Pensions client update: developments in DC governance and charges

Written on 23 Oct 2014

The DWP has published further details of minimum governance standards and charges restrictions that will apply to defined contribution (DC) occupational schemes from April 2015. These requirements overlap with the Pensions Regulator’s (TPR’s) requirements on DC governance, which will be updated to reflect the new regime. The increased focus on governance and charges in DC schemes is being propelled by the millions of members being automatically enrolled into DC schemes, as well as increased numbers in DC schemes due to the closure of many defined benefit (DB) schemes in recent years. The reforms are also designed to complement the “freedom and choice” announcements in the budget this March, that liberalise how DC members can take their benefits.

Actions for trustees

Trustees of occupational DC schemes need to start preparing for these developments that will come into force next April 2015, and the following areas should be at the top of their list:

  • Reviewing the design of scheme default funds, and in relation to those default funds used for automatic enrolment, ensuring that they comply with the 0.75% charge cap (see below under “Charges” for further details on the cap).
  • Assessing costs and charges across the scheme and ensuring that members are receiving good value for money.
  • Ensuring that a chair of the trustees is in place, and preparing to issue the first chair’s statement for the scheme year ending on or after 6 April 2015.

Which schemes will these requirements affect?

The minimum governance requirements will apply to most occupational DC schemes (but not to DB schemes that provide DC additional voluntary contributions (AVCs) and no other DC benefits). The default fund charge cap applies to default funds in DC occupational schemes that are qualifying for automatic enrolment, provided members are actively contributing on or after 6 April 2015. It will also apply to a default AVC fund in a DB scheme with DC AVCs, if the scheme is a qualifying scheme for automatic enrolment.

Workplace personal pensions such as group personal pensions are regulated by the Financial Conduct Authority (FCA) which consulted separately on requirements for Independent Governance Committees (IGCs). The FCA will also shortly issue a consultation on rules to introduce and enforce the charges measures for workplace personal pensions.

What is the timetable for these new requirements?

The new requirements will come into force on 6 April 2015, setting a tight timetable for affected schemes to ensure compliance. The DWP paper includes a set of draft regulations – the Occupational Pension Schemes (Charges and Governance) Regulations 2015, and a consultation on those regulations, which closes on November 14. This legislation is expected to be laid before Parliament in early 2015 and to come into force in April 2015.

Details of the new requirements

Governance: the minimum governance standards include requirements on trustees to:

  • design default arrangements in members’ interests and keep them under regular review. They must be reviewed at least every 3 years and without delay after any significant change in investment policy, or in the demographics of the scheme. This review is also an opportunity to consider amendments that may be needed to existing ‘lifestyle’ and other investment strategies in default funds, given the changes to the way retirement benefits will be taken after the freedom and choice reforms.
  • ensure that core financial transactions (such as the investment of contributions into the correct funds and switches from one fund to another) are processed promptly and accurately.
  • assess the value of costs and charges borne by scheme members, both in the default fund and across other funds in the scheme.
  • have a chair of trustees (to be appointed within 3 months of 6 April 2015), who will be responsible for signing off an annual statement on how the governance standards have been met.

The chair’s annual statement must include a report on the design and any recent review of the default arrangement, the charges and transaction costs in the scheme, and how the trustees’ have assessed the value for money that the charges offer. It must also include a statement on the knowledge and understanding levels of the trustees. The statement must be produced within 7 months of the end of each scheme year, and included in the scheme’s annual report.

Charges: the aim of the charge cap is to protect members who have not made an active choice about their pension investments. It will be a cap on charges in the default funds of qualifying schemes (schemes which are used for automatic enrolment purposes), set at 0.75% of funds under management. There are specific provisions enabling trustees to identify default funds. The charge cap will apply to all member-borne deductions paid to the pension provider or another third party, excluding transaction charges. The trustees will have responsibility for complying with the cap.

The charge cap does not include transaction charges (defined as the costs incurred as a result of the buying, selling, lending and borrowing of investments), but trustees will be required to report on these in the chair’s statement.

Active member discounts and member-borne adviser commission and consultancy charges will be banned from qualifying schemes from April 2016. The government will also consider whether regulation for additional transparency on costs in DB schemes is required. The level of the charge cap will be reviewed in 2017.

What will happen if trustees fail to comply with the new requirements?

Information on compliance with the new governance and charges requirements will be gathered by the Regulator via the chair’s statement and the scheme return. The latter will include questions requiring the trustees to confirm the identity of the chair, whether they have produced the chair’s statement on governance standards, and whether the scheme complies with the charge cap. The Regulator will have power to issue compliance notices for failure to comply with the new requirements, followed by penalties, of up to £5,000 or £50,000 for an individual or corporate respectively, or a lower amount of between £500 and £2,000 for a first failure to produce a chair’s statement.

Interaction with TPR requirements

Many of these requirements on governance and charges complement and overlap with the requirements in TPRs Code of Practice 13 on the governance and administration of occupational DC schemes, and its associated regulatory guidance for DC schemes. Trustees who are working through TPR’s 31 DC quality features should therefore be well-placed to cover these new requirements. TPR currently expects trustees to produce a governance statement each year explaining the scheme’s position and progress in these areas, and this will overlap with the new requirements for a chair’s statement.

TPR has issued a statement on the DWP’s paper, in which it states that trustees should continue to follow its DC code. It will be updating the Code of Practice next year once the new legislation is in place, and states that it will be providing further guidance as soon as possible. It is to be hoped that this process will ensure that TPR’s requirements and guidance dovetail with the new legislative position, streamlining the processes required of trustees as far as possible.

Click here to be taken to the DWP paper making the proposals highlighted in this update.