UK: Regulator Issues New Consultation On Defined Contribution Pensions

The Pensions Regulator has launched a new consultation exercise on the regulation of Defined Contribution (DC) pension schemes. This marks the latest stage in its ongoing campaign to put in place a suitable framework for the regulation of DC schemes. It will assume increasing importance as more and more employers become subject to the new automatic enrolment legislation.

Why this? Why now?

There are specific reasons why the Regulator has embarked on this exercise.

There are now 205,000 private sector DC schemes in the UK, and the Regulator has been criticised in the past for giving insufficient attention to them. More particularly, the advent of automatic enrolment will lead to millions of individuals being compulsorily enrolled into pension schemes which they have not chosen and whose workings they may not understand. This represents a huge shift in the DC marketplace and lends an additional urgency to the need to ensure that DC schemes are properly regulated in the interests of all members and sponsoring employers.

The Office of Fair Trading has also announced a major study into the DC market. Again, this has been precipitated by the advent of automatic enrolment. This is believed to be the OFT's biggest enquiry into pensions for 16 years. Issues of interest to the OFT include whether market forces are operating efficiently among providers of DC schemes, whether there is sufficient market pressure to keep charges low, and the challenges faced by smaller employers.

It should be noted that the Regulator's principal concern is with trust-based DC pension schemes. Most DC pension schemes are contract-based products operated by insurance companies, and the Regulator shares jurisdiction over these with the FSA. The majority of the consultation is therefore specific to trust-based schemes. In contract-based schemes, the Regulator's attention is focused on matters such as the functioning of the scheme in the workplace and whether contributions are being correctly deducted and paid. In trust-based schemes, the Regulator is concerned with a broader range of matters such as the internal governance of the scheme and the conduct of the trustees (e.g. in relation to investment matters).

Nevertheless, the Regulator makes it clear that it considers that members of contract-based schemes are entitled to the same level of protection as members of trust-based schemes, and it plans to continue liaising with the FSA on how best such members might be protected. The prospect of a full merger between the Regulator and the FSA has, however, been ruled out by the Government.

The Regulator's approach

The consultation includes a Regulatory Approach document which sums up the Regulator's objectives in this way:

Elsewhere, the Regulator states that its approach to enforcement will be "robust and proportionate".

The Regulator intends to be proactive in monitoring the functioning of DC schemes. It also sees its role as including ongoing education of stakeholders, which means that further publications – as well as reports of enforcement action – can be expected to be issued over time.

The Regulator has reaffirmed its Six Principles of DC regulation, which are as follows:

• Schemes are designed to be durable, fair and deliver good outcomes for members
• A comprehensive scheme governance framework is established at set-up, with clear accountabilities and responsibilities agreed and made transparent
• Those who are accountable for scheme decisions and activity understand their duties and are fit and proper to carry them out
• Schemes benefit from effective governance and monitoring through their full lifecycle
• Schemes are well-administered with timely, accurate and comprehensive processes and records
• Communication to members is designed and delivered to ensure members are able to make informed decisions about their retirement savings

The Regulator intends to conduct research in the future to verify how far both trust-based and contract-based schemes are complying with the framework which it has set out. This will complement its past research into how far DC schemes have been operating within the existing regulatory parameters, which has revealed variable levels of compliance.

Clyde & Co Comment

The advent of automatic enrolment – which will affect every employer in the UK – will mean a necessary increase in attention from the Regulator. An influx of new pension scheme members, many of them not financially sophisticated, will open the door to governance failures and misunderstandings, and consequently to complaints and litigation. The Regulator will want to avoid this scenario as far as possible.

Responding to the consultation announcement, the CBI has urged the Regulator to adopt a light-touch approach to its role. The National Association of Pension Funds (NAPF) has likewise suggested that the Regulator should concentrate its attention on the higher-risk sectors of the DC pensions industry, and has pointed to the Regulator's own research which appears to suggest that large-scale schemes are already well governed. The TUC has echoed this suggestion that large-scale DC schemes represent the best run segment of the market.

The Regulator states explicitly that it wishes to intervene only where the market fails to deliver. It is to be hoped that the Regulator will prefer to rely upon stakeholders educating and policing themselves (through mechanisms such as "comply or explain") rather than heavy-handed interventions, though it does envisage intrusive investigative activity where appropriate.

The consultation closes on 28 March. The OFT study which is running in parallel is expected to take a little longer, with the evidence-gathering stage alone set to take up to six months.

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