IGG consultation on the investment governance of DC schemes: Sackers’ response

Background

The consultation proposals for best practice guidance relating to the investment governance of DC pension schemes, was published by the Investment Governance Group (IGG) on 10 February 2010 .

Given the increasing numbers of employees offered membership of DC schemes (both trust- and contract-based), it is essential that those involved in running such schemes have the necessary tools to enable good investment decision-making and governance practices.  To this end, we support the concept of practical guidance designed to assist trustees, providers, employers and advisers of DC pension schemes in this regard.

In this response:

• Aims of the guidance
• Distinguishing between trust and contract-based schemes
  
• Defining responsibilities
• Protection for decision makers
• Conflicts of interest
• Costs
  
• Conclusion
  

Aims of the guidance

The draft is described as best practice guidance.  However, the consultation document states that the principles “should be regarded in the same way as the HMT/DWP Principles of 2008 for DB schemes and so be adopted on a ‘comply or explain’ basis.”  As drafted, employers or trustees failing to comply would be required to explain why and to justify their actions to scheme members and their representatives.

This follows the approach taken from the main Myners principles.  The Myners principles codify best practice in investment decision-making but they remain voluntary.  Paragraph 1.1 of the response to Updating the Myners Principles stated that trustees are expected to “consider their applicability to their own fund and report on a ‘comply or explain’ basis how they have used them”, but it remains up to the individuals concerned how to apply them.

Many trustees will be familiar with this standard of compliance from TPR’s codes of practice (which have a statutory basis).  Section 90(5) of the Pensions Act 2004 also provides that a code of practice may be admissible in evidence in legal proceedings.  Guidance, (in the word of TPR), by contrast, is generally understood by the pensions industry to be just that – “to help improve understanding of work-based pension schemes and to promote good practice” as well as “to help trustees, employers and others understand what the law requires”.

If, therefore, it is intended that the level of compliance usually associated with codes of practice is to apply here, it would be helpful if that intention was expressed in unambiguous language, with the document setting out clear standards against which employers, trustees and others can “comply or explain”.  Whereas, if it is intended that the principles should in fact apply in the form of guidance, this approach could be reflected by using permissive language.

Distinguishing between trust and contract-based schemes

Our principal concern regarding the structure of the guidance is that the distinction between the requirements for trust- and contract-based schemes is insufficiently clear.  Greater clarity could be achieved by separating the information for different types of schemes into separate sections.  While some information is relevant to all DC schemes, there are necessarily greater obligations on those running trust-based schemes (as evidenced by the existing guidance and tools).

As drafted, there is a risk of the guidance implying that the duties of employers who choose to use contract-based DC schemes for their staff pension arrangements are greater than their actual legal obligations.  Should the Guidance be interpreted in this way (i.e. as imposing additional duties on employers in relation to contract-based schemes) this may ultimately act as a disincentive for employers to offer such schemes to their employees.

In the paragraphs below we examine some examples where users may find the guidance more accessible as a result of the separation of the provisions relating to trust- and contract-based schemes.

Defining responsibilities

Having selected a provider or investment manager in relation to a contract-based scheme, the employer will have delegated primary responsibility for the monitoring and review etc. of investment performance to such provider or manager.  These providers are subject to regulation by the FSA (as noted in the aims of the consultation document set out on page 8).  For the purpose of the guidance therefore, the employer’s responsibilities (as distinct from those of the provider) need to be delineated more clearly.

The ability to delegate investment matters is an important factor influencing whether employers select a contract-based pension arrangement over a trust-based one.  In a contract-based scheme, while employers may have a duty to periodically monitor the providers that they have selected in respect of their employees, they do not have the same responsibilities in law in relation to the performance of investment functions, as trustees do under the Pensions Act 1995 and trust law generally.  The guidance makes detailed reference to the role and responsibilities of decision makers.  But in contract-based schemes, these will, for the most part fall within the remit of the provider.  As such, employers are not currently under law obliged to duplicate these responsibilities and so care needs to be taken to ensure that the guidance reflects the current legal position.

Protection for decision makers

A further issue to consider is the level of protection afforded to those carrying out their investment duties.  Under section 34 of the Pensions Act 1995, provided the decision is delegated properly, trustees of trust schemes may be protected against responsibility for the act or default of any fund manager.  Similarly, there is often indemnity or insurance protection under the scheme rules.  This provides trustees who act in good faith with some legal protection in the event of DC scheme members bringing claims in relation to a DC scheme’s investment performance.  By contrast, there is no equivalent provision for employers in relation to contract-based schemes.  Consequently, employers may open themselves up to the risk of mis-selling claims, if they are required to take a greater role in selecting and monitoring DC scheme investments.

While the guidance focuses on the responsibilities of those choosing and monitoring investments, there is little guidance on the steps to be taken if the monitoring process highlights deficiencies in the investment process itself.  It would therefore be helpful if the guidance also covered the available options and steps to take in these circumstances.

Conflicts of interest

As TPR’s guidance on conflicts of interest in force at the date of the response makes clear, the management of conflicts is key to good scheme governance.  Trustees and others involved in the running of trust-based schemes will be familiar with issues relating to conflicts (and to TPR’s guidance on conflicts), but for those involved with contract-based schemes, it can be less obvious where conflicts may arise.  It would therefore be helpful if the guidance specifically defined what is meant in relation to conflicts in the context of contract-based arrangements.  Alternatively, it may be preferable for conflicts of interest to dealt with by the existing guidance.

Costs

In finalising the guidance, it will be important to bear in mind the costs associated with implementation of the governance practices which are suggested.  Following the Guidance will require additional resource, in terms of both personnel and funds, to meet the requirements which are outlined.  These costs will necessarily differ depending on the type of pension arrangement involved but may be disproportionate for smaller employers.

Conclusion

We support the IGG’s attempts to close the governance gap between trust-based and contract-based arrangements DC pension schemes.  Our primary concern, however, is that the guidance does not adequately reflect the current legal position of employers who provide their employees with access to contract-based schemes.  It needs to be clarified whether the intention is to “raise the bar” with regard to employer’s legal duties regarding contract-based DC schemes.  If so, then without corresponding “safe harbour” protections akin to those in place for trustees of trust-based DC schemes, employers may well decide not to continue to offer their own selected contract-based DC schemes with a subsequent flight to NEST.