is no need to agree valuations as they should be irrelevant in paying a premium that is set by reference to notionals. Comparing valuations can help occasionally though for example with inflation-linked bonds where the notionals are sometimes recorded without inflation.
- Previous and next interest pay date – the scheme should be aware of these dates to track and reconcile realised and future incoming cashflows which are due over the price-lock period. The insurer will be keen to confirm that the actual payment received matches the expected/accrued amount, so it can reconcile to its own expected cash balance.
- Record/Ex-div date – this is a key date to be aware of in order to track and reconcile expected bond interest receipts. This date determines a holder’s entitlement to bond interest and is particularly important to track if the scheme is buying/selling assets or posting assets as eligible margin under their swaps.
Word of caution! Both the scheme and insurer should be aware of the ex-div date when agreeing the settlement date for the assets to be delivered. If the settlement date falls in between the ex-div date and payment date for a given bond, the scheme will receive the coupon as the holder of the bond on the ex-div date, and will need to transfer this to the insurer as a cash payment.
- Pre-inception – the scheme and insurer will need to confirm the logistical details around delivering the bonds to the insurer – this is where the scheme might want to pull in their custodian contacts. Importantly, the delivery will need occur “free of payment” which is not the usual approach for custodians. The scheme will likely have a five to ten-day period in which to deliver the assets, but in reality this can be achieved within two or three days if both sides are well-prepared and agreed on these details. Key points for each bond in the portfolio will be the agreement of:
- Custody locations (which clearing system does the scheme currently hold the bond in, e.g. Euroclear, Crest etc.);
- Respective “SSIs” (custody account numbers of the scheme and insurer);
- Trade date and settlement date to transfer the assets.
- On signing the bulk annuity policy – the scheme should give the instruction to the custodian to enter into the agreed delivery instructions and should confirm when they are matched with the insurer. This should be confirmed within a day of the instruction to the custodian. Reconfirming the matching status the night before settlement date means the bond delivery should then happen automatically in the clearing systems on settlement date. Ask your custodian (or check the status in the portal!) for regular updates so you are aware, but the insurer should also provide you with these updates.
Swaps are the most complex asset to transfer operationally and we cannot cover all technical points here, but a sophisticated insurer (and your relationship manager at the bank) should be able to guide you through the process – it is a relatively standard process for them and the bank!
Where swaps form part of the premium to be transferred, these will be novated away from the scheme and to the insurer on the signing date of the contract. The bank with whom you executed the trade remains a constant party to the contract.
- Legal confirms – let’s start from an assumed position that you have copies of all legal confirmations with your existing banks. Interest rate swaps will likely be electronically confirmed on industry standard systems/platforms such as MarkitWire, inflation swaps will be confirmed on paper. Make sure you have current copies of all confirms reconciled to your systems and have them to hand, ready to send to the insurer when needed.
- Spreadsheet – preparing for the price-lock you will want to build a spreadsheet showing the economics of each swap, row-by-row. Include your trade reference so you can easily reference a particular trade (the insurer and bank will also need this to execute the novation). Key columns the insurer will need include currency, effective date, fixed and floating rate, payment dates, notional, day count fraction, maturity date. This will enable the insurer to book and price a reasonably accurate representation of your swap portfolio in its own system.
When you are in the price-lock, you will need to send the legal confirms to the insurer in order for them to fully review the legal terms against their spreadsheet representation – they can effectively risk manage the price-lock from that point as they have built a shadow of your book in their risk system.
- Cash reconciliation – the insurer will want to reconcile any cashflows due under the swaps against the payment you are physically settling with the banks (both paying and receiving) in order to ensure their aggregate cash balance is in line with your actual balance – as they did with the bond interest covered earlier.
- Margin – assuming the swaps are executed under standard ISDA terms, the scheme will likely be performing daily margin calls against the banks. Ensure you have a clear representation of any margin paid or received to the banks. You will need to recall or return this margin on the date of inception. If you have posted bonds as margin, ensure you are aware of when those bonds are due to pay a coupon (see the ex-div date point above) – you should ask the bank to pay this coupon to you as soon as possible in order that your actual cash balance matches the insurers assumed cash balance.
- Pre-inception – you can expect the insurer to line each bank up to novate the swaps from the scheme in the run-up to execution. The scheme will have to discuss the expected novation with their bank but expect the insurer and bank’s operations and trading teams to help you through the specific legal and operational points required. The electronically confirmed swaps are novated through the system; the paper confirmed swaps will require a novation agreement, which should be drafted by the insurer (or the bank) and sent for your review.
- On signing the bulk annuity policy – when the contract has been signed the scheme should initiate the swap novation with the bank and the insurer via email. The insurer and bank will then take the lead on the operational processes to legally confirm the transfer, effecting it either through the electronic system or by the three parties signing the paper confirms.
- Post-inception – the day after the policy incepts will trigger a recall of the margin balance that had been exchanged between the scheme and bank. This will settle either that day or the following day (in line with your standard arrangement). The scheme will then have to pass that recalled collateral through to the insurer, likely one or two days after receipt from the bank to give yourself a buffer against any fails.
It is sensible and important to reconcile any cash balance due regularly throughout the process. Making a test payment is also advisable.
You will be holding a running cash balance at your bank and/or custodian which will simply represent your starting balance plus/minus any cashflows received on your bond portfolio and exchanged on the swaps. It is important to reconcile this balance though as this is the cash balance part of the premium that you will need to transfer to the insurer. Expect to reconcile your actual balance to the insurer’s on a weekly basis, which will likely step up to daily in the days running up to signing the policy.
Transferring the cash is a standard wire process but, as with custody, having a good contact at your bank will be important in advising you of the safest way to transfer. Making a test payment of £1 before signing to check you have the insurer’s bank details correct would be sensible.
It may be that there are several cash transfers you will make: (i) a lump sum in your account available to transfer immediately; (ii) cash margin to be recalled from the banks and transferred within three to five days of the inception date; and (iii) bond coupons where you are in the ex-div period that could take anywhere up to 14 days to be received from the issuer. The insurer should be sensible about agreeing how and when these should best be transferred.
When all assets have been delivered you are there! The key points to take away to ensure an efficient and well-controlled process are clear communication, regular reconciliations, and management of your third parties.
Ask the insurer for help if you are in any doubt. They will have done this before and what may seem a daunting task to you at the outset can be broken down into simple steps at each stage of the process.
About the author
Dan is Head of Asset Operations at Rothesay and has been with Rothesay since Rothesay purchased Paternoster in 2011. Prior to that he worked at Goldman Sachs for 10 years. His team’s day to day work supports Rothesay’s asset deployment and hedging activities, liquidity and collateral management, and oversight of key third parties working for Rothesay such as custodians and banks.