The final version of the charges cap regulations were published last week and are due to come into force on 6 April. Broadly, they will impose a 0.75%  cap on charges in money purchase default arrangements. But the regulations give an unexpectedly  wide meaning to “default arrangement” in this context, and they will in fact apply to investment  options that one wouldn’t normally think of as default funds. Trustees of all schemes where money  purchase contributions are still being accepted should consider whether they need to take urgent  steps in order to comply.

The charges cap only applies to “qualifying schemes”, i.e. schemes where money purchase contributions are still being accepted, where the employer’s  staging date for automatic enrolment has arrived, and the employer is using the scheme to meet its  automatic enrolment duties in relation to the scheme’s active members.

Additionally, the charges cap is not intended to apply to AVC funds in DB schemes unless the same  funds are also made available to members of a money purchase qualifying scheme used by the same employer for automatic enrolment purposes.

The charges cap and its implications

If contributions are paid after 6 April 20151 to an investment option which counts as a “default  arrangement”, the charges cap applies to all money invested in it (past and future). This means  that the charging structure must be either a single charge structure (where charges are calculated  solely by reference to the value of the member’s rights and do not exceed 0.75% a year), or a  combination charge structure (based partly on the value of the member’s rights and partly on either  a f lat fee or a percentage charge on new contributions; the regulations contain detailed rules  setting out how the cap applies to combination charge structures).

If a fund is a “default arrangement” in relation to an employer and accepts contributions on or after 6 April 2015, or the employer’s later staging date, the regulations will treat it as a default fund in relation to that employer forever, even if members stop contributing to it or if it stops being used on a default basis.

“Default arrangements”

The crucial points here are that a “default arrangement” includes things that one wouldn’t normally  think of as a default fund, and that the charges cap will apply to all types of default arrangement.

The definition does include default funds in the traditional sense, i.e. a fund or funds into which  new joiners’ contributions are paid automatically unless the member expressly chooses a different  fund.

But the charges cap will also apply:

  • (if there is no default fund in that traditional sense) to any investment option which is  accepting new contributions in respect of 80% or more of the active members on 6 April 2015 (or the  staging date if later), even if those members have made a specific choice to invest in it,2 and
  • to any other fund which accepts new contributions in respect of active members on or after 6  April 2015 (or the later staging date), without all those members having expressed an active choice  to contribute to it.

The mapping and white-labelling problem

The last limb of the definition will catch funds to which contributions are paid following a  “mapping” exercise. Mapping occurs when trustees change the fund range available in their scheme,  and members who contributed to funds that are being withdrawn are automatically transferred  (“mapped”) into a similar replacement fund unless they actively choose an alternative fund.

Members who did not actively choose an alternative fund under a mapping exercise have not expressed  an active investment choice: they moved into the replacement fund by default. If contributions are  still being paid to the replacement fund on or after 6 April 2015 (or the later staging date), and  the members concerned have still not expressly chosen that option, then the replacement funds will  count as “default arrangements”. The charges cap will apply to them, just as it would to a  traditional default fund.

The same issue may arise where a scheme offers “white-labelled” investment options, in other words  where members choose the generic type of fund they want their contributions to be invested in, but  others can decide from time to time which particular fund is used behind that “wrapper”. Whether  the same issue arises will depend on the way that the investment option is structured.

What should trustees do?

Where the charges cap applies to an arrangement, trustees must either:

  1. satisfy themselves that the charges in the arrangement are below the cap (or arrange for them  to be reduced below it); or
  2.  from 6 April 2015 (or the later staging date) divert contributions to an alternative  arrangement where the charges are below the cap, except where, before that date, an active member  has expressly chosen that contributions should continue to be allocated to the current arrangement.

Where option 1 is not available, trustees should write to the affected members and give them the  choice of confirming in writing that they wish to remain in the higher charging arrangement or (if  they fail to confirm by an appropriate deadline) having their future contributions moved by default  to a lower charging arrangement. However, scheme rules will need to be checked to ensure that they allow this approach.

As the charges cap comes into force on 6 April 2015, trustees have very limited time to run this communications exercise (bearing in mind that a  decision will need to be taken first about what the appropriate lower-charging vehicle should be).  They should therefore make a decision on the course of action they plan to take as a matter of  urgency.

While the regulations do contain some limited easements for trustees who have used their best  endeavours to comply with the law, trustees will not be able to rely on them unless they really  have taken  every step available to them to comply before the 6 April deadline: trustees who don’t do their best to comply have not used their “best endeavours”.  This will be therefore at best only a partial solution.

What if trustees don’t take action?

Should the trustees fail to ensure that charges in their default arrangements are below the charges  cap from 6 April 2015, the Pensions Regulator has the power to issue compliance notices requiring  them to take corrective action and/or to issue penalty notices (i.e. fines).  In addition, members in the default arrangement could bring a claim against the trustees  for the financial loss caused to them by the trustees’ failure to comply with the charges cap.

In addition to the charges cap, the regulations impose a range of governance standards on money  purchase schemes. We will be writing separately about these.

The Regulator has published an essential guide for trustees on the new charges cap and governance standards.