In a dramatic move potentially impacting on a number of UK pension schemes, the Government has this month announced the removal of certain exemptions to the employer related investment regime. It may come as a shock to many trustees and managers that the changes relating to collective investment schemes take effect at such short notice (with effect from 23 September 2010), despite only being announced earlier this month. The type of investments constituting a collective investment scheme would include unit trust schemes, limited partnerships and open ended investment companies (OEICs).

Some schemes will be required to take immediate action to review their investments and even those schemes who do not hold the types of investments falling within the new restrictions may need to prioritise putting in place new monitoring processes to ensure future breaches are avoided. Repercussions for failure to comply with the restrictions include both fines and criminal sanctions. Details of the removal of this exemption and other changes also taking effect at the same time are outlined below.

Background to restrictions on employer related investments

There are restrictions set out in the Pensions Act 1995 (section 40) on the extent to which the trustees of occupational pension schemes may make investments that are connected with employers sponsoring or participating in the scheme. In most cases, trustees must not make investments of more than 5% of the current market value of the scheme's assets in employer-related investments. (Please note: the rules are slightly different for multi-employer schemes, for example, in a sectionalised scheme, and we can provide tailored advice if required.) Whilst restrictions on employer related investments are not new, the legislative changes that came into force on 23 September remove several easements that applied to UK pension schemes.

Why have these changes been implemented?

The need for compliance with a 2003 European Parliament and Council Directive (on the activities and supervision of institutions for occupational retirement provision) known as the IORP Directive has led to these changes being implemented through secondary legislation in the UK. As mentioned above, UK legislation has been in place for many years providing for restrictions on employer related investments in most circumstances, but there were exceptions in place for investments in certain collective investment schemes and for pension schemes that exceeded the employer-related investment limits before 6 April 1997. These exceptions were possible because, up until this point, the UK has taken advantage of provisions permitting the full application of the IORP Directive to be postponed until this month - from 23 September 2010, however, the terms of the IORP Directive must be fully transposed into UK law.

Although it has been known for some time that certain changes would be introduced this month, the pensions industry has been taken by surprise by the extent of the loss of exemptions with some commentators believing that the UK Government has actually gone further than necessary to comply with the Directive when it comes to collective investment schemes. As recently as April last year, the Department of Work and Pensions (DWP) decided not to implement proposals to remove this exemption on collective investments and although no promise was made to continue this exemption indefinitely, it was certainly not anticipated by many in the industry that changes would be introduced at such short notice. We are aware that approaches to the DWP may already have been made by some in the pensions industry, highlighting their concerns about the loss of the collective investment exemption which some consider to be overly restrictive.

 What is the impact of the loss of exemption relating to collective investment schemes?

The loss of the collective investment exemption will be met with concern by trustees and employers who must urgently take steps (if they have not already done so) to review their scheme investments to ensure they are not in breach of the 5% employer related investment limit. We understand the Pensions Regulator is considering the issue of appropriate monitoring of employer related investments by trustees and that either a statement or guidance is likely to be issued in the next few months. Although this information is expected before the end of the year, it is not known precisely when it will become available. It is also not known how strictly the Regulator plans to enforce the new legislative requirements in the case of a relatively minor or inadvertent breach. The consequences for trustees whose scheme knowingly invests in contravention of the rules could, however, be serious, with potential for imposition of a fine or period of imprisonment.

In the meantime, pending the publication of advice on what constitutes appropriate monitoring of collective investment schemes, it would be advisable for all scheme trustees to take the following steps:

  • Put in place a monitoring system, perhaps delegated to an investment sub-committee, to try to ensure that breaches are avoided. There may be practical difficulties for schemes in ensuring compliance in relation to collective investments if, for example, they have indirect holdings in pooled investment products;
  • Keep a clear line of communication open with the scheme investment managers to help prevent breaches for any collective investments; and
  • Consider whether there is a need to review and amend the terms of the scheme's investment management agreement. Ultimately, the investment manager will look to the trustees for up-do-date information on the employer's corporate structure in order to prevent a breach and this is something the trustees will need to bear in mind.  

We will keep you updated once the Regulator's statement or guidance becomes available.

What other changes are being introduced this month?

Other changes in relation to employer related investments took effect on 23 September 2010, but unlike the last minute changes on collective investments, these other changes were included in legislation published last year. These other changes involve the removal of exemptions relating to additional voluntary contributions, investment in certain qualifying insurance policies and investment in authorised bank and building society accounts.