Northern Trust is winning a great deal of pension business from multinational clients on the basis of its tax-transparent cross-border pooling. To enable international companies to pool the assets of their pension funds from many countries without running afoul of the IRS, the firm developed a tax-transparent cross-border pooling solution in September 2005. In fifteen months, assets in the product have grown from 0 to $10 billion and Northern Trust is seeking a patent on its methods of handling this unique product.According to Kathy Dugan, Northern Trust's cross-border pooling product manager, the reason companies are interested in cross-border pooling is this: A "typical" multinational may have as many as 25 funded plans. Of these, two might be large, and the remaining 23 relatively small. Every one of these plans needs exposure to global equities. If all these plans are managed independently, then the corporation will conduct 25 independent searches and 25 separate groups will need to monitor ongoing performance. This process is inefficient and prone to risk. It's not feasible to give the same amount of time and attention to a $10 million plan as you do to a $10 billion dollar plan, yet if something goes wrong with a small plan the corporation can suffer significant damage to its reputation. These multinational clients want to pool the assets of different subsidiaries together into a single vehicle. This allows them to focus the best expertise of the entire corporation into a single investment committee tasked with selecting and monitoring managers. Cross-border pooling benefits the pension plans in two ways: enhanced governance and risk management through tighter controls around the decision-making process and economies of scale. The small plans in particular gain diversification, access to best-in-class managers and lower fees. The glitch in this rosy picture is the IRS. Although in many countries, including the U.K. and the Netherlands, a pension plan pays no withholding tax on dividends from U.S. equities, most pooled funds pay as much as 30% withholding tax on U.S. dividends. The success of multinational pooling rests on finding a solution to this problem, because no plan will invest in a pool if it means paying additional taxes. The answer Northern Trust has found is tax-transparent vehicles. While in most pooled vehicles, all investors pay the same withholding tax rate, in tax-transparent vehicles, the IRS "looks through" the vehicle to the underlying investor to determine what tax is due. Tax-transparent vehicles enable pension plans to take advantage of pooling while paying the same tax they would if they invested directly in the marketplace.
Supporting these new tax-transparent vehicles presents technical challenges for the custodian and fund administrator. The custody, fund accounting, and securities lending system must be modified to support the features of tax transparency. Northern Trust has developed systems and processes to support these tax-transparent vehicles and has applied for a patent to protect this intellectual property.