DWP consultation on draft legislation to extend CDC provision to whole-life unconnected multiple employer schemes and other related provisions

Background

The DWP has issued a consultation on draft legislation to extend CDC provision to whole-life unconnected multiple employer schemes and other related provisions.

Responses to specific consultation questions and related comments

We welcome the opportunity to respond to this consultation. In addition to answering specific consultation questions which are pertinent to our practice, or which we believe could give rise to difficulties in practice for our clients, we have provided some initial general comments.

General comments

We understand and appreciate the enormous effort that has gone into this consultation – setting out the background to the draft regulations, providing clear explanation as to the intention behind various provisions and producing the Keeling Schedules have all made responding to the consultation easier and, as a result, we hope that you receive some valuable feedback from the industry. We can see that a lot of thought has gone into finding the balance between creating a regime that is commercially viable, whilst also protecting members.

Cross over with the DC Master Trust regime

As the new unconnected multi-employer CDC scheme and the DC Master Trust regimes will differ (for good reasons) it would be helpful to understand how the DWP sees the two regimes working together in practice. We expect some DC Master Trust providers could be interested in offering unconnected multi-employer CDC schemes but they would need to consider how they could meet both sets of requirements. For example, would a provider need a separate DC Master Trust and a CDC Master Trust, or could a single Master Trust be authorised under both regimes, eg with a DC section and a separate CDC section? If the latter, would one regime take priority over the other? As it will be important for providers to have confidence in the framework from the outset if they are to invest significant time and resources in creating their propositions for the DC market, we suggest this is covered in the initial legislation rather than in the revised CDC code of practice, which we imagine would follow at a later date.

Single scheme proprietor

We note the unconnected multi-employer CDC schemes will need to have a single “scheme proprietor”. This is a point of difference from the DC Master Trust framework concepts of “scheme funder” and “scheme strategists”. In addition, we note that this extends to a requirement for the scheme proprietor to finance the scheme in certain circumstances – in contrast to DC Master Trusts which can operate without a “scheme funder”. We can understand the basis for this difference but if DC Master Trust providers are the most likely candidates for setting up commercial CDC schemes such difference in approach will need careful explanation, to avoid creating unnecessary barriers to market entry.

Trustee duties

As any unconnected multi-employer CDC scheme will be an occupational trust-based pension scheme, any proposed designs will need to be consistent with the overriding duties of trustees, including to act impartially between members and to treat members fairly.

We believe the code should explicitly reference the importance of trustee duties, as it is not always possible to answer a question or make a decision by simply checking what statute or regulatory materials provide. It is often the case that trustees need to apply trust law principles when making decisions, and given difficult questions could arise around fairness and intergenerational matters that is even more likely to happen in unconnected multi-employer CDC schemes. Similarly, their overriding trust law duties will apply when considering how much flexibility to allow within the same section of a scheme, for example when making decisions about offering different accrual rates, and it is important to consider how that would work in practice if trustees were to have any discretions or powers in respect of that flexibility.

Scheme or section?

Given the nature of unconnected multi-employer CDC schemes, including (i) intergenerational considerations, (ii) the possibility of different accrual rates within the same section, and (iii) that the employers are entirely independent from each other, there needs to be clarity in terms of each requirement and whether it applies (i) to the scheme as a whole, (iii) section by section or (iii) to each employer.

Reliance on the code of practice

There are several areas where the detail is to be set out in the revised CDC code of practice eg how trustees are to evidence that they meet the financial sustainability criterion (para 69) and how trustees are to evidence how they are not prevented from continuing the scheme as a closed scheme (para 113). Whilst we can see the advantages of putting the detail in a code, rather than in the legislation itself, in certain situations, not seeing the proposed wording of the code alongside the proposed legislation makes it difficult to comment on the proposed approach as a whole.

Responses to specific questions

Question 1: Do you think draft regulation 25 delivers the policy intent for the opening of a new section for unconnected multiple employer CDC schemes? [para 13 to 17]

Yes – regulation 25 sets out a new trigger for creating a new section for unconnected multi-employer schemes, very broadly, where there are “materially different” rates / amounts / adjustments to benefits due to a change in the investment strategy. The provision cross refers to the viability report, in which trustees have to explain what changes to investment strategy the trustees consider would result in “materially different” rates etc (para 9(1)(c) of Schedule 2 to the Regs).

Trustees will need guidance as to what to consider in their viability report on this point, with sufficient clarity as to what level of differences could be permitted within the same section. This will need to strike the balance between allowing the sections to become large enough to benefit from economies of scale so they are commercially viable, but also ensuring that trustees can meet their overriding duties, including to act impartially between members and treating members fairly (see general comments above).

It is also not clear what advice trustees should take when considering what changes to investment strategy would result in “materially different” rates (and so on), as, while regulation 31 requires actuarial advice in relation to the viability report, it doesn’t seem to extend to this particular point.

Question 2: Do you think the definition of connected in draft regulation 22 can work effectively to establish whether a scheme is a single or connected employer CDC scheme or an unconnected multiple employer CDC scheme? [para 18 to 21]

Yes, and we agree with the suggested approach of using the existing definition from the DC Master Trust regime.

Question 3: Do you have any comments on the draft regulations on the fit and proper person requirements? [para 26 to 36]

We agree with the proposed approach of using the existing fit and proper persons test in Schedule 1 of the Pension Schemes Act 2021. We also agree with the proposal to use the “expertise and competence” limb (taken from “scheme strategist” in the DC Master Trust regime) for the scheme proprietor, any person who promotes or markets the scheme and the chief financial officer.

The reference to “a strategic, executive or management role” in the concept of “core functions” (in regulation 29(4)) is rather widely drafted. It would be helpful if TPR could provide further detail as to who it expects to be caught by this definition in the revised code.

Question 4: Do you agree with the functions we have identified for the role of the Chief Investment Officer? [para 31 to 35]

Yes the suggested functions of the chief investment officer seem appropriate for such a role. There are some aspects of the role that may overlap with trustees’ investment duties, so if the wider “expertise and competence” limb is going to apply to that role, but not to trustees, then care will be needed in drafting to ensure that trustees aren’t inadvertently caught by the term.

Question 6: Do you have any comments on the drafting of the actuarial equivalence test? Is it clear that the scheme actuary must use the methods and assumptions used in the most recently completed valuation to satisfy the test? [para 55 to 62]

We will leave any detailed commentary on this section to the actuaries but from a non-actuarial perspective, the “employer level” actuarial equivalence test seems a much harder concept to explain to members, in what is an already complex benefit structure.

Question 7: Do you have any comments on the draft regulations on financial sustainability? [para 63 to 83]

Business plan

We welcome the requirement for the “scheme proprietor” to prepare a business plan and agree that they are the appropriate entity to be responsible for the plan. We note that new section 14A(5) introduces a requirement for the trustees to “approve” the business plan (and any revised business plan). Whilst we can see the importance of the trustees, who are ultimately responsible for running the scheme and ensuring members’ benefits are paid out, understanding and being on board with the business plan, we are concerned about:

whether it is appropriate for trustees to “approve” all parts of the business plan (eg the “overall competence of the scheme proprietor” (para 23 of Schedule 1B to the Pension Schemes Act 2021)
the level of detail that trustees will be expected to check (eg on the key financial information) before they can give their approval
what will be in the code, and whether these will be areas that trustees can “approve” and how they should go about approving them
what is the consequence if trustees do not approve the business plan (or more likely, do not approve any revisions to the plan) – is it expected that they just work things through with the scheme proprietor?
what are the consequences for trustees if there is something in the business plan that turns out to be wrong?

We note that the scheme proprietor is expected to confirm that the business gives a “true and fair presentation of the matters to which it relates” but the trustees only have to approve it (para 5 of Schedule 1B) – does this mean that there is no expectation for trustees to “look behind” the information given to them by the scheme proprietor?

Question 8: Do you have any comments on the draft regulations on promotion or marketing? [para 84 to 93]

We agree with the principle that there needs to be great care around promotion and marketing of CDC schemes, and the general approach taken here. Was there a particular reason to use the approach of not promoting or marketing which is “unclear or misleading”, rather than the well-established FCA principle of communicating in a way which is “clear, fair and not misleading”? We wonder if there could be cause for disagreement as to whether something is clear and not misleading, but could still be unfair?

We are concerned that there doesn’t appear to be a definition of “promotion and marketing”, which means there is no clear line between when a communication is simply providing information about a scheme, and when it is going further ie straying into “promotion and marketing”. It appears that not all provision of information is expected to fall under this heading, as paragraph 87 explains that schemes with a fixed pool of employers may not carry out this [promotion and marketing] activity. However, these schemes (and the employers) will need to explain how a scheme works to employees, so it is vital that trustees and employers understand what they can provide without crossing into promotion or marketing.

Question 9: Are the draft regulations clear that a trustee’s ability to pursue continuity option 3 must not be unduly constrained or fettered and how this would be evidenced to the Regulator? [para 106 to 113]

We agree that trustees of these schemes should have an option to continue to operate as a closed scheme (continuity option 3) where it is actuarially viable and where permitted by legislation. However, we are concerned that the proposed test, ie of trustees “not being prevented” from pursuing continuity option 3 is too wide, making it hard for trustees to give that assurance. As trustees will only ever be able to exercise such a power where it is in line with their overriding trustee duties (see general comments), there may be cases where there are no restrictions in the scheme rules but the specific circumstances may mean that it would not be in line with their trustee duties to pursue continuity option 3.

Under new section 9(3)(cc)(iv) (inserted by regulation 5), TPR would be required to decide if it is satisfied that “the trustees will not be prevented from pursuing continuity option 3 if they consider it appropriate to do so”. In turn, regulation 27(7) requires the application for authorisation to include an explanation from the trustees as to “why they consider” that they wouldn’t be prevented from pursuing continuity option 3, including setting out whether they are required to:

obtain the consent of any person
consult with anyone other than employers, the scheme proprietor and members of the scheme
follow any other process.

We can see that requiring another person’s consent would prevent option 3, but it is not clear when an extensive decision-making process could “tip over” into trustees being prevented from pursuing continuity option 3, and when a consultation requirement could be treated as a restriction. It would be easier for the trustees to be able to confirm that there is no requirement in the scheme rules for another person to have to agree to option 3, and that they have not entered into any agreement outside the rules requiring consent. However, for anything else, we feel that TPR needs to set out clearly what the parameters are in the legislation itself, rather than just in the revised CDC code, as suggested in paragraph 113.

Question 10: Are the draft regulations clear on how valuation and benefit adjustments should happen? [para 114 to 123]

From a non-actuarial perspective, the proposed adjustments seem sensible and appear to have at their heart one of the key principles behind CDC schemes, ie that they operate in a way that avoid bias in favour of any group or cohort of members.

Question 11: Do you think that the significant events listed in draft regulation 44 will provide the information the Regulator needs or are there other significant events that should be added?

Yes – the list seems comprehensive and we agree that it should cover scheme proprietor, anyone who promotes or markets the scheme and the chief financial officer (and the chief investment officer, to the extent that role is built into the legislation).

Question 12: Do you have any comments on the draft regulations that provide for ongoing supervision of unconnected multiple employer CDC schemes? [para 124 to 159]

Not at this stage.

Question 13: Do you agree with the changes in Part 6 [consequential amendments] of the draft regulations?

We’ve not looked at these in any detail but listing the other areas of legislation where you decided no amendments were necessary was helpful, as it demonstrated that detailed thought has gone into this exercise.

Question 19: Do you have a) any comments on the impact of our draft regulations on protected groups and/or how any negative effects may be mitigated? b) any other comments about any of our draft regulations

Automatic enrolment

When employers are looking at whether CDC is a viable option for them, one consideration would be how it satisfies their automatic enrolment obligations. To this end, we note that there is no automatic alternative arrangement available for employers to use to meet their automatic enrolment obligations if the CDC scheme can no longer accept contributions. This could put some potential employers off CDC as an option. However, if employers and providers are comfortable that alternative offerings in the market mean that an alternative can be found quickly, and can be implemented smoothly and cost effectively such that employees and members won’t be disadvantaged and employers don’t have a window where they are at risk of not meeting automatic enrolment obligations, then this may not be an issue in practice.

Commercial vs industry wide (not for profit)

We note that you have decided to take the same approach to both commercial unconnected multi-employer schemes, as well as not-for-profit industry wide schemes. We will be interested to see how this affects potential take up but will leave it to those affected to comment on this.