Although nine years have passed since the Myners' Principles were first introduced, concerns remain about investment governance in pensions. The Treasury and Department for Work and Pensions (DWP) sponsor a group known as the Investment Governance Group (IGG), which is now turning its attention to how investment governance might best apply to defined contribution (DC) schemes. The IGG has published draft guidance for consultation. Can employers afford to ignore guidance classed as "voluntary"?
It's understandable that there is increasing interest in how DC schemes are run. In the private sector, there are now more active members in DC schemes than in defined benefit arrangements. Our alerts on DC governance looked at the state of play as at last December, as well as the challenges ahead. The IGG's draft guidance forms another part of the jigsaw.
What the draft guidance says
The draft guidance is intended to cover both trust-based and contract-based DC arrangements. As guidance, the idea is that it will operate on a voluntary "comply or explain" basis (in other words, where a scheme doesn't comply it should explain why and justify its actions to members and their representatives). The IGG envisages everyone involved in setting up, running and advising private work-based DC schemes to assess their practice against the guidance, much like a checklist, although decision-makers are not expected to implement every element of 'best practice' all of the time. Comments on the draft guidance can be made until 5 May.
The best practice guidance is structured around six principles:
1. Clear roles and responsibilities for investment decision-making and governance
The IGG wants members to be told how responsibilities are allocated (including those responsibilities which members must take on for their own retirement planning). It also wants this information to be set out in the statement of investment principles, or in a similar document. The identification and management of any conflicts of interest is also highlighted, as is the stewardship code. The stewardship code (which, reportedly, has the support of Paul Myners) outlines how fund managers should vote, engage with company management and report back to the pension schemes appointing them. The IGG wants schemes to report on the implementation of that code to "interested parties", including members.
2. Effective decision-making
Effective decision-making includes having the relevant knowledge, understanding and skills to make decisions (which, of course, are likely to be based on experts' advice) and being "sufficiently familiar" with scheme documentation, as well as with regulatory requirements and guidance. "Sufficient" time and resources need to be made available for making investment governance decisions too. Doing a good job demands having enough knowledge and enough time to execute your duties and this makes sense in the context of something as important as a scheme's investments. The IGG also wants schemes to report to members or other interested parties on assessments looking at the effectiveness of the investment decision-making and governance process.
3. Appropriate investment options
Schemes are expected to take account of a range of member risk profiles, investment time horizons and members' requirements, including the likely structure of their benefits, especially as retirement approaches. Interestingly, there's an express requirement to ensure that investment options/funds have "appropriate names'"(this appears to be another way of saying "not misleading"). This makes sense, especially in the light of (for example) the far reach of sub-prime assets, which many investors had not appreciated. In terms of investment managers, decision-makers are expected to be consistent in their selection/removal by drawing up guidelines, as well as making sure that their fees are reasonable and competitive.
4. Appropriate default strategy
Decision-makers are expected to consider the overall objective of the default fund, including risk/return, members' needs and its position in relation to all the other investment options. Lifestyling is also in contemplation here, but it does present its own issues (please see our alerts on DC governance).
5. Effective performance assessment
Here, the IGG is looking for an "appropriate amount of time and resources" to be devoted to reviewing and managing each investment option. Presumably, what counts as appropriate has the potential to vary from scheme to scheme. If an investment option isn't performing well, and the expectation is that it won't perform well in the future, then the decision-maker should consider removing that option. Equally, the IGG wants the suitability of any investment wrapper to be monitored and, when appropriate, the decision-maker should be prepared to swap to other arrangements.
6. Clear and relevant communication with members
Although the IGG suggests that communications with members should be tailored to the members' expertise and that plain English be used, there's quite a bit of information that it wants members to have, such as regular performance reporting on the investment options available to them. There's a clear emphasis on helping members to understand risk and return, both in relation to the investments on offer and more generally. The IGG is also focusing on relevance, with schemes expected to give members investment information relevant to their term to retirement and circumstances.
Table of accountabilities
Sitting alongside the guidance (and, in essence, supplementing Principle 1) there's a draft table of accountabilities, setting out who should be responsible (employer, trustees or provider) at various key stages, namely: scheme initiation; scheme set-up and design; monitoring, review and change; and member communications. The table also, helpfully, sets out the related principles applicable to a range of sub-stages and recognises that whoever the decision-maker is, there will most likely be input from advisers and providers as well as (in the case of trustee decision-makers) input from the employer.
The end of the story?
There is a lot of common sense in the draft guidance and press reports indicate that it has been well-received. Knowing who is responsible for what and keeping a close eye on investments are the basic building blocks for investment governance which will already be in place within the better-run schemes. Although the draft guidance attempts to pin down each principle with fairly detailed 'best practice' expectations, the way in which schemes will implement those expectations is bound to vary. Thought needs to be given, for example, to how all of this fits in with knowing your membership.
There is a clear steer in the guidance towards giving members regular, and possibly very detailed, information. Any schemes deciding to take this fully on board may risk exposing their membership to information overload, regardless of the plain English wording used in each communication. Picking appropriate investment options and an appropriate default strategy also requires care. Is your range of risk profiles broad enough (how well do you know your membership, especially your deferreds)? Are your default arrangements sophisticated enough to adapt to a sufficiently diverse set of circumstances, making those arrangements best placed to meet your members' likely needs?
The voluntary "comply or explain" status of the guidance suggests that its impact is restricted to those DC arrangements sponsored by employers who are committed to governance. Indeed, many contract-based DC arrangements are set up without governance in mind and there is no law to force employers to go the extra mile. In the light of this, can employers minded to ignore the guidance afford to do so? There are several good reasons for the answer to that question to be "no". One reason is that sponsoring a well-run scheme enables staff to afford retirement and, consequently, a healthy level of staff turnover. Another aspect of the guidance is how it might be used by members. There is the possibility that disgruntled members will look to the guidance in support of a claim (for example, by presenting those aspects of the guidance relevant to the circumstances of the claim as benchmarks for minimum engagement, as opposed to best practice).
The draft guidance is certainly a useful indicator of what to aim for, but each scheme will need to decide for itself how to put this into practice in a way that isn't counterproductive. One starting point has to be getting to know your membership as well as possible. In short, this is the beginning of the story for those DC schemes focusing on their investment governance.