The Pensions Regulator has revised its 2017 guidance on investing for defined benefit pension schemes to take account of changes to the statutory environment.
Trustees should ensure they are familiar with the new requirements set out in the Guidance, which includes changes taking effect this year.
If your trustee board has not recently reviewed its governance structures around investment decisions, the publication of the revised guidance provides a good opportunity - and useful examples - of how you might proceed.
Key action points for trustees with defined benefit investments
1. Read the revised Guidance
Trustees should ensure they are familiar with the revised Guidance and its associated regulatory Code. A number of changes have taken effect this year which trustees should be complying with. If you have not recently reviewed the governance structures around your trustee board's investment processes, the issuance of the revised Guidance provides a good opportunity for doing so.
2. Update your investment documentation
From 10 December 2019, trustees will need to ensure that they have set objectives for their investment consultants (both new and existing), which should be set by reference to their scheme's statement of investment principles.
3. Does your scheme operate an investment sub-committee?
If not, it is worth considering if your trustee board is able to devote enough time, and respond quickly enough, to the necessary investment decisions. Establishing an investment sub-committee (with appropriate terms of reference to manage risk) can help maximise your trustee board's chances of complying with the governance requirements around investments and minimise the risk of missing the boat on good investment opportunities.
The investment landscape
In November 2018, we published an article considering whether the outpouring of recent pension investment publications, legislation and guidance meant a sea change for trustees' investment duties, or whether it was just more of the same. That was followed by an article in early 2019 considering the Competition and Markets Authority's Final Report on its Investment Consultants Market Investigation.
In this new instalment of our series on trustees' investment duties, we consider what the Pension Regulator's revised "Investment guidance for defined benefit pension schemes" (the "Guidance"), published in September, means for trustees as they grapple with maintaining good governance in turbulent times.
The Guidance is an updated version of guidance published by the Pension Regulator ("TPR") in March 2017, consisting of the same six sections, including a focus on governance, implementation and monitoring. The Guidance provides information on how trustees might meet in practice the standards set out in TPR's "Code of Practice 3: Funding defined benefits", which are to be met when complying with the law. TPR recommends trustees familiarise themselves with the Code before reading the Guidance.
What has changed?
A large part of the Guidance is unchanged from the rather substantial document that trustees will be familiar with from 2017. There are, however, some key changes of which it is worth taking note.
The trustee board's role
In describing the role of trustees, there appears to be a greater emphasis in the Guidance towards ensuring trustees work well with their investment professionals. While the fundamental position remains unchanged - trustees are ultimately responsible for their scheme's investments - there is an increased emphasis on how good investment outcomes can be achieved through finding the right advisers.
- take reasonable steps to satisfy themselves that whoever is undertaking the task of investing their scheme's assets has the appropriate knowledge and experience and is performing their role competently in accordance with statutory requirements;
- have suitably documented investment governance arrangements appropriate for their scheme's circumstances; in particular, TPR emphasises the need to focus on those decisions most likely to make a difference;
- consider if their board has the necessary skills and expertise in relation to its investment arrangements; if not, TPR suggests ways of addressing this could include increased delegation, simplifying the investment arrangements or, (obviously at the more extreme end!) winding-up the scheme.
Investment delegation structures
TPR emphasises the need for trustees' investment governance structures to strike the right balance between the ability to move quickly (one reason for the focus, noted above, on decisions most likely to make a difference) and ensuring the right checks and balance are in place. A simple investment structure could involve the trustee board determining the overall objectives and making strategic decisions such as asset allocation and risk appetite. The board will be supported by the investment consultant and legal adviser advising on the appropriate considerations for that decision-making process, while the investment manager makes the day-to-day investment decisions.
If the trustee board is not able to devote enough time, or be responsive enough, to manage the investment decisions needed, use of a sub-committee is recommended. TPR lists a number of questions to consider when deciding whether you need an investment sub-committee, including:
- Does your scheme have the resources to cover the cost of a sub-committee? What benefits might it offer? Does the size of the scheme and the number of members justify the use of a sub-committee?
- Do members of the proposed sub-committee understand their legal duties and responsibilities?
The use of investment sub-committees, while not new, is something we are seeing increasingly commonly in practice; it is a good way of ensuring the necessary time is given to this important issue, without dominating an entire trustee meeting or detracting from the consideration of other critical issues.
If trustees are considering moving to this structure, we consider it important to get the right terms of reference in place for the committee, to ensure a suitable level of governance and oversight is maintained, and risk is managed.
Fiduciary management and investment consultants
When delegating to a fiduciary manager, TPR considers that trustees should consider matters such as:
- their objectives for appointing a fiduciary manager, including the interaction with existing governance arrangements, the range of models available and the benefits, risks, costs and value that different approaches can offer;
- the potential for conflicts of interest, including the extent of separation between those providing strategic investment advice and those implementing the mandate;
- how performance will be delivered, the cost implications for the scheme, and how they expect the mandate to add value; and
- how the assets could be transferred away from the fiduciary manager, in full or in part, and the costs involved in doing this (for example, if the trustees decide to move to a new manager or buy-out the scheme).
In addition to the Guidance, trustees should also consider the implications of the Competition and Market Authority's Order in respect of fiduciary management and investment consultants.
- From 10 December 2019, trustees will need to ensure that they have set objectives for their investment consultants, with some advisers warning they will not be able to advise clients after 9 December unless and until agreed objectives are put in place. New pensions regulations are expected to replace this obligation for occupational pension schemes in the spring, as well as expand it to include annual and triennial reviews.
- Also from 10 December, where trustees wish to delegate investment decisions for 20% or more of their scheme assets to a fiduciary manager, it must be as a result of a competitive tender. The new definition of fiduciary manager means a broader set of arrangements than previously thought could be caught, including where the ultimate investment decision sits with the trustees. Again, the Order is expected to be replaced by pensions specific legislation from 6 April 2020 but the definitions and requirements are expected to be very much aligned. TPR has also now published four guides covering the new obligations which are aimed at helping trustees understand and comply with their duties.
Stewardship, sustainability and financial considerations
Unsurprisingly, given the statutory changes around these topics, a large part of the changes in the Guidance compared to the March 2017 version focus on these areas. Some key points to note from the Guidance include:
- Stewardship. This includes the management of capital to create sustainable value for beneficiaries, the economy and society. It is up to trustees to exercise stewardship and ensure, as far as they are able, that this is done through the whole investment chain. TPR acknowledges that, for many schemes, stewardship activities are likely to be undertaken by the investment manager on the trustees' behalf. Nonetheless, trustees should become familiar with their managers' stewardship policies. From 1 October 2019, most DB schemes will be required to include in their SIP details of the trustees' policy in relation to voting, engaging, and monitoring.
- Sustainability. Trustees must consider financially material risks relating to their investments over an "appropriate time horizon", meaning the length of time you consider is needed for the funding of future benefits taking into account the scheme's profile and maturity.
- Financially material factors. When considering investment decisions/setting investment strategy, trustees should take into account factors including environmental, social and governance considerations that are financially material to the performance of an investment. Determining what will constitute a financially material consideration will often involve professional judgement. From 1 October 2019, a scheme's SIP must include the trustees' policy on these factors.
- Non-financial factors. The Law Commission concluded that trustees may take non-financial factors into account if they have good reason to think that scheme members share a particular view, and their decision does not risk significant financial detriment to the fund. To this end, TPR suggests that trustee boards may find it useful to challenge themselves about what they believe to not be financially material. From 1 October 2019, a SIP must include the extent, if at all, to which non-financial matters will be taken into account in the selection, retention and realisation of investments. Here, "non-financial matters" means the views of members and beneficiaries, including in relation to ethical matters and their views on social and environmental impact and the present and future quality of life of members and beneficiaries.
This is not to say the law has fundamentally changed in this area; Cowan v Scargill and investing in members' best financial interests remains good law when it comes to deciding what investments your scheme should be making. Nonetheless, there are other matters that trustees should also be giving consideration to.
You might be excused from wondering how the increased focus in the Guidance on delegation and working with ones' investment professionals fits with a greater emphasis on investor values and engagement. In reality, much of the above is going to be dependent on what your investment professionals are able to offer, but the Guidance expects trustees to be willing and able to engage with those professionals on these issues for the purpose of achieving good investment outcomes.
Immediate steps for trustees
A number of issues come out of the Guidance for trustees:
- TPR notes that it may be helpful for trustees to prepare a table of accountabilities, showing the delegation and control structures within their scheme. A high-level summary of the governance arrangements could form part of the scheme's SIP or be part of a larger, overall governance plan. The document may help when trustees review the investment governance arrangements, as it will record the outcome of the previous review and the rationale behind it.
- If trustees do not already operate an investment sub-committee, consideration should be given to whether or not one is required, including where relevant, the make-up of the committee and the terms of reference.
- The requirements set out in the Guidance are varied in respect of some schemes, such as those with fewer than 100 members, wholly-insured schemes or small self-administered schemes, the trustees of which may wish to seek advice on how the obligations are varied.
- The Guidance contains a list of issues to consider in reviewing performance as trustees - these issues could helpfully be included in any self-assessment questionnaires which trustees may run to determine their board's training needs and when reviewing risk management processes.
- Outside the Guidance, more information can be obtained from the UK Stewardship Code, which outlines best practice on stewardship. TPR encourages trustees to sign up and adhere to the code in their stewardship activities with a view to improving long-term returns and reducing the risk of poor outcomes due to poor strategic decisions.
- If your scheme has an existing fiduciary management arrangement in place, which was not established through a competitive tender process, it would be sensible to check the new statutory deadline for renewing the arrangement. A number of schemes are likely to go to market at a similar time due to the new obligations, and a saturated market could well result in a less competitive market for smaller schemes trying to run a competitive tender process.