Proposed rules for independent governance committees – Sackers’ response to consultation

Background

The FCA is consulting on proposed rules for independent governance committees (IGCs) (CP14/16) in connection with current Government initiatives aimed at ensuring that all workplace pension schemes deliver value for money.

Under the FCA’s proposed rules, providers of workplace personal pension schemes will be required to set up and maintain IGCs. The IGCs will have a duty to act in the interests of scheme members and will operate independently of the firm.

General comments

We welcome the opportunity to comment on the FCA’s proposed rules for IGCs. Many of the proposed rules put forward by the FCA are workable and reflect procedures and processes which are already used effectively in the governance of trust-based schemes.

However, there are, in our view, some key issues which merit further consideration:

Indemnity

As we explain in more detail below, we are of the view that all IGC members should have the benefit of an indemnity. Not only would this help with recruitment, but it would help to put all members of an IGC (both those associated with the firm in question – who are likely to have the benefit of directors’ and officers’ liability insurance, and independent members – who may not have an equivalent insurance) on a more even footing.

Capacity

The timescale for getting IGCs up and running is very short. So that firms have IGCs in place ahead of April 2015, recruitment of IGC members is already underway. As such, appointments may not be carried out in a way that meets all the requirements of the FCA’s Policy Statement, which is not due to be published until January 2015. We therefore hope that the FCA will adopt a proportionate approach in its supervision of the first round of appointments.

Requirement to establish an IGC (Questions 2-6)

Deferred members

We agree with the FCA’s comments that deferred members of workplace personal pension schemes continue to need protection and therefore agree that they should be within the mandatory scope of IGCs.

Individual personal pensions

We are not convinced from the consultation that individual personal pensions which did not originate as workplace personal pensions should not also fall under the scope of IGCs. In reality, significant numbers of people using these arrangements will not be that financially sophisticated and we believe it would also be appropriate for IGCs to consider value for money in these arrangements. However, we appreciate there is a lot for IGCs to do in a short timeframe and it would be understandable if individual arrangements were not to come under IGCs in the first phase. We do not believe, however, that they should be taken out of the picture completely.

Firms required to establish an IGC

We welcome the FCA’s approach in support of workplace pension schemes that are used for automatic enrolment and appreciate the distinction drawn between those schemes which have been selected by an individual (which are likely to fall outside the scope of IGCs) and those which have been selected (or designated) by an employer for the purpose of providing workplace pension benefits. However, in our view, the number of members of such an arrangement (irrespective of whether direct payment arrangements are in place) is not necessarily indicative of the overall control of the arrangement. We therefore do not consider that this should be a determining factor as to whether IGC representation is required.

IGCs established at a group level

We agree with the FCA’s proposal that IGCs can be established at Group level.

Establishing and maintaining an IGC (Questions 7-15)

Independent members and chair

It is proposed that an IGC must have a majority of members who are independent of the firm. This should help IGCs to demonstrate that their decision making is fair and transparent, and ensure good levels of governance. Given the key role they will play, we also support the recommendation that IGC chairs be independent of the firm.

We note that it is unclear what legal personality an IGC board will have. We would suggest allowing an IGC to be established as a corporate entity. This would give IGCs the ability to take advantage of the protections from individual liability provided by company law.

Minimum size

In principle, we agree that requiring a minimum of five IGC members is likely to strike the right balance between burden on the firm and benefit to members.

We would expect schemes to take a proportionate approach in the selection and composition of their IGC and to have the ability to manage any transitions, such as a change in the composition of the IGC following a retirement, resignation or removal of a member. It would also be helpful to establish a quorum (for example, a simple majority of the IGC board), to ensure the smooth running of the IGC day-to-day.

Independence

Trustees of a mastertrust will have very similar responsibilities to those of IGC members, including a duty to act in the best interests of the scheme’s members and beneficiaries. We therefore agree with the comments that ICGs can benefit from the experience of individuals who also act as mastertrust trustees and, as such, support the modification of the definition of “independence” to allow trustees of a firm’s mastertrust to be independent IGC members.

Indemnification of IGC members

The consultation suggests that there should be no “requirement” on firms to indemnify individuals against liabilities incurred in their capacity as IGC members, but that firms will be able to choose to do so.

However, we support the Law Commission’s recommendation (referred to in the consultation), that pension providers should be obliged to indemnify members of the IGC against the liabilities incurred while fulfilling their duties as IGC members.

In our view, an important reason for requiring firms to provide an indemnity is to put all IGC members on the same footing. IGC members who are associated with the firm in question are likely to be covered by the firm’s directors’ and officers’ insurance policy. Independent IGC members may or may not have similar protection (this is likely to depend on whether they are set up in business as a professional trustee / IGC member) which could ultimately affect their willingness to make certain decisions and impede the effectiveness of the IGC. We believe that providing an indemnity will help firms to attract individuals to become members of the IGC of appropriate quality and in sufficient numbers.

IGC member behaviour may be affected if some members are less well protected than others. Similarly, permitting different levels of protection could put IGC members at a disadvantage when compared with pension scheme trustees, including trustees of mastertrusts.

(As an alternative to a firm providing an indemnity, it may be worth considering a form of compulsory insurance. If there is a concern about indemnity risk being placed with a provider, this would be a way of moving that risk away from the provider and into a wider market area. The exposure of the firm would then be limited to the payment of insurance premiums for such insurance cover.)

Approved persons

For the reasons outlined in the consultation paper, in particular the fact that the FCA’s proposed rules will set high standards for IGCs and the tight timetable for implementing them, we agree that it is not necessary at this stage to introduce a requirement for IGC members to be approved persons.

In addition, at the current time we believe it would narrow the field of applicants for IGCs too much, and potentially defeat the object of their independence, if they needed to be approved persons

Recruitment process

We agree that an open and transparent recruitment process, for example, using external adverts and/or a recruitment consultant, should help to mitigate the risk of potential conflicts of interest arising during this time. See also our general comment above regarding capacity.

Duration of appointments

The proposed five year terms (subject to a cumulative maximum of ten years) are reasonable, as they would give individuals sufficient time to know and understand a firm’s pension schemes and general background.

Having terms of office that are staggered will be important to ensure that, at any one time, there is sufficient knowledge and experience of a firm’s pension arrangements on the IGC board.

It would also be helpful to allow a certain amount of flexibility around the duration of IGC board appointments. For example, this would enable the board to manage a situation where the end of one individual’s term happens to coincide with the resignation or retirement of another.

Corporate persons as IGC members

We are seeing a growing trend towards the appointment of corporate trustees to the boards of trust based pension schemes, either as a sole appointment or as part of a larger trustee board. Professional trustees bring with them a high level of experience, expertise and professionalism, and it is to be expected that this trend will also apply to IGCs.

It is therefore reasonable, in our view, to permit the appointment of corporate persons to IGCs, including as IGC chair. We also consider that it would reasonable to leave the duration of corporate appointments unrestricted.

Terms of reference for an IGC (Questions 16-24)

Duty to assess value for money on an ongoing basis

One of the key functions of an IGC will be to consider the value for money received by individuals enrolled in default funds.

We agree that in some cases, it is likely to be difficult, impractical and not cost effective to assess the value for money for each employer’s scheme individually. However, it will still be important to review regularly the characteristics and net performance of all investment strategies available to scheme members.

While we agree that there should not be a mandatory approach to a value for money assessment, we consider that it would be helpful for IGCs if the FCA provided some general guiding principles.

We do have concerns that it will not be realistic in practice for IGCs to evaluate value for money for individual employer arrangements. We wonder, therefore, whether IGCs might focus on the value for money of particular investments / products and ensure that the providers communicate clearly to employers they ways in which these measure up to being value for money, hopefully enabling employers to pick investments that are suitable for their particular workforces. For example, an investment providing good capital protection and low volatility, but also low expectation of returns, is likely to need e.g. lower charges to be good value for money. But for investors for whom it is important to diversify growth assets in the hope of higher (but steady) returns, value may only be obtainable with e.g. higher charges (due to the blend of funds and greater administration requirements).

Scheme quality and minimum governance standards

As noted above, we consider that default investment strategies, the characteristics and net performance of investment strategies, as well as core scheme financial transactions will be key areas for IGCs to monitor regularly and review. We agree that review by IGCs of these aspects of scheme quality should be a minimum requirement.

However, the proposed scheme quality and minimum governance standards are, in our view, too widely drafted. If the policy intention is to provide for a consistent approach in assessing schemes so that they can be easily compared, use of a principles based approach with associated guidance, such as the Myners principles (which were subsequently built on by the Investment Governance Group), could provide an platform against which effective assessments can be made.

In a workplace pension arrangement, it will often be the employer that selects the investment strategy. Thought will need to be given as to how employers’ choices will be assessed and what, if any, action might be taken where an IGC considers the employer’s selection to be inappropriate.

There are other areas which will also be important for IGCs, such as scheme administration. It will also be increasingly important to focus on the retirement pipeline.

As the retirement savings market develops with newfound “freedom and choice”, IGCs will need to review communication strategies with members in the retirement pipeline. Given the range of choices that will be on offer to pension savers, clear information on their options (in particular the potential tax implications and relevant investment considerations) will need to be clearly signposted. In order to ensure that individuals can get value for money from their retirement savings, communication strategies will also need to extend beyond the current timescales proposed in conjunction with the Guidance Guarantee.

Costs and charges

We agree that IGCs will need to assess the level of charges born by scheme members, as well as all transaction and other costs (both direct and indirect).

Raising and escalating concerns

We also agree that, in the event that an IGC is unable to resolve concerns, having raised them with the relevant firm’s board, the IGC should be able to escalate those concerns to the FCA. It may (although not necessarily in all circumstances) be appropriate to inform the firm’s board of the IGC’s intention to approach the FCA, before any such approach is made to the FCA.

It may also be appropriate to inform members of developments in these circumstances. Thought will need to be given as to who would meet the cost of such communications.

Annual report

As the FCA notes, publication of an annual report by the IGC should help to increase transparency and accountability. It is also likely to facilitate comparison of the different schemes that are provided by different firms. As we note above, use of a principles based approach would help with comparison between schemes.

However, whilst we consider the publication of an annual report to be an important tool for IGCs, we do not agree that this needs to be the sole responsibility of the IGC Chair. Rather, we see it as a responsibility for the IGC board as a whole.

Priorities for IGCs

In the first year or so of operation, IGCs will need to consider carefully their priorities, as there will be a significant amount of work involved in getting up to speed with firms’ pension arrangements (including legacy schemes), in order to be in a position to assess value for money.

Ensuring effectiveness of IGCs (Questions 25-29)

Duty to provide information

It will be essential for an IGC to have access to a variety of information relating to the relevant firm(s) in order to carry out their duties. A duty on firms to provide reasonable information to the IGC is likely to facilitate this. What is “reasonable” will depend on the circumstances, however it would be helpful to all parties if there were guidelines as to what is expected here.

We agree that the requirement should be subject to the maintenance of mechanisms for protecting confidential and commercially sensitive information. Such practices are common between workplace pension trustee boards and sponsoring employers and include the use of confidentiality agreements between the parties.

Duty to provide sufficient resources

A duty on firms to provide sufficient resources to IGCs, in a form that is useful, will help to ensure that they can operate effectively. Without such an obligation, there is a risk that a firms may seek to control the IGC by means of the information that it chooses to share or withhold. Again, it will be helpful to all parties if guidance is available outlining what is likely to be reasonable in this regard.

Duty to ensure representation of member views

The NEST model may be an appropriate one to follow. Currently, NEST member panel vacancies are publicly advertised, with selection based on merit. For large schemes such as NEST, and many of the schemes that will be subject to IGC governance in 2015, using a member panel can be an effective way of ensuring that member views are appropriately represented. Such panels could include representatives of the different types of organisation that use the schemes, including SMEs and larger employers. An experienced member panel can also help ensure that the IGC is fully accountable.

The appointment process is also likely to be more efficient than attempting to appoint representatives of all employers concerned.

Duty to make annual report and terms of reference publicly available

Given that one of the aims behind the introduction of IGCs is to introduce greater transparency, we see no reason to prevent the IGC’s annual report and terms of reference from being publicly available.

“Comply or explain” duty

In order for the relationship between the IGC and the firm to operate effectively, it will be important for a firm to address any concerns brought to it by the IGC, or explain why it does not intend to do so.

There should also be a mechanism for pension scheme members to raise concerns about the IGC.

Proportionate alternative arrangements (Questions 30 & 31)

In principle, we welcome the proposals for governance advisory arrangements as an alternative to IGCs for firms that operate smaller and less complex workplace personal pension schemes. However, we do have a concern that it is not entirely clear who would be the appropriate bodies to set these up, and it may be helpful for the FCA to give more guidance on this to try to ensure appropriate arrangements are put in place.