There are two basic types of regulatory change applying to UK trust based pension plans.
The first are the essentials, the things that keep the system running, particularly where there is an identified problem. These are relative no-brainers in terms of the work that needs doing, compliance is its own reward and improves member outcomes which is a good result for trustees, employers and service providers.
The second tends to be more nuanced. These are perceived improvements to existing systems where there is clear debate to be had over whether a trustee or employer should take advantage of the relevant change. Unfortunately with pensions regulation being pensions regulation, there is also usually an associated mandatory requirement to report on how this improvement is being addressed which adds to the overall burden on stakeholders to no great improvement overall.
This divide is nicely illustrated by two sets of changes coming to the investment regulation of pension plans.
Procuring fiduciary management and investment consultancy services
The first change falls clearly into the first pot as evidenced by the 10 June 2019 Order from the Competition and Markets Authority (CMA). This followed an investigation into how competition in the investment consultancy (IC) and fiduciary management (FM) services provided to trust based plans was working.
The CMA's final report contained a number of recommendations to remove distortions that it had identified. In particular the CMA was concerned that trustees:
- showed a low level of engagement with IC and FM services, both in terms of procurement and in terms of monitoring results
- lacked clear and comparable data that would allow them to assess value for money, and
- were steered by incumbent IC providers to their own FM services, with marketing documents including details of both IC and FM services giving the impression of bundling and preventing competition from outside advisers on FM services in particular.
Limited competition meant that trustees were not getting the best outcome for members and, given the employers' interest in pension plan costs and returns, could be argued to be driving up their costs as well.
The CMA therefore proposed a number of changes. The Government's policy is to implement any CMA proposals within six months of being notified of a competition problem, provided that there is no solid policy reason not to do so, and the CMA's Order takes effect on 10 December 2019.
The DWP has introduced draft regulations to bring pensions law into line with the relevant parts of the Order. Under the regulations, trustees will need to:
- run a competitive tender with at least three participants if they propose to delegate 20% or more of their investment decisions to an FM
- run a new tender within five years if they have an existing FM delegation at this level, and
- set strategic objectives for investment consultants so that the trustees can measure their performance against those objectives.
Although the consultation on the draft regulations had just closed at the date of this article, it seems unlikely that anything will change for mainstream pension plans. The DWP has proposed a number of exemptions, for example, for pension plans where the plan funder is effectively a monopoly provider of IC and FM services to the plan (which is a general issue around master trusts, for instance, which cannot really be unpicked) and for public sector pension plans (for now). Guidance from the Pensions Regulator, already in draft, will follow for those trustees who have limited experience with tender processes.
The draft regulations are expected to take effect from 6 April 2020. However, trustees will need to ensure that they are complying with the new responsibilities from the date that the CMA Order comes into force.
Meanwhile IC/FM providers are expected to take steps to separate their marketing materials for IC/FM services, to put in place some very specific wording reminding trustees of the need to hold a tender and to separate fees for the two services so that they are easily identifiable and comparable and take a standardised form.
Changes to SIPs: financial and non-financial matters in investment decisions
The second set of changes falls squarely into 'improving existing processes' basket. The question is how far they reflect an actual improvement and how much they simply reiterate existing law whilst introducing yet more reporting requirements on trustees.
ESG (environmental, social and (corporate) governance) considerations have been the subject of a great deal of pensions soul searching over the past few years. How can trustees balance financial considerations against ethical ones and how far are ESG matters actually financial in nature?
Pressure in this area has increased as climate change, ethical investment and corporate governance concerns have moved up the news agenda. Trustees control a lot of 'spend', though the level of investment in UK equities, for example, has actually reduced as pension plans have moved into gilts to match liabilities.
Many trustees and advisers were not sure how this fitted with the trustees' basic fiduciary duties to members. For those pension plans which have a trust deed which expressly allows them to take these issues into account when setting their investment policies this is not a problem. Trustees can do what the trust says they can do. But what about those plans lacking a 'no unethical investing' clause? How can they handle ESG concerns?
Law Commission report: clarification needed
The Law Commission produced a report in 2016 which suggested that, given the confusion, clarification was needed. Having reviewed the limited case law on the topic, it came to the conclusion that the way to cut this Gordian knot was to divide the issues into two.
The first are financial, and include ESG issues on the basis that ESG issues link to long term financial success which is a key concern for pension plans given the nature of their liabilities. With the exception of good governance this is a brave assertion. If the economy has shown anything it has been that nice guys often (but not always) finish last, and many of the potential conceptual problems with a blanket acceptance of this statement are set out in a (draft) paper produced by Max M. Schanzenbach and Robert H Sitkoff which considers ESG investing against the stronger US injunction on fiduciaries to invest solely in the financial interest of members.
The second are non-financial matters, which the Commission suggested could be taken into account where:
- they would not have a substantial financial impact on returns (although what that means is not defined), and
- the trustees reasonably considered that the matter(s) in question also reflected the interests of the membership following appropriate soundings.
It is not clear how this moves us any great distance from where we were, but the Government is now erecting an edifice of regulation to give effect to the Law Commission's findings, hopefully with half an eye on the work that the EU is doing in this area, for example, through the proposed Taxonomy Regulation which is intended to establish a framework to facilitate sustainable investment.
Despite some concerns that this policy may be based on faulty assumptions and that it may not actually change much, the Government has implemented the proposals through a raft of new disclosure requirements, implementation of which are staggered over the next two years.
From 1 October 2019, all trustees will need to disclose via their pension plan's statement of investment principles (SIP):
- which financially material considerations they have taken into account when picking investments, including how these are taken into account in the selection, retention and realisation of investments
- the extent (if at all) to which non-financial matters are taken into account in the selection, retention and realisation of investments
- their policy in relation to undertaking engagement activities in respect of the investments, and
- their stewardship policy.
They will also need to explain, by 1 October 2020, how their arrangements with their asset managers and their monitoring of the same implement the trustees' policies in this area through length of engagement terms, incentivisation structures and portfolio turnover, having a view to the overall medium to long term investment horizons of the scheme.
Trustees of defined benefit plans will also need to publish their SIP on a public, free to access website by 1 October 2020. An "implementation statement" addendum, showing how they have applied the stewardship and engagement policies in the SIP in the previous year, must be published by 1 October 2021.
For defined contribution (DC) plan trustees with more than 100 members, similar obligations have been added with the same requirement to publish their SIP on a free, publicly available website but this has to be done by 1 October 2019.
By 1 October 2020, DC plans will also have to publish an implementation statement which shows:
- how, and the extent to which, the SIP has been followed during the year
- details of any SIP review conducted and any changes to the SIP following review, and
- where there has been no review, confirmation of when the last review was conducted.
So what does all this add?
The changes to IC/FM are to be welcomed. Competition in this area is likely to improve financial outcomes for members (and employers) and also to provide additional reassurance to trustees that they are getting, and can be shown to be getting, value for money which is a key governance point.
The investment changes add a number of layers of disclosure to an already complex area and do not actually appear to provide the clarity that the Law Commission suggested was necessary. Trustees may feel that they cannot be expected to heal the world whilst providing members with appropriate financial returns.
Where those two aims align it is sensible to say that the trustees should follow that route. However, it appears that there is a little "wishful thinking" going on if the Government believes that all members of a pension plan might have the same views on non-financial matters or will be happy to enjoy a penurious retirement in the sound knowledge that the trustees have the best interests of the planet at heart.