Investment Hot Topics

Introduction

• On 2 September, the DWP published new regulations which will have an impact on the self investment rules that apply to occupational pension schemes.
• Whilst Europe continues to grapple with the fallout from the credit crunch, it continues to flex its muscles when it comes to pensions.
• Two European directives are in the pipeline which could have an impact on any pension funds that have “alternative” investments or use derivatives.
• Our newsletter focuses on these changes as well as the recently published UK Stewardship Code.

In this Alert:

• Changes to the self investment rules – a new headache for some pension funds
• Alternative Investment Fund Managers (AIFM) Directive
• Central clearing of derivatives
• First UK Stewardship Code published

Changes to the self investment rules – a new headache for some pension funds

Occupational pension schemes are subject to a general rule that no more than 5 per cent of their assets can be invested in their sponsoring employers.

The Investment Regulations1 currently include an exemption for any investments by an operator of a collective investment scheme provided the operator is FSA authorised and the fund has a sufficiently wide investment base.

Despite representations from us and the pensions industry generally, the DWP have taken the view that in order to comply with the EU’s IORP Directive this exemption will be removed from 23 September 2010. Whilst not unexpected, this is disappointing news. It could give some pension funds a real headache as they try to work out how to ensure that they do not inadvertently breach the employer related investment rules.

There may be further guidance from the DWP but, in the meantime, those pension funds at risk of breaching the self investment limits and who have previously taken advantage of the collective investment scheme exemption will need to re-consider their position. In particular, trustees will need to look at what practical steps, if any, their fund managers and custodians can take to ensure that the trustees do not inadvertently fall foul of the revised regulations.

In addition, as expected, the current transitional provision which allows certain schemes to retain employer-related investments in excess of the 5 per cent limit will be removed from 23 September 2010.

Alternative Investment Fund Managers (AIFM) Directive

A new EU directive could significantly restrict the ability of UK pension schemes to invest in hedge funds, private equity funds and other alternative investment funds which do not comply with the directive.

Hopefully some of the more draconian provisions will be removed or watered down, although there is no guarantee of that. Under the current proposals:

• pension funds could effectively be banned from investing in funds which do not have EU authorised fund managers and which would not therefore meet the requirements of the AIFM Directive;
• EU based funds will be subjected to increased disclosure and transparency requirements;
• the scope of the funds intended to be caught by the AIFM is not clear – it could include any collective investment scheme (i.e. it may not simply cover hedge funds and private equity funds); and
• there will not necessarily be an exemption for current investment holdings once any transitional period has elapsed – this means that pension funds could effectively be forced to sell any fund holdings that are non AIFM compliant.

The European Commission and Parliament are currently attempting to hammer out a compromise with a view to the directive being adopted in the autumn. We will continue to monitor its development.

We would expect those funds with a significant proportion of their assets referable to EU investors to find a way to comply with the directive. However, this could involve re-structuring costs, which would in all likelihood be passed on to investors, and potential changes to investment strategy. There is also a concern that those non AIFM compliant funds with a small proportion of EU investors may decide to pull out of the EU.

Central clearing of derivatives

The European Commission has recently published a consultation on Derivative and Market Infrastructures. There are concerns that should these proposals be implemented they could result in increased costs and risks for those UK pension funds who use derivatives. It’s unclear whether or not these proposals will be implemented. We will continue to monitor its development.

First UK Stewardship Code published

On 2 July 2010, the FRC published the first Stewardship Code for institutional investors (including pension schemes). The Stewardship Code is designed to improve the quality of corporate governance through better dialogue between shareholders and company boards, and more transparency about the way in which investors oversee companies.

Institutional investors are encouraged to publish a statement on their website by the end of September 2010 on the extent to which they have complied with the Stewardship Code, and to notify the FRC when they have done so.

1The Occupational Pension Schemes (Investment) Regulations 2005