EMIR (EUROPEAN MARKET INFRASTRUCTURE REGULATION) - REGULATION 648/2012
We provided an update on the European Market Infrastructure Regulations (EMIR) in our Summer Pensions Update. EMIR is an EU regulation which affects schemes using derivatives (including those which use them solely for hedging through their custodian). These regulations require certain over-the-counter (OTC) derivatives contracts to be cleared centrally. Pension schemes were given a three-year exemption from the OTC central clearing requirement, which was due to expire in August of this year, due to the need to provide significant amounts of cash collateral in order to meet margin calls - an inefficient way of holding assets. However, the European Commission has acknowledged the difficulties the EMIR regime causes for pension scheme trustees and has extended the exemption by a further two years to 15 August 2017.
Trustees operating hedges or using derivatives held directly for liabilities driven investments purposes should continue to work with advisors to ensure their compliance with the full EMIR regime when the exemption period ends.
UK CASE LAW
In the UK some decisions of the Pensions Ombudsman and the High Court are of interest.
Bridge Trustees Limited (PO-763)
This was a decision of the Deputy Pensions Ombudsman (the "Ombudsman") in the UK, handed down on 31 March 2015, which held two trustees personally liable for payments made in breach of trust. The Ombudsman held that the two trustees were not protected by the exoneration and indemnity provisions in the scheme trust deed and rules and ordered to make a payment of c.£200,000 to the scheme.
The facts of the case were as follows:
- The indemnity clause granting protection to the trustees did not extend to fraud or "deliberate disregard of the interests of the beneficiaries" by the trustees.
- Two of the trustees were directors of Pilkington's Tiles Limited ("Pilkington").
- On 24 December 2009, Capita, the scheme administrator, transferred excess DC contributions to Pilkington's bank account (the "Transfer").
- Bridge Trustees Ltd were appointed trustees after the company went into administration and made a complaint to the Pensions Ombudsman that two of the previous trustees contravened rule 5.6 of the scheme rules in relation to excess contributions and failed to act in the members' best interests.
- The trustees admitted they had authorised the repayment to Pilkington but claimed that they were advised by Capita that the excess contributions must be repaid under the rules of the Scheme.
- Rule 5.6 of the scheme provided that excess employer DC contributions, resulting from early leavers whose benefits had not vested, should be held in a general reserve and "applied by the trustees as the principal employer shall from time to time direct to pay the costs and expenses of the scheme and/or to reduce the amount of the contributions which would otherwise be required from the employers...".
The Ombudsman upheld the complaint against the trustees and confirmed that in no circumstances could rule 5.6 be interpreted to allow payment from the scheme's general reserve back to Pilkington.
The Ombudsman also found that on the balance of probabilities the scheme administrator would not have advised the trustees to repay the excess employer contributions to Pilkington. He further found it critical to this conclusion that Capita provided administration, but not consultancy, services to the trustees. In any event, the Ombudsman found that the trustees could not be excused by simply relying on any such advice; rather, trustees should consider the reasonableness of any advice and challenge it if necessary. Furthermore, the Ombudsman found that the trustees should have considered seeking legal and tax advice, which they had not.
The Ombudsman found the trustees to be in breach of trust in authorising the payment in contravention of the scheme rules. In addition, they had failed to inform their fellow trustees of the repayment. The Ombudsman reasoned that if the other two trustees had been aware of the repayment, they may have concluded that the loan was not reasonable or prudent.
The Ombudsman concluded that the trustees were more interested in the company's position than protecting the interests of the members of the Scheme. The Ombudsman found the trustees' actions to be a conscious decision on their part which amounted to a deliberate disregard of the interests of members. The trustees could not, therefore, enjoy the protection of the indemnity and exoneration clause and were directed to reimburse the scheme for the total excess employer DC contributions payments to the company of £193,011 plus interest, together with any tax charges and late payment charges.
This case is a stark illustration of the potential personal liability of pension trustees. It also illustrates the dangers of trustees relying on indemnity and exoneration clauses as a "catch all" protection.
However, this case is a decision of the Deputy Pensions Ombudsman and therefore it is not clear if it will be appealed. While Trustees should take account of the decisions for the moment, it may be the case that this decision will be overturned on appeal.
Sterling Insurance Trustees Limited v Sterling Insurance Group Limited
The case concerned the meaning of the phrase "benefits accrued due in respect of any member up to [the date of the amendment]" in a restriction on a power of amendment that prohibited amendments that substantially reduce in aggregate the value of such benefits. An amendment had been made which terminated the accrual of final salary benefits and did so in a way that broke the link between past service benefits and future salary increases. The question was whether the breaking of the final salary link was valid or ineffective as contrary to the restriction on the amendment power. The High Court in the UK handed down its judgment on 3 July 2015.
The analysis is convoluted and turns on several factors specific to the UK including: the wording of the deed in question; the UK legislature background; certain agreed positions of the parties; and section 67 of the UK Pensions Act. In the circumstances it was held that "accrued due" was taken to include a link to final salary.
The judge granted permission to appeal, recognising that the question of construction was a difficult one in relation to which the Court of Appeal might take a different view and also expressed the view that it would be desirable for the Court of Appeal to consider the decision in In re Courage Group's Pension Schemes  1 WLR 495 regarding the meaning of the phrase "secured" benefits, and consequently the meaning of "accrued" benefits adopted in Briggs and others v Gleeds and others  EWHC 1178 (Ch) (another relevant case on this issue).
VAT & PENSION FUNDS
The Revenue Commissioner's VAT Manual has been updated to set out the VAT treatment applying to pension funds following decisions of the Court of Justice of the European Union (CJEU) in Wheels (Case C-424/11), ATP (Case C-464/12) and PPG (Case C-26/12).
1. VAT treatment of management services supplied to pension funds
Investment management of DC schemes (other than 1 member schemes) is exempt from VAT. Because of a CJEU ruling that classified DC schemes as "special investment funds" for the purpose of EU VAT law, the Revenue Commissioners have accepted that the management of DC schemes is exempt from VAT. However, one-member arrangements do not come within the scope of the exemption.
VAT applies to management services supplied to DB schemes. The CJEU ruled that a defined benefit scheme cannot be regarded as "special investment funds" within the meaning of EU VAT law; consequently, fund managers should continue to charge VAT on services supplied to defined benefit pension schemes.
2. VAT deductibility in respect of pension fund establishment and administration costs
The CJEU also provided clarity on an employer's entitlement to deductibility in the setting up and management of a pension fund for its employees. Revenue accepts that an employer is entitled to VAT deductibility in respect of costs incurred in the setting up, on-going management, administration and management of the assets of a pension scheme where the following conditions are met: (1) the costs are part of the employer's general costs; (2) the costs are not passed on to the pension fund; and (3) there is a direct link to the employer's taxable activity.
UK REGULATOR PUBLISHES GUIDANCE ON ASSESSING AND MONITORING THE EMPLOYER COVENANT
Useful new guidance from the UK Pensions Regulator should assist trustees of defined benefit pension schemes in assessing and understanding the significance of the employer covenant. The employer covenant is the extent of the employer's legal obligation and financial ability to support the pension scheme currently and into the future. It is vital that trustees correctly manage the employer covenant in compliance with their duties under the trust.
In recent years trustees have been less concerned about the requirements of the employer covenant being met and more concerned that their schemes are funded above the Minimum Funding Standard ("MFS") in compliance with their legislative obligations. In 2011, 70% of defined benefit schemes were in deficit. However, the tide is changing and more and more schemes are now funded above the MFS. Increasingly trustees are considering the strength of the employer covenant in assessing the risks facing a DB Scheme.
While the Irish Pensions Authority has yet to publish updated guidance in relation to employer covenants, the UK guidance provides a useful outline of the approach trustees should take. The guidance follows the introduction of a new statutory objective for the UK Regulator "to minimise any adverse impact on the sustainable growth of an employer" when exercising its powers in relation to scheme funding. The new guidance for trustees reflects this aim.
The main points raised in the UK guidance are:
- An integrated approach should be used when assessing funding and investment risks by including the employer's ability to contribute and maintain the scheme as part of the assessment.
- A proportionate approach should be taken to the level of assessment and monitoring of the employer covenant, taking into account how much the scheme relies on the employer for the maintenance of the scheme and how complex the employer's operations are.
- Trustees who lack the expertise or independence required to perform an assessment of the employer covenant should hire independent professional advisors to assist.
- It is mutually beneficial for the trustees and employer to share information and work collaboratively to produce a covenant assessment that uses the most accurate information and aims to ensure that in the future, the scheme will not pose an unnecessary risk to the employer's sustainability.
- The focus of the assessment should be on entities that are obliged to contribute to the fund. Trustees should be cautious in giving weight to medium or long term contributions from sources that are more informal in nature. However, in the short term, it would be reasonable to take into account contributions from such sources if they have previously contributed and are likely to continue to do so in the near future.
- When assessing the employer covenant, the future prospects of the employer and the market in which the employer operates should be taken into account when assessing the ability of the employer to make future contributions to the scheme.
- If the employer's ability to provide funding to the scheme is restricted by its investment in sustainable growth, the trustees should consider how the scheme may benefit from this sustainable growth in the future.
- Contingency plans should be put in place and the covenant regularly monitored so that action can be taken on short notice when necessary.
This article contains a general summary of developments and is not a complete or definitive statement of the law. Specific legal advice should be obtained where appropriate.