Defined contribution investment: a changing landscape?

8 minute read
24 February 2014

The publication of the Law Commission report in October 2013 and the Pensions Regulator's DC Code of Practice and regulatory guidance in November 2013 indicates an increasing focus on defined contribution (DC) investment issues.

The Law Commission report looks at DC pension fund trustees' fiduciary duty to invest in the interests of beneficiaries and problems in the way this duty is applied in practice. The Regulator's DC Code of Practice sets out six principles which relate to making good investment decisions and good quality communications and to accountability for those decisions and communications.

The Law Commission Report

The Law Commission published a consultation on trustees' fiduciary duties last October, following the Kay Review which looked into the UK equity market. The report looks at pension fund trustees' fiduciary duty to invest in the interests of beneficiaries. The report considers the existing position under trust law and legislation and goes on to consider problems in the way in which fiduciary duties are applied in practice.

DC investment duties

Trust law: Investing in the interests of beneficiaries

Pension fund trustees have a duty to invest in the interests of beneficiaries of the pension scheme. This is a well-established principle derived from a range of trust law cases, but most notably Cowan v Scargill (1984) which clarified that trustees must invest so as to yield the best returns for beneficiaries judged in relation to the risk (putting aside the trustees' own personal interests and views).

Pensions legislation: investment powers and duties

In relation to occupational pension schemes, the investment decisions of pension fund trustees are governed by the Pension Acts 1995 and 2004, together with Regulations made under these Acts.

Trustees must invest pension fund assets "in the best interests of the beneficiaries" and in a "manner calculated to ensure the security, quality, liquidity and profitability of the portfolio as a whole". Trustees are also required to maintain a statement of investment principles. This sets out the basis on which the trustees plan to invest the scheme assets.

Do fiduciary duties work in practice for DC schemes?

The Law Commission report identified problems in the way fiduciary duties are applied in practice in DC pension schemes (both contract and trust based).


The Law Commission report comments that:

  • some single employer schemes are too small which means that trustees often lack the expertise and support to exercise their investment duties;
  • some "master" trusts may suffer conflicts of interest where trustees are appointed and paid by the pension provider; and
  • there are different regulators for trust and contract based DC schemes: trust based schemes are regulated by the Pensions Regulator and contract based schemes are regulated by the Financial Conduct Authority.

It concludes that, on their own, legal investment duties are insufficient to ensure that DC schemes work in the interests of members. Legal duties need to be embedded in an industry structure which provides the expertise and resources for good governance and duties must be enforced by efficient regulation.

The government shares the Law Commission's concerns over small schemes and master trusts. In the Department for Work and Pension's call for evidence (July 2013) it said that it would expect people managing a small occupational scheme to consider whether standards of governance and charges could be improved and, if so, whether the size of the scheme is a barrier in doing so.

In relation to master trusts, the government is working with the industry on an independently audited voluntary assurance framework which is due to be finalised this spring.

Fiduciary type duties in contract based schemes

The Law Commission says in its consultation paper that it is not currently clear how often providers of contract-based schemes are required to reassess investment strategies, nor when they should seek new information about their scheme members. The Law Commission's provisional view is that rules requiring contract-based pension providers to reassess the suitability of investment strategies over time should be clarified and strengthened.

The report notes that the Association of British Insurers has agreed to introduce independent governance committees embedded within insurance pension providers. The Law Commission's tentative view is that members of these committees should be subject to clear legal duties to act in the interests of members. In addition, pension providers should provide a full indemnity to members of these committees for any liabilities they incur.

This is a move towards a level playing field for contract and trust-based pension schemes. The government's aim is for members to achieve good member outcomes, no matter whether they are in a contract or trust based DC scheme. Many of the fiduciary duties that currently apply to trustees of occupational DC schemes are likely to apply in future to members of governance committees who are responsible for overseeing contract-based schemes.

Code of Practice: Is too much investment choice a good thing?

The Pensions Regulator published its DC Code of Practice and guidance in November 2013, adding to the increased focus on DC schemes.

The Code of Practice is a really helpful document for trustees of DC schemes, who should be encouraged to read it. Under the Regulator's "comply or explain" regime, trustees are expected to comply with the Code or explain why they have not done so. The Code sets out six principles which relate to making good investment decisions and good quality communications and to accountability for those decisions and communications.

The government wants all DC members to have investment choice. There is an interesting question as to whether investment choice is suitable for all DC schemes. Trustees may be focusing on how many funds to offer and what the default fund should be. But in some situations time may be better spent actively focusing on and monitoring a single fund (for example, in a DC scheme where most of the members are invested in the default fund).

So is the DC investment landscape changing and why?

While there is no immediate impact on fiduciary duties following the Law Commission Report, it has sparked debate in the DC investment arena. Together with the recent Pensions Regulator DC Code of Practice and Guidance there has been a deluge of activity. This trend looks set to continue.

A large number of employees are being automatically enrolled into DC schemes, so an increasing focus on DC investment makes sense. After all, the investment risk lies with the member (as opposed to the employer under a defined benefit scheme) who is arguably least well placed to be making investment decisions.

As more members retire from DC schemes disappointed with the value of their pensions, there is likely to be more focus on:

  • Exactly what investment decisions were made and how;
  • How suitable the investment options really were;
  • How closely the options were in fact monitored;
  • Whether the options were changed when they should have been; and
  • The quality of communications with members - could they have been understood by the lay person?

Pensions Minister Steve Webb has warned against a piecemeal reform of fiduciary duties. This recognises the need to for all government departments to work together rather than the Department for Work and Pensions alone.

What actions do trustees of DC Schemes need to be taking now?

Trustees of DC Schemes need to be taking the following actions:

  • Trustees of DC Schemes have clear fiduciary duties already and need to comply with them. Trustees should be addressing their legal duties as part of compliance with the DC Code of Practice.
  • For contract based arrangements, the legal basis for fiduciary duties and governance is unclear, which makes it very important for the terms of reference of governance committees to be properly scoped and drafted to fit into a grey legal arena.

The Law Commission consultation closed on 22 January 2014 and a response is due by June of this year. The follow up report will be one to watch to understand what further actions trustees of DC Schemes need to be taking.

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