From April 2015, providers of workplace personal pensions will be required to establish and maintain independent governance committees (IGCs). This obligation will be set out in rules to be added to the Conduct of Business sourcebook (COBS) by the Financial Conduct Authority (FCA). IGCs will have a duty to act in the interest of scheme members and will operate independently of the relevant firm. Their role will be to assess and (where necessary) raise concerns about the value for money of such schemes.
This IGC obligation will only apply to personable pensions run by firms regulated under the financial services legislation—ie it does not apply to occupational pension schemes established by an employer (which in the private sector will have a board of trustees already). The FCA estimates that the cost of setting up IGC for larger firms will be £35,000–£465,000, with annual ongoing costs ranging from £135,000–£545,000. Employers that currently engage firms to provide personal pensions for their employees and the employees themselves may, in turn, indirectly bear the cost of these additional expenses in exchange for additional safeguards for their employees and deferred members.
The proposed rules governing IGCs were published by the FCA in August 2014 as part of Consultation Paper 14/16.1 The deadline for responses to this consultation is 10 October 2014. Final rules are due to be published by FCA in January 2015 and will come into force in April 2015.
This briefing provides an overview of the purpose of, and criteria for, establishing IGCs under the proposed rules and outlines which firms will need to comply with these requirements.
It also notes where equivalent reforms could be introduced for occupational pension schemes.
The introduction of IGCs follows increased government scrutiny into the governance of defined contribution pension schemes since the introduction of auto-enrolment— in particular, the Office of Fair Trading’s (OFT) market study in September 2013 and a new Code of Practice published by the Pensions Regulator in November 2013.2
Members of the Association of British Insurers (ABI) have already agreed with the OFT
to establish and maintain IGCs to assess and raise any concerns about the value for money of workplace personal pension schemes by mid-2014.3 The Law Commission endorsed the
proposals for IGCs in its report on fiduciary duties of investment intermediaries in June 2014.4
IGCs are independent governance committees whose purpose is to represent the interests of relevant policyholders (including both
active and deferred members) in
the firm’s relevant schemes.
The Department for Work and Pensions (DWP) proposed earlier in 2014 that trustee boards of occupational pension schemes should have equivalent powers and duties to report on costs and charges.5 The introduction of IGCs also mirrors a greater focus on the transparency and accountability of occupational pension schemes at a European level, illustrated most recently in the European Commission’s proposal for a revised version of the IORP Directive, published in March 2014.6
What are IGCs?
IGCs are independent governance committees whose purpose is to represent the interests of relevant policyholders (including both active and deferred members) in the firm’s relevant schemes.
Which providers will be caught?
Firms which operate workplace personal pension schemes will need to establish and maintain IGCs with terms of reference which satisfy FCA rules (COBS 19.5.5R). The FCA’s rules will apply to any provider operating a personal or stakeholder pension scheme with direct payment arrangements in place covering two or more employees of the same employer.
‘Direct payment arrangements’ are defined in the proposed rules as arrangements under which contributions are paid by or on behalf of an employer (including both employer and employee contributions) to a pension scheme.7
The FCA proposes that it will allow corporate groups with a number of providers, which fall within the scope of the rules, to operate a single IGC at group level. Accordingly,
a group could establish a single IGC to represent the interests of policyholders across several different personal pension schemes and different employers. However, the FCA has emphasised that it would expect each of the separate providers operating workplace personal pension schemes within the same corporate group to ensure that all relevant scheme members have their interests represented by an IGC.
The FCA’s consultation paper maintains that individual personal pensions, such as self- invested personal pension schemes for executives, should not be caught by the FCA’s rules, even where an employer has agreed to make or facilitate contributions to this. Accordingly, the FCA considers that firms will not be required to establish an IGC where schemes have been set up by individual members for their own benefit, and where employers contributing to the scheme were not involved in selecting the scheme. However, without an explicit exemption in the FCA’s rules, employers may have difficulty distinguishing in practice between ‘direct payment arrangements’ and any situations where the employer has two
or more employees who contribute to the same personal pension arrangement and where the employer has agreed to contribute to such an arrangement, even where such an arrangement has been selected by the employees independently from their employer.
Occupational pension schemes not caught
Occupational pension schemes are not regulated by the FCA and, accordingly, fall outside the scope of the proposed rules. However, DWP has announced that certain ‘minimum quality standards’ will be set for all pension schemes. Accordingly, while contract based schemes will meet these standards through IGCs, the DWP proposes that the trustee boards of occupational pension schemes should have equivalent powers and duties to report
on costs and charges.8
Composition of IGCs
The FCA requires that firms take reasonable steps to ensure that its IGC has sufficient collective expertise and experience to assess the value for money of workplace personal pension schemes. The proposed rules require IGCs to have a minimum of five members, the majority of whom must be independent, including an independent chair.
The proposed FCA rules provide that an IGC member is unlikely to be considered ‘independent’ if they:
- are an employee of the firm or of another company within the firm’s group or paid by them for any other role other than as IGC member, including participating in the firm’s share option or performance-related pay scheme;
- have been an employee of the firm or of another company within the firm’s group within the five years preceding his appointment to the IGC; or
- have, or have had within the three years preceding his appointment, a material business relationship of any description with the firm or with another company within the
firm’s group, either directly or indirectly.
The IGC will assess the ongoing value for money for relevant policyholders delivered by
relevant personal pension schemes.
The FCA considers that firms should be allowed to appoint corporate persons to an IGC (including as chair) provided that they are independent of the firm, noting that such persons could benefit IGCs through greater central resources and offering continuity.
The FCA proposes that independent IGC members be appointed for fixed terms of no longer than five years, with a cumulative maximum duration of 10 years, unless that member
is a corporate person (although the representative of any corporate member can only be appointed for up to 10 years).
The FCA does not currently propose to make any roles on IGC a controlled function (ie a function, relating to the carrying on of a regulated activity by a firm, which need to be carried out by persons approved by the FCA). However, the FCA notes in the consultation paper that this may change if the FCA determines in the future that IGC members (and IGC chairs in particular) are not suitably qualified.
Role and duties of IGCs
The FCA will not regulate IGCs directly, and therefore proposes that firms be required to make contractual arrangements for IGCs, with mandatory content to be included in IGCs’ terms of reference.
A firm must include, as a minimum, the following requirements in its terms of reference for an IGC:
- the IGC will act in the interests of relevant policyholders;
- the IGC will assess the ongoing value for money for relevant policyholders delivered by relevant personal pension schemes;
- the IGC will raise with the firm’s governing body any concerns it may have in relation to the value for money offered to relevant policyholders by a relevant scheme;
- the IGC will escalate concerns as appropriate where the firm has not, in the IGC’s opinion, addressed those concerns satisfactorily or at all (it is not clear from the proposed rules or the consultation paper what is meant by ‘appropriate’ in this context— eg whether this refers to ‘appropriate’ in an objective sense, or in the view of the IGC
or the FCA); and
- the Chair of the IGC will produce an annual report of the IGC’s findings (see information and disclosure requirements, below).
Acting in the interests of members
The proposed rules provide that an IGC is expected to act in the interests of relevant policy holders both individually and collectively, and to manage any conflicts between individual and collective interests. However, the proposed rules and consultation paper are somewhat vague about how granular the consideration of ‘individual’ interests needs to be, and the particular distinguishing factors which the IGC should consider—for instance, the age of the policyholders, or the value of their policies.
Ongoing value for money
When assessing whether personal pension schemes have delivered ongoing value for money for policyholders, IGCs will need to have particular regard to:
- whether the firm’s default investment strategies are designed in the interests of relevant policyholders (being members of workplace personal pension schemes) with a clear statement of aims, objective and structure appropriate for those relevant policyholders;
- whether the characteristics and net performance of investment strategies are regularly reviewed by the firm to ensure alignment with the interests of relevant policyholders and action taken to make any necessary changes;
- whether core scheme financial transactions are processed promptly and accurately;
- the levels of charges borne by relevant policyholders; and
- the direct and indirect costs incurred in relation to transactions and other activities in managing and investing the pension savings of relevant policyholders.
Firms will need to provide funds to ensure that IGCs receive sufficient administrative and analytical support.
Resources and information and disclosure requirements
Under the proposed rules, firms will be required to provide to the IGCs all information reasonably requested and ‘sufficient’ resources to enable IGCs to carry out its role (it is not clear whether the FCA intends that the sufficiency of resources be assessed on an objective basis, or in the opinion of the IGC or the FCA). This information will relate to both:
- the scheme and investment administration (including related charges), and
- the management and investment of pension assets and all related costs and charges (including transaction costs).
Firms may need to approach third parties, such as fund managers, to provide the latter information and establish mechanisms to share confidential and commercially sensitive information with IGCs, where required.
Firms will also need to provide funds to ensure that IGCs receive sufficient administrative and analytical support, including independent advice from investment advisers and lawyers where this is necessary and proportionate.
Each IGC chair will be required to produce an annual report, which will include:
- the IGC’s opinion on the value for money delivered by relevant schemes (taking into account the minimum requirements set out in the terms of reference);
- how the IGC has considered relevant policyholders’ interests;
- any concerns raised by the IGC with the firm’s governing body and the response received to those concerns;
- whether the membership of the IGC has sufficient expertise, experience and independence to act in relevant policyholders’ interests;
- details of each independent member of the IGC, including confirmation that the IGC considers these members to be independent; and
- details of the arrangements put in place by the firm to ensure that the views of relevant policyholders are directly represented to the IGC.
Firms will have a duty to ‘comply or explain’.
The firm will be responsible for making this report publicly available (eg through the firm’s website, or providing them on request to members and employers).
Firms will have a duty to ‘comply or explain’—that is, they will need to address any concerns raised by the IGC or explain in writing to IGCs why they do not intend to do so. The IGC chair may consider that such explanations would need to be notified to relevant policyholders and employers and made public (for instance in the annual report), or escalate concerns to the FCA.
In order to minimise the potential for conflicts of interest arising, the FCA agreed with DWP proposals that the appointment process for IGCs must be open and transparent.
The consultation paper proposes that firms should be able to meet this requirement by using an external search consultancy or open advertising to appoint independent members, including the IGC chair.
The FCA rejected the possibility of requiring scheme members electing IGC members directly to represent their interests, but states that it would encourage firms to consider how to involve scheme members in future appointments of IGC members.
Indemnification of IGC members
The Law Commission recommended that pension providers should be obliged to indemnify members of an IGC against liability for breach of its duty to act in the best interests of scheme members. The FCA currently proposes that while firms should consider indemnifying IGC members, this is not a requirement. Nevertheless, potential applicants to IGCs are likely to seek an indemnity, and firms may have difficulty attracting candidates with appropriate experience and encouraging them to participate actively in the affairs of the IGC if they
do not provide an indemnity.
Alternative arrangements: governance advisory arrangements
The proposed rules permit certain firms to establish a governance advisory arrangement (GAA) as an alternative to an IGC where they decide that it would be proportionate to do so, having regard to the size and complexity of the schemes they operate.
A GAA would involve the firm appointing another independent firm to establish a committee to take on their IGC responsibilities and represent the interests of relevant policyholders.
The firm must ensure that the GAA is established on terms that ensure its independence and meet the mandatory requirements in the terms of reference for an IGC. A third party may provide GAAs to multiple firms, and thereby maximise economies of scale.
The proposed rules do not specify a threshold for determining whether a GAA would be appropriate, but provide that firms should consider the following factors when considering the size of the scheme:
- the number of relevant policyholders in relevant schemes;
- the funds under management in relevant schemes; and
- the number of employers contributing to relevant schemes.
The August 2014 FCA consultation paper notes that a GAA may be considered appropriate for firms with less than a 5 per cent market share on two or more of these measures.
The proposed rules also provide that the following features might indicate complex schemes:
- schemes that are operated on multiple IT systems;
- schemes that have multiple charging structures;
- schemes that offer a with-profits fund; and
- the firm offers relevant policyholders access to investment funds it operates or which are operated by an entity with the same ownership.
The new requirements may appear familiar to firms which operate a with-profits fund.
Comparison to with-profits committees
The new requirements may appear familiar to firms which operate a with-profits fund. Such firms are required, in relation to each with-profits fund operated, to appoint either a with-profits committee or a with-profits advisory arrangement (but only if appropriate,
in the opinion of the firm’s governing body, having regard to the size, nature and complexity of the with-profits fund in question). The with-profits committee or advisory arrangement
is required to be independent and to operate in accordance with its terms of reference (which must be available to policyholders). The role of the with-profits committee or advisory arrangement is to act in an advisory capacity to inform the decision making of the firm’s board of directors ultimately with a view to ensuring that decisions made by the firm are fair for all with-profits policyholders. The with-profits committee or
advisory arrangement acts as a means by which the interests of with-profits policyholders are appropriately considered within a firm’s governance structure.
The FCA consultation paper notes that firms which currently operate with-profits committees may seek to appoint the non-executive members of such committees to the IGC. However, the FCA has warned that they consider that such appointments may present difficulties for the independence of the member, particularly if they are asked to review decision that they have made in other roles within the firm.
The DWP had announced previously that the introduction of IGCs is only an initial step towards increasing the transparency of workplace schemes. It proposes to introduce new requirements, following the introduction of IGCs, which make standardised disclosure of
all pension costs and charges to both trustees of occupational schemes and IGCs mandatory.
Preparation for April 2015
Firms which operate workplace personal or stakeholder pension schemes will need to assess whether they fall within the scope of the FCA’s proposed rules. If so, they will need to consider the following:
- whether they intend to respond to the FCA’s consultation (the deadline for responses is 10 October 2014);
- whether they will need to establish an IGC, or whether a GAA would be more appropriate given the size and complexity of the schemes it operates;
- if they are part of a corporate group which includes more than one firm within the scope of the FCA’s rules, whether they will establish an IGC at group level;
- how they will recruit members (particularly independent members) to the IGC in an open and transparent manner (eg through appointing an external search consultancy or open advertising);
- whether they will indemnify IGC members against liability for breach of the duty to act in the best interests of scheme members;
- what resources they will need to provide to the IGC to ensure that it can carry out
its role, including making provision for the disclosure of confidential or commercially sensitive information; and
- whether the terms of reference for their IGC should reflect only the mandatory requirements in the FCA rules, or whether their IGC should have any additional responsibilities.
Employers which engage external firms to provide workplace personal or stakeholder pensions should confirm that their providers are taking steps to comply with the new regime, and how the additional costs of such compliance will be met. They should also consider whether they themselves would be equipped to establish similar processes in relation to any occupational pension schemes which they administer internally, if such requirements are introduced.