In our April 2014 update, we reported on the DWP’s publication of “Better workplace pensions: Further measures for savers”. This command paper set out the Government’s proposed scheme governance measures which were intended both to complement the Budget 2014 provisions in respect of DC pension reforms and to bolster the implementation of auto-enrolment. The paper included consultation questions which sought views on the governance standards in personal and occupational DC schemes, the charging structures in schemes used for auto-enrolment and the independence requirements for master trusts.
On 17 October 2014, the DWP published its follow-up command paper “Better workplace pensions: Putting savers’ interests first”. This publication provides a response to the March 2014 consultation and launches a new consultation on the draft Occupational Pension Schemes (Charges and Governance) Regulations 2015.
The current consultation ends on 14 November 2014.
The essential elements of this paper are:
- the Government’s response to the March 2014 consultation on minimum governance standards. Comments are sought on the draft Occupational Pension Schemes (Charges and Governance) Regulations 2015, which will introduce the relevant requirements for occupational schemes, and which are included at Annex C. The Financial Conduct Authority (FCA) will place requirements on providers of contract-based schemes to establish Independent Governance Committees (IGCs) to oversee the governance standards in those arrangements;
- the Government’s response to the March consultation questions on the transparency of costs and charges. From April 2015, trustees and IGCs will be required to report on costs and charges to TPR or the FCA, as appropriate. Details will be published by each of these governing bodies in due course and TPR will update its DC governance Code of Practice accordingly;
- the Government’s proposed approach to DC scheme charges in both trust-based and contract-based arrangements. This is considered in more detail below;
- the proposals in relation to how TPR will oversee occupational DC schemes, with the annual scheme return incorporating additional questions to identify the chair of trustees, gather information on governance standards and confirm compliance with the charging measures. The FCA will produce its own proposals for consultation in relation to contract-based schemes; and
- an implementation timetable for the new regime.
Minimum governance standards
New quality standards will apply across all DC schemes and also in relation to the DC elements of non-DC schemes. IGCs, introduced under new FCA rules from April 2015, will oversee contract-based schemes. Trustees of occupational schemes will be required to design default arrangements in members’ interests and to keep them under regular review. Trustees will also be required to assess the value of costs and charges and their chairperson will be responsible for signing off an annual statement on how the governance standards and charge compliance measures have been met.
Occupational schemes will be prevented from requiring trustees to use particular service providers and this requirement will override any conflicting provisions of the scheme.
There will be additional requirements to strengthen the independent oversight of master trusts, which must have a minimum of three trustees, the majority of whom, including the chair, must be independent of any company providing advisory, administrative, investment or any other services to the trust. These independent trustees (or directors) are to be subject to limited term appointments of up to 5 years with a 10 year cumulative maximum. The process for trustee (or director) recruitment must be open and transparent, and trustee boards must encourage members to make known their views on scheme matters.
Costs and charges – AMDs and the charge cap on default funds
With auto-enrolment now in place for all but the smallest employers, the Government is keen to ensure that members who are enrolled in membership of a pension scheme are protected from high and unfair charges in default funds.
The Government intends that any employee member who contributes to a qualifying scheme (that is, a scheme which qualifies for use as an auto-enrolment scheme) after April 2016 must not be charged more when they cease contributing than they were as a contributing member. This practice, which until these proposed changes, has meant that deferred members often experience higher management charges than active member investors in the same fund, is known as the active member discount (AMD). From April 2015to April 2016, any AMD structures remaining in qualifying schemes must not charge members who cease contributing more than the default arrangement charge cap of 0.75 per cent.
However, the ban on AMDs will not prevent employers subsidising or paying the member-borne deductions of active members. The practice of employers paying charges on behalf of employees will not be banned, as long as the total charge level imposed is the same for contributing members and non-contributing members.
The intention is that a charge cap of 0.75 per cent (excluding transaction costs) for default funds will apply from the relevant date, which is the later of April 2015 and the date from which the scheme begins to be used as a qualifying scheme. The charge cap will continue to apply for as long as the member’s funds remain invested in the default arrangement, including where the individual becomes a deferred member and stops contributing.
Where a scheme is not being used as a qualifying scheme, it will not be subject to the charge cap.
Does the charge cap have retrospective effect?
As noted above, the 0.75 per cent cap on default fund charges will apply from the relevant date (April 2015 or the date from which the scheme is used for auto-enrolment purposes, whichever is later). However, it is possible that the charge cap could apply going forward to a default arrangement that is already in existence at the relevant date. This is because the term “default arrangement” covers:
- any arrangement into which workers’ contributions are directed without them making an active choice;
- an arrangement into which 80 per cent of the employer’s workers are actively contributing on the relevant date. A one-off assessment is carried out at the relevant date, and there is no ongoing requirement to monitor the proportion of active members, although the proportion is likely to change over time; and
- an arrangement into which 80 per cent of the employer’s workers who first made contributions after the relevant date are contributing. This will require trustees to monitor on an ongoing basis the proportions of members invested into the employer’s various funds to see whether any arrangement meets the default fund definition at any point.
The intention is that members of the same scheme in the same organisation enrolled in the same arrangement should also pay the same charges. Where members’ contributions have been redirected to a new fund without them making any active choice, this fund will be considered a default arrangement. However, where a member made a recent active choice to remain invested in a particular fund, despite an alternative cap-compliant fund being on offer, the fund in which they have chosen to remain invested is not classified as a default arrangement. If at any time in the three month period ending with the relevant date a charge cap-compliant default is offered to all the members who are actively contributing to such an arrangement, where a worker agrees in writing to remain in that arrangement (i.e. in the fund with higher charges than the cap) then it would not be subject to the cap.
The consultation paper provides detailed examples which clarify how these provisions apply in practice.
The proposed changes set out in the command paper will be the subject of one of our future briefings once the consultation is complete and the detail of the changes is finalised.
Following the spotlight on DC provision arising after the surprise focus in the Budget 2014, and the recent further announcement relating to inherited DC pension funds at the Conservative party conference, there is now clear momentum to improving the way these schemes are run, with the second command paper focusing chiefly on governance and administration rather than risk issues.
With DC pension benefits firmly positioned centre-stage since auto-enrolment commenced, the Government’s view is that member confidence in the way their schemes are managed is essential. Requirements for transparency and standardised mandatory disclosure should enable trustees, members and regulators to make easier comparisons between schemes, and this is to be welcomed.
The way that default funds have been defined in the draft regulations will require schemes to assess their current default offering to ensure it is compliant with the charge cap from the scheme’s relevant date. Where the current default fund is not charge cap compliant, action will be needed to notify members where it is necessary to put in place a different fund as a default arrangement.
In what feels like a recent whirlwind of change for DC pension provision, it is also good news that the new requirements are to be implemented in phases. The first wave of changes should be in place by 2015, followed by more in 2016. The level of the charging cap is then to be reviewed in 2017.
These intended changes, together with the governance controls proposed in IORP II, should be watched closely by all involved in DC pension provision.
View the Command Paper.