Trustees of schemes with DC benefits (excluding those schemes where the only benefits are AVCs) will need to take action to ensure compliance with the new legislation as they reach the relevant compliance deadlines. Deadlines will vary depending on the scheme, but will fall some time after the legislation comes into force. In addition, trustees should be aware of the wider developments covered in this alert, which are likely to result in the introduction of further requirements on trustees in due course.

Removing barriers to investment in illiquid assets: "disclose and explain" requirements and new exemption for "specified performance fees" from the charge cap

Following a number of previous consultations, the Government has confirmed its intention to move ahead with changes implementing its policy objective of removing the barriers to trustees investing in longer term, less liquid assets. It has now published final legislation implementing the changes, together with accompanying guidance. The Government hopes that this will encourage trustees to explore a fuller range of investment products, which could deliver higher net returns while unlocking pension fund investment in assets that benefit the UK economy. 

The changes are expected to come into force from April, although the compliance deadline will be sometime after this (more on timings below). The changes will impact all schemes with DC benefits, unless the only DC benefits are additional voluntary contributions (AVCs), in which case they will not be impacted. The Government had previously proposed that schemes with under GBP 100 million assets would not be required to do comply, but this has not been included in the final legislation meaning that, subject to some very limited exceptions, all schemes with DC benefits will need to comply with both the new "disclose and explain" requirements and, where relevant, to the disclosure requirements about specified performance fees.

• New disclose and explain requirements: trustees will be required to include an illiquid assets policy in their default Statement of Investment Principles (SIP). Broadly, this is the SIP which trustees are required to have in relation to any default arrangements. Illiquid assets are defined as "assets of a type which cannot easily or quickly be sold of exchanged for cash". Where assets are invested in a collective investment scheme, any illiquid assets held by the collective investment scheme will also fall within the definition. The changes do not require trustees to invest assets in default arrangements in illiquid assets but if they do, trustees will need to provide certain information set out in the legislation as part of the default SIP. Importantly, if default arrangements do not contain any investment in illiquid assets, trustees will be required to explain why they have a policy of not doing this. In practice, this means that if trustees do not already have a policy on illiquid assets, they will need to put one in place. Additionally, trustees will be required to disclose the asset allocations of default arrangements as part of their annual Chair's statement. Trustees will need to disclose the percentage of assets in each of their default arrangements which are allocated to a prescribed list of assets classes (broadly, cash, bonds, listed shares and unlisted shares, infrastructure, property and debt instruments). Where scheme assets are invested in a collective investment scheme, trustees must "look through" to the underlying assets. When making asset allocation disclosures, trustees will need to take into account the new statutory guidance, which provides additional detail on what is expected.
• Changes are being made to current legislation so that where performance fees meet a new definition of a "specified performance fee", they will not be counted as costs for the purposes of calculating the 0.75 charge cap, meaning that specified performance fees will effectively be exempted from the charge cap. Broadly, the charge cap operates to restrict the level of charges which can apply to the default arrangements used in automatic enrolment arrangements. Specified performance fees are defined in the legislation as pre-agreed fees or profit sharing arrangements which are payable by trustees to a fund manager in relation to investments (either directly or as part of a collective investment scheme) and which are payable when investment performance exceeds a certain amount or rate. Many of the illiquid assets which the Government is keen to encourage trustees to consider including within default arrangement portfolios carry performance fees, such as private equity, infrastructure, or other longer term assets. By allowing these to be exempted from the charge cap (provided they meet the relevant criteria), the Government hopes to remove a barrier to trustees considering investing in these type of assets. Despite concerns having been expressed that this change runs counter to the original policy objective behind the charge cap and risks exposing members in default funds to greater levels of financial risk, the Government has reached the position, broadly, that it is comfortable that trustees should be given the flexibility within default arrangements to invest in products carrying performance fees on the basis that it is only those fees which fall within the definition of "specified performance fee" which can be exempted from the cap. "The Government's primary consideration and expectation in allowing for this change is that paying higher fees is only justifiable as a result of the scheme receiving higher net performance returns." The Government has made clear that trustees will still need to be comfortable that it is in members' interests before investing in funds with such fees. In order to retain visibility of any specified performance fees which are being exempted from the cap under the new regime, there will be a corresponding new requirement on trustees to disclose any specified performance fees which are in place as part of the disclosures in the annual Chair's statement. Any specified performance fees will also need to form part of the overall "general" value for member assessment which trustees are required to undertake under the legislation (and which is distinct from the more detailed value for member assessment which schemes with under GBP 100 million asset are required to undertake). Statutory guidance has been published providing more detail on when fees will meet the statutory definition and the disclosure requirements.
• The current disclosure regulations, which set out certain information which has to be made available on a publicly accessible website, will be updated to include the new information which trustees will be required to disclose under the new requirements,  both as part of the updated Chair's Statement and the default SIP. 

These changes give rise to the follow main action points for trustees:

• In relation to the new default SIP requirements: if trustees do not currently have an illiquid asset policy in place in relation to their default arrangements, they will need to consider what their approach will be going forwards. Trustees will need to ensure that they comply with their fiduciary duties when taking decisions about what their policy will be, ensuring that they take appropriate professional advice. Where a scheme's default arrangement does contain illiquid assets trustees will need to ensure they will be in a position to make the necessary disclosures in relation these assets as part of the updated default SIP by the relevant deadline. Recent market volatility has demonstrated how difficult it can be to make assumptions about how liquid a particular asset is, as well as the range of liquidity that can exist within portfolios, and so the initial challenge for many trustees will be to determine exactly what they class as illiquid. The definition in the legislation is broad and will require a degree of judgment by trustees supported by their advisers. The Government has said that it will consider how guidance can best be provided on the new requirement in consultation with the Pensions Regulator, so it is possible that we could see something further in due course - the new illiquid asset policy is not covered in the new statutory guidance covering the other new requirements.
• In relation to the new Chair's Statement requirements: trustees will need to gather information to make the necessary asset allocation disclosures and, if these apply, specified performance fees. Trustees should build in sufficient time to gather the relevant information, take the necessary advice, and ensure that disclosures are consistent with the statutory guidance. Where trustees are currently making use of the option in legislation to smooth performance fees as part of any charge cap calculations, they will need to consider what their approach will be going forwards as the current option will be removed (subject to some transitional arrangements). There is no legal requirement for trustees to make use of the new exemption for specified performance fees from the charge cap. Trustees should, however, be aware that this exemption exists and, if they are considering investing in assets in default arrangements used for automatic enrolment which come with performance fees, consider whether any fees would meet the requirements to be exempted. Trustees will also need to act in accordance with their fiduciary duties and seek appropriate professional advice.
• Trustees will also need to ensure that the publicly available information which they currently disclose on a website is updated to reflect the new requirements. 

As in other areas recently, such as ESG and the new detailed value for member assessments, the Government is hoping that increased disclosure requirements will drive changes in the market rather than mandating schemes to take action. Time will tell how much appetite trustees' have for investing in illiquid assets, particularly in the current environment, where the aftershocks of recent market volatility is still being felt.  

Trustees will need to comply with the new requirements by the following deadlines. The differing deadlines for the different requirements means that additional care will need to be taken when updating Chair's statement and SIPs to ensure that the correct requirements are being complied with: 

• Illiquid investment policy disclosure will be required to be added to the default SIP the first time it is revised after 1 October 2023 and at the latest by 1 October 2024.
• Asset allocation disclosures for default arrangements will be required in the Chair's statement for the first scheme year which ends after 1 October 2023.
• Requirements to disclose specified performance fees, if these are in place, will apply in relation to the Chair's statement for the first scheme year which ends after 6 April 2023. The ability for trustees to exempt specified performance fees from the charge cap will apply from 6 April 2023. 

The consultation response can be found here, the regulations here and the statutory guidance here.

Regulator publishes guidance for trustees on supporting DC savers in the current economic environment

The Regulator recently published guidance for setting out the steps which it considers trustees should be taking to support DC savers in the current economic environment. It emphasises the importance of member communication to help members understand the impact of current volatility, as well as the importance of reviewing governance and investment arrangements. Many of the steps which the Regulator is recommending are not new, but the guidance serves as a useful reminder of the Regulator's expectations of trustees, and is a useful reference point as trustees continue to monitor, and where they consider it necessary address, the impact of market changes on their own schemes. 

The Regulator guidance can be found here. 

Consultation on the new value for money framework: paving the way for further DC consolidation?

The Regulator and the Financial Conduct Authority (FCA), together with the Department for Work and Pensions, have recently published a joint consultation seeking views on the proposed value for money (VFM) framework. The consultation, which builds on previous work undertaken by the Regulator and the FCA puts forward a number of policy proposals which would require trustees of occupational pension schemes, and Independent Governance Committees (IGCs) of workplace personal pension schemes, to publicly disclose, assess and compare the value for money of their pension schemes.  

The policy objective driving the value for money framework is to allow schemes and their members to be able to compare arrangements - across both occupational and contract-based - more easily and see which offers better value for money. It is also being seen as a way for employers to be better able to compare arrangements when deciding which arrangement to use to automatically enrol their employees. It is seen as a key driver in the Government's ultimate objective of ensuring that the increasing number of savers in DC arrangements get the best possible value and the best possible long term outcomes. Consolidation has previously been cited as a benefit of the framework (on the basis that greater transparency would likely drive further consolidation, which the Government considers will ultimately also be beneficial). The Government has confirmed for the first time as part of this consultation that it is considering introducing a statutory requirement on schemes to consolidate if they are consistently underperforming against the requirements. It has also said that it is considering giving the Regulator power to enforce wind up and consolidation where a scheme is consistently not providing value for its members.

Under the proposals schemes would be required to make specified disclosures in the form of "framework data" in three main areas - cost, investment performance and quality service. The inclusion of investment performance and quality service, in addition to cost, reflects the growing concern amongst policy makers and regulators that cost is not the only factor in determining long term value for members. As expected, the proposals adopt a phased approach to implementation.  Initially the focus would be on the accumulation phase and the default arrangements of workplace schemes (i.e., schemes used for automatic enrolment). The proposal is then to extend the framework more widely to cover self-select options, non-workplace pensions, and DC pensions in decumulation. Once framework data had been disclosed, schemes would then need to assess (and disclose) whether their scheme provides value for money. The Government has indicated that the compliance deadline would be common across all schemes and is likely to be the end of October. It is not clear at this stage exactly how this will interrelate with the compliance deadlines for the current Chair's Statement.

The framework is intended to build on (and ultimately to replace), the legal requirement for trustees of smaller DC schemes (broadly, those with assets of under GBP 100 million) to undertake detailed value for member assessments and the current (wider) disclosure requirements relating to whether DC costs and charges represent value for money. Under the new framework all schemes (regardless of size) would be required to report on a much wider set of value metrics than is currently required and to use this date to assess the value of their offerings. A number of options are put forward as to whether the comparison would be conducted against a single, objective benchmark (set by regulators) or whether it would involve comparison against market (which is similar to the approach used in value for member assessment). No firm timings have been given for when the framework would be introduced, but the consultation suggests a timeframe of "a few years" might be likely. The consultation confirms that the DWP expects to conduct a further consultation with proposed changes to current regulations in due course, although no firm timing has been given.

The consultation document does not give rise to any immediate actions for trustees. Trustees with DC benefits should keep abreast of developments - this is a significant policy development for DC arrangements and the industry more widely. If implemented, it will also be relevant to employers in the context of their enrolment automatic duties.

The consultation, which runs until 27 March, can be found here.

DWP publishes call for evidence on addressing the challenge of deferred small pension pots

Following extensive work by the Small Pot Cross-Industry Co-ordination Group, in which Baker McKenzie representatives were involved, the DWP has published a call for evidence to gather feedback on the potential ways to address the industry challenges posed by deferred small pension pots. The publication refers to estimates by the Association of British Insurers that there may be over 2.2 million deferred pots under  GBP 1,000 currently held within contract-based schemes.

The call for evidence poses 25 questions, some of which are specifically aimed at pension providers, relating to several potential solutions to address the small pots issue and the general advantages and disadvantages attaching to each solution. The two main options put forward are the “default consolidator” model, where small pots are consolidated into a single or multiple consolidator vehicles in specified circumstances, and the “pot follows member” model where a deferred pension pot is transferred into the member’s current active pension arrangement, again in specified circumstances.   

Several unsuccessful attempts have been made to address the issue of small pots and it remains to be seen if the nut will finally be cracked this time. The broader spectrum of changes which the Government is seeking to introduce, such as the new value for money framework, may provide added impetus. Certainly, the drive to find a solution for this is becoming ever more relevant and is an issue which trustees are increasingly having to grapple with.

The call for evidence, which runs until 27 March 2023, can be found here.

Call for evidence on broadening collective defined contribution

The Government has published a consultation seeking views on policy proposals for broadening Collective Defined Contribution (CDC) beyond single or connected employer schemes to accommodate multi-employer schemes. It is also seeking views on the possible role of CDC in decumulation. A decumulation only model gives rise to a number of potential issues and it is early days in terms of this development. 

The consultation, which runs until 27 March can be found here.