Trustees reviewing their Statements of Investment Principles (SIPs) will have to be mindful of the need to formulate policies on the broader range of matters by October 2019 (particularly in relation to financially material considerations and exercising investment rights). Trustees need to also be mindful of the latest requirements in relation to their arrangements with asset managers and extended stewardship and engagement reporting duties, which were introduced in June 2019.
The Pensions Regulator's Guide to defined contribution (DC) Investment Governance has been revised to reflect the recent changes in the law, and also to guide Trustees through many other changes in the DC Investment landscape.
Key action points for trustees to consider
1. What are your policies on financially material considerations?
Financially material considerations now include environmental, social and governance considerations (including climate change). Have you made your policy assessments yet? The revised guidance provides examples and helpful links.
2. What are your policies on non-financial matters?
Do you have policies on ethical or quality of life matters and are you surveying members for views? There are helpful suggestions on when or how member views might be sought and what is required.
3. How will you be exercising rights attaching to investments?
Work with your advisers to formulate your policy on voting and undertaking engagement activities.
4. Where can members learn more about how your policies work?
Links to online websites will soon have to be included in member benefit statements. Are yours nearly ready?
5. Is it time to review your Trustee board's investment governance structure?
Have your Trustees assessed their skills, expertise and performance in investment, and taken action to address any weaknesses? The guidance sets out the Regulator's expectations.
6. Is it time to review the performance of your investment consultants and your investments?
Are you asking the right questions of your advisers and getting the right advice? The guidance helps you to ask, and maybe even answer, these questions.
7. Are you considering retendering for your fiduciary manager?
Are you affected by the Competition and Markets Authorities (CMA's) requirement to retender for fiduciary managers in certain circumstances, or are you simply considering appointing a fiduciary manager? If so, this Guidance might help you.
Last year, new requirements were introduced on what must be included from October 2019 in Statements of Investment Principles ("SIPs"). Our alert "Trustee Investment Duties: All change or more of the same?" provides further detail, but in summary, these were:
- From October 2019, SIPs must now include trustee policy on:
These policies must be provided within two months of a request.
- Financially material considerations (rather than a statement of whether social, environmental or ethical considerations are taken into account);
- Stewardship policies (i.e. how rights connected to investments are exercised); and
- Non-financial matters.
- Some schemes will also need to, from October 2019:
- Publish their SIP on a freely available website; and
- Signpost the information available on the website via annual benefit statements.
- From October 2020, some trustees may have to also provide a report on how they implemented their policies and publish that report on a website.
- In addition, last month (June), further changes were introduced in relation to policies on engagement with asset managers. These policies must be in place by October 2020.
The key point is that even well run schemes are likely to require tweaks to their trustee policies and others may need change that is more substantial.
This article (with page references to the Guidance where helpful):
- Explains how the Guidance can help Trustees and their advisers comply with the new requirements; and
- Sets out what else is new in the Guidance for DC Trustees to consider in terms of their investment governance.
Care is required as to what sort of scheme is involved, how many members there are and whether the policies relate to a "default arrangement" when looking at the new SIP requirements and disclosure obligations. The obligations typically depend on whether there are 100 or more members or whether the fund is a DC "default arrangement". The following is a very broad overview and we will be able to assist with your particular circumstances.
In more detail - SIPs
There are three main changes in relation to the content of the SIP when it comes the various policies trustees must have in relation to investments. These are policies on:
- financial materiality;
- non-financial matters; and
- voting and engagement policies.
From October 2019, the SIP must state the trustees' policy on "financially material considerations over the appropriate time horizon of the investments, including how those considerations are taken into account in the selection, retention and realisation of investments."
Financially material considerations are defined as "including (but not limited to) environmental, social and governance considerations (including but not limited to climate change), which the trustees of the trust scheme consider financially material."
The revised Guidance (pages 10-13) discusses this obligation, providing some practical tips on how to formulate a policy and what might be considered a relatively minor negative factor so as not to be of material concern to trustees. Our insight "Trustee Investment Duties: All change or more of the same?" explores what that means in practice.
Alongside the requirement to take into account financially material considerations, the Regulator expects Trustees to consider long term funding performance, rather than focusing on short term considerations (unless there is a particular reason to take the short term into account) (pages 37-38).
From October 2019, trustees must state the extent (if at all) to which non-financial matters are taken into account in the selection, retention and realisation of investments.
"Non-financial matters" is defined as meaning the views of members and beneficiaries, including but not limited to their ethical views and their views in relation to social and environmental impact and present and future quality of life for members and beneficiaries.
The inclusion of the words "if at all" means it will be sufficient for the trustees' policy to be simply that they do not take any non-financial matters into account, if that is the case. There had been a proposal to require trustees to state in the SIP the extent to which member views (including on non-financial matters) would be taken into account, but this was dropped in the final regulations.
The revised Guidance provides examples (pages 14-16) of what non-financial factors might be, how trustees can consider them as part of an investment strategy and when or how it might be appropriate to engage with the membership on their preferences.
Voting and engagement
SIPs must currently state the trustees' policy (if any) in relation to the exercise of rights (including voting rights) attaching to investments. From October 2019, the words "if any" are removed, meaning there must be a policy, and, additionally, the SIP must also state the trustees' policy on "undertaking engagement activities in respect of the investments (including the methods by which and the circumstances under which trustees would monitor and engage with relevant persons about relevant matters)."
Relevant persons and relevant matters are both defined terms. "Relevant matters" include (but are not limited to) matters concerning an issuer of debt or equity, including their performance, strategy, risks, social and environmental impact and corporate governance.
The revised Guidance (pages 21-24) discusses what's meant by stewardship in the pensions context and how trustees can influence policy, and there are links to various codes and external sources of help. It also considers the interaction with Financial Conduct Authority (FCA) activities. For example, the Regulator believes the practices of trustees giving investment managers voting instructions or expressing an interest or engagement with asset managers' voting behaviour would not generally constitute the regulated activity of managing investments.
What do you have to do with the policies?
Once formulated, trustees may need to tell members about them, in response to specific member requests, by signposting the SIPs via annual member benefit statements or by publishing them on a freely available website as required. An implementation statement may also need to be prepared setting out how the trustees have implemented the policies (and that report may also need to be published online and signposted via the annual benefit statements).
The revised Guidance provides help on what an implementation statement should look like (page 31). The Regulator considers that the process of having to consider the content of a statement will help to focus trustees' minds on how well their investment policies and stewardship arrangements are delivering against their scheme's agreed investment principles. A very broad range of matters (from the time and resource dedicated to production, public policy work undertaken and lessons learned) are all potential topics for inclusion.
Last month, further expansions on SIP content and expanded disclosure obligations were introduced, with effect from October 2020. SIPs will need to state the trustees' policy in relation to arrangements with the "asset manager" and how the asset manager is incentivised to:
- align its investment strategy and decisions with the trustees' policy on various investment considerations (including risk/return and financially material factors); and
- make decisions/engage with investee companies based on an assessment of their medium to long term performance.
Other matters such as asset manager performance, remuneration and turnover costs are also to be included.
Stewardship and engagement requirements are also expanded, so that the "relevant persons" with whom trustees must engage (discussed above) will include any stakeholder and "relevant matters" will include the capital structure of an investee company and management of conflicts of interest. Trustees will also have to report on their voting behaviour (in terms of how they exercised voting rights or used the services of proxy voters, for example) from October 2021.
The revised Guidance very helpfully draws attention to these latest developments too in pages 10, 21 and 30.
Trustee Investment Governance
The Regulator has also taken the opportunity to update its Guidance more generally. Here is a sample of the 'best new bits':
- Appointing and monitoring fiduciary managers - Pages 44-46 set out the factors to consider when appointing a Fiduciary Manager. We discussed the new CMA requirements in our article "Fiduciary management: improvement through competition" and the guidance on what an appropriate tender process might look like is helpful.
- Consider Trustee skills and expertise and take steps to address any weaknesses - this may include reconsidering the full spectrum of who provides the scheme's investment advice and how. Pages 19 and 20 of the Guidance sets out what questions Trustees could ask themselves to establish their strengths and weaknesses.
- Monitoring investments and investment advisers - the revised Guidance contains several suggested checklists, including about decisions to be made with investment advisers (see page 6) and how to review and monitor fund performance (see pages 35-39).
- Unregulated Investments - The revised Guidance comments on unregulated investments, warning trustees to be careful because investors will not be protected by regulators, ombudsmen or official compensation schemes (page 29).
- Fund documentation - The revised Guidance discusses appropriate reviews of investment managers' fund documentation and flags the need to negotiate additional protections where appropriate, for example, in relation to the administrator's liability for non-investment losses, such as operational errors (pages 40 and 50).
Is this guidance a big deal?
There are more requirements for the content of a scheme's SIP and more disclosure obligations on trustees in relation to scheme investments than previously. They are also different in feel. The Regulator sees it as important that this does not become a "tick box" and wants relevant useful information to be available so that members can be confident expectations are being met.
Some of the obligations are being phased in, but given the direction of travel, it may be more cost effective for some schemes to carry out a "deep clean" rather than make incremental changes in time for 2019, 2020 or 2021. Either way, trustees will need to start thinking about what they need to do in order to comply with these additional requirements and begin (or expand!) conversations with advisers.
Interestingly, the online SIP reporting is also being extended to all schemes with 100 or more members (thereby including DB schemes too) from October 2020. But that's another story!