Employer Related Investments: TPR’s Statement

Introduction

TPR has today published a statement on the self investment restrictions that apply to occupational pension schemes. The wording of parts of it may cause concern, if not alarm, amongst some trustees and employers. This alert explains why, if trustees and employers follow the right process, they can “keep calm and carry on”.

Key points

Set in part against the backdrop of recent changes in legislation, TPR’s statement is aimed at trustees, employers and their advisers involved in scheme funding negotiations and decisions about investment strategy.
Occupational pension schemes are subject to a general rule that no more than 5% of their assets can be invested in sponsoring employers.
Prior to 23 September 2010, there was a limited exception to the general rule where a scheme invested in certain types of collective investment scheme (CIS). This meant that trustees did not have to ‘look through’ to see whether the underlying assets of the CIS were invested in a sponsoring employer.
TPR’s statement sets out some considerations for trustees who, despite best efforts, find themselves at risk of being in breach of the complex legislative requirements.

The legal background

The ERI restrictions are set out in the Investment Regulations1 and extend not only to investments in the sponsoring employer, but also to investments in parties connected or associated with it.

Given the complicated drafting of the Investment Regulations, it can be difficult to pinpoint whether a particular arrangement with a sponsoring employer constitutes ERI. As a breach of the restrictions could give rise to civil or, rarely, criminal liability, legal advice is vital.

ERI and Collective Investment Schemes

Since 23 September, any investment made in a sponsoring employer or its associates via a CIS constitutes ERI.2 Certain types of CIS had previously been exempt.

TPR recognises that it may not be straightforward for some schemes to look through to the underlying holdings in a CIS to assess whether the ERI restrictions are being breached. It therefore stresses the need to have adequate internal controls in place aimed at reducing this risk. Its statement sets out some non-exhaustive examples as to how this could be achieved, including:

the CIS restricting its investments in any one issuer;
in combination with the above, the scheme restricting the percentage of assets it invests in the CIS; or
the CIS providing a regular report of investment holdings of 5% or more so that, if a sponsoring employer features in the report, the trustees can consider whether to adjust their investments.

ERI and scheme funding

Although TPR is clearly of the view that ‘cash is king’, it recognises that there has been an increase in alternative funding methods and that this trend is likely to continue in the current economic environment. TPR acknowledges that such “mechanisms can strengthen the employer covenant, or support the scheme, by providing the scheme with an enforceable legal arrangement which reduces risks to members”.

As the ERI restrictions are complex, TPR reinforces the need for both employers and trustees to take specialist legal advice when considering alternative funding mechanisms. In addition, TPR states that where “trustees agree to the use of such a mechanism, and in the absence of a court decision confirming that it does not involve ERI breaches, we expect trustees to recognise the risk that the agreement could, in the future, be proved to be in breach of ERI restrictions…[and if]…this risk could impact on the scheme, we will expect the agreement to include an ‘underpin’” (the idea being that this could provide alternative funding if needed).

TPR should be made aware of alternative funding structures, whether put in place as part of the normal valuation cycle or otherwise. It also expects details to be subsequently communicated in a “clear and transparent manner” to members (for example, in the summary funding statement).

TPR’s approach to ERI

Where there has been a potential breach of the ERI restrictions, TPR will take account of a number of factors before taking any action. Reassuringly, these include whether:

in the case of a funding mechanism, it provides demonstrably better protection to members’ benefits than available alternatives that do not carry risk of an ERI breach;
the mechanism reduces risk to the scheme or of there being a call on the PPF;
the trustees have received appropriate independent advice;
a breach was the result of a genuine mistake or misunderstanding and, where unintentional, it has been remedied within a reasonable time frame.

Conclusion

We anticipate that TPR’s statement will give rise to vigorous comment in the pensions industry, not least because of its reference to the extremely rarely used criminal sanctions (indeed, we are not aware of these ever having been used in relation to a pension scheme). But it does not change the existing law. So the statement should not be a cause of undue concern for trustees, whether they are grappling with their investment strategy or considering an employer proposal to put in place an alternative funding method.

The key is to seek specialist legal advice as to whether what is being put forward might breach ERI requirements and, if there is any room for doubt, to consider whether appropriate alternative funding is available as a backup.

If you have any questions or concerns about TPR’s statement, please speak to your usual Sackers’ contact.

1 The Occupational Pension Schemes (Investment) Regulations 2005
2 For more information, see our September 2010 News: “Investment Hot Topics“