Nadia Dabbagh-Hobrow Secretary SORP Working Party c/o KPMG One Snowhill Snow Hill Queensway Birmingham B4 6GH Dear Ms Dabbagh-Hobrow 3 rd July 2014 Comments on the exposure draft Statement of Recommended Practice: Financial Reports of Pension Schemes We are grateful for the opportunity to comment on the exposure draft of the Statement of Recommended Practice ( SORP ) Financial Reports of Pension Schemes and are pleased to set out below the views of the Railways Pension Trustee Company Limited ( RPTCL ). 1. Background and introduction RPTCL is responsible for preparing and approving the financial statements of all the main pension schemes in the UK railway industry. At the end of 2013 these schemes, of which the largest is the Railways Pension Scheme, had combined assets of over 21bn and total membership of around 350,000. During 2013 RPTCL paid over 966m in benefits and collected over 715m in contributions on behalf of the pension schemes of which it is trustee. RPTCL s common investment funds also accrued investment income during 2013 of over 330m. Following the publication of FRED 48, which preceded FRS 102, RPTCL wrote to the Financial Reporting Council (then the Accounting Standards Board), expressing strong opposition to the risk disclosures that were being proposed. When FRS 102 eventually appeared, we noted that the risk disclosures had been somewhat reduced compared to FRED 48, but were disappointed to see that what remained still amounted to significant new disclosures in this area. We remain of the view that risk disclosures are of little or no value to the users of scheme accounts, and will only result in increased costs of production and audit. This is therefore the main area we address below. We also make some remarks on consolidation, the pricing hierarchy, and on the other areas on which comments are sought in the exposure draft. 2. Risk disclosures Though the risk disclosures in the draft SORP are not as onerous as they would have been if FRS 102 had reflected FRED 48 in full, we still believe they represent a burden, in the form of preparation costs and audit, that is unrewarded by any benefit. Defined benefit pension scheme accounts exist first and foremost, to give members and their representatives (such as trades unions) a stewardship report of the most recent year of their scheme, and second as a key input into each triennial actuarial valuation and annual actuarial update reports. The addition of risk disclosures does not enhance the ability of scheme accounts to meet either of the above mentioned objectives, and it is almost inconceivable that fiduciary trustees and their advisors would ever, or should ever, use the annual report and accounts as the source of risk information when making investment decisions. Typical timescales for the production of reports and accounts means that while they are useful as a matter of
audited historical record, by the time they are published, any risk and liquidity information they contain will be well out of date and hence useless for informed decision-making. In any case, the sort of information envisaged is of a completely different kind from that which decision-makers would use in practice. The risk and pricing disclosures are part of a worrying trend of importing non-accounting information into reports and accounts and hence bringing further information into the scope of the financial audit when such information is much better dealt with through other channels. Investment risk and liquidity information is undoubtedly useful in the right context, but in the case of pension schemes it is best kept out of periodic, historical financial statements, in order that it can be produced more quickly, more cheaply, be directed at the correct audience, and be more effectively targeted at particular decisions, which will all tend to have a forward-looking dimension. In our view, the relentless year-on-year expansion of disclosures in accounts generally is seriously misguided, and seems only to benefit those who are paid to implement and audit accounting regulations, rather than the users. Many problems are far better and much more cheaply solved without recourse to piecemeal accounting standards and audit confirmation bias. 3. Fair value hierarchy The exposure draft asks whether it is helpful to draw a distinction within category C investments between those that are priced using market observable data and those that are not. As with risk disclosures, we do not believe the pricing hierarchy generally will be a desirable or useful feature in pension scheme accounts. However, if such a hierarchy has to be included, it is extremely unfortunate that it is not identical with the similar, but slightly different, hierarchy of IFRS. Having two hierarchies will be confusing to even the informed reader, and service providers and custody systems will needlessly be forced to deal with the two different analyses. Our preference, if the hierarchy cannot be dropped, would be to approach the Financial Reporting Council to see whether FRS 102 could be changed, or if not whether the SORP could override FRS 102 in order to bring the analysis into line with IFRS, on the grounds that these are exceptional circumstances. If the hierarchy cannot be dropped and FRS 102 cannot be overridden either, then it would seem to be sensible to draw the distinction between the two sub-classes within category C, if only for consistency with the IMA SORP. 4. Consolidation Section 3.20 of the exposure draft states that investments in Special Purpose Entities (SPEs) should not be consolidated, even where the scheme is the only investor. The justification for this relies on following a chain of definitions in FRS 102 s glossary. This conclusion seems to RPTCL to be contrary to the underlying theory of consolidation, which would require that subsidiaries are consolidated, or at least that there exists the option to consolidate them. Good accounting principles seem to be being sacrificed merely to favour the letter of the way terms are defined in FRS 102 s glossary. The phrase exclusively with a view to subsequent resale has a meaning in ordinary English and in normal accounting usage that would exclude, for example, property subsidiaries generating a stream of rental income, which might never be sold, and therefore allow their consolidation.
We also note that the IMA s recently published SORP allows consolidation of SPEs where they meet the definition of Intermediate Holding Vehicles (IHVs), and that this appears to be for consistency with the FCA s handbook. At the very least this must open the door to the possibility of consolidation in spite of the definitions in the glossary of FRS 102, which should be reconsidered. Furthermore, as the exposure draft itself points out in paragraph 3.20.1, other sections of FRS 102 can be interpreted as requiring the opposite treatment, that is, consolidation of SPEs. In this case we feel that the parts of FRS 102 which allow consolidation should be allowed to prevail over a convoluted series of definitions in the glossary. We believe it is an important accounting principle that accounts should represent substance over form, and as a result, subsidiaries should in general be consolidated. RPTCL strongly disagrees with the conclusion that SPEs should be excluded from consolidation. 5. Annuities The exposure draft specifically asks for views on whether annuities should be reported at the amount of the related obligation. We note the difficulty referred to in 3.12.19 that there are several bases for determining actuarial liabilities. Given that actuarial liabilities are usually excluded from pension scheme accounts, it could be argued that the proposed treatment results in an inconsistency within a single set of accounts (the inclusion of annuity liabilities but not other liabilities) in order to deal with FRS 102 s requirement that the value of annuities should be included. On balance we feel that the complete exclusion of annuities would have been the better and most pragmatic option, but we do not feel quite so strongly on this point, especially in view of the fact that there will be no material impact on RPTCL s schemes. We cannot speak for other schemes which may have written more annuity contracts over a long number of years, although we hear this will involve trustees in additional costs payable to service providers to get them to build up and report the required details for audit. If the value is to be included, it seems sensible to follow the exposure draft s recommendation that the basis of valuation should reflect the circumstances and purpose of the annuity arrangements. 6. Financial statements presentation This is another area where the SORP specifically asks for views. As already noted, we are not in favour of the new risk disclosures generally. However, if they are to be included at all, having the alternatives available seems to do no harm, and it might be worth clarifying that pension schemes may be able to devise alternative approaches of their own which meet the requirements of FRS 102 and the SORP. There is a tendency on the part of preparers of financial statements and their auditors to place undue emphasis on examples of the kind given in the appendix to the exposure draft. Sometimes such examples appear to take on more importance than the text of the standards they are intended to illustrate. We therefore think it would be helpful if the SORP could further emphasise that the appendices are mere examples and that schemes may able to devise their own alternative presentations that satisfy the requirements of FRS 102 and the SORP. To give an idea of what we may mean here, we suggest that information about asset allocations over time, about security selection, market timing, duration management and
currency exposure may be more helpful to users wishing to understand how trustees approach investment decision-making in practice. RPTCL, for example, uses a Return, Risk, Liquidity framework which could be described more helpfully to give readers an understanding of how perceived risks are managed in practice. 7. Auto-enrolment The exposure draft asks for views on the treatment of the first contributions deducted for auto-enrolled members who opt-out. Section 3.8 of the exposure draft suggests a different treatment depending on whether the opting-out takes place before or after the employer has remitted the contributions to the scheme. Arguing from first principles, we would prefer a method that results in the same treatment irrespective of whether or not the contributions happen to have been remitted to the scheme, which would also be consistent with the method of accounting for contributions generally. However, we find it extremely difficult to envisage a situation where the amounts in question will ever be material to the report and accounts; in fact we expect these numbers will usually be so small that we shall not report them separately at all. The given method at least has the merit of being easy to apply, therefore we have no very strong objection to the proposed treatment if only on the grounds of materiality. 8. Legislative disclosure requirements In the view of RPTCL, the legislative disclosure requirements of Appendix 7, which are sourced from the Audited Accounts disclosure regulations, add nothing of value to the format of scheme accounts beyond that already required by FRS 102 and the exposure draft. In particular the regulations require the division of investments between UK and overseas. This distinction has always been difficult to draw. For global companies with operations in many countries including the UK, the distinction may only be drawn arbitrarily, and has no value to the users of accounts in our opinion. Similar difficulties are to found with pooled investment vehicles. In practice, investment risks tend to be considered across developed and developing markets as a whole, rather than UK and overseas (which obviously breaks down between developed markets and developing or emerging markets). We therefore concur with the exposure draft s approach of confining these disclosures to an appendix, so that they may easily be ignored once they cease to be a regulatory requirement. 9. Concentration of investments Finally, the exposure draft seeks views on the requirement to disclose any investment in which more than 5% of the net assets of a scheme are invested. As the exposure draft points out, this needs to be considered in light of the fact that there are separate regulations and disclosure requirements for employer related investments. Concerning the question about whether such a calculation should be done on a look-through basis for pooled investment vehicles, we note that analyses of this kind are extremely difficult in practice, due to the opacity of the investments. With this in mind, RPTCL believes that the SORP should adopt a risk-based approach. The proposed treatment should balance the likelihood of schemes breaching the 5% limit against the time and cost of deriving the relevant number, which in the case of schemes with significant investments in hedge funds and private equity partnerships would be considerable.
In this particular case, RPTCL believes that the value to the reader of the 5% disclosure does not warrant the time and cost that would be required to calculate the number on a lookthrough basis, and since the number would be of even less use to the reader on a non-look through basis, our view is that this disclosure is really not necessary at all. 10. Summary and conclusion Concerning the specific issues raised by the consultation, we have the most difficulty agreeing with the risk disclosures, since we believe they will be of absolutely no value to the readers of pension scheme accounts. We appreciate that the SORP has to be consistent with FRS 102, but think that PRAG should consider whether the disclosures can be further reduced to be made more meaningful, while retaining sufficient broad consistency with FRS 102 to satisfy the Financial Reporting Council. We are also concerned that the exposure draft has reached the wrong conclusion on consolidation rules. The problem derives from the definitions in FRS 102, but given the consolidation requirements of other areas of FRS 102, it would seem to be possible to reach the correct conclusion and still retain broad consistency with the standard. This could be done by merely interpreting terms according to their usual accounting meaning, rather than according to the strict letter of the glossary of FRS 102. We should like to thank PRAG for the standard of the exposure draft, which is the most significant revision of pension scheme accounting rules in many years. We do hope you can take our comments on the exposure draft into account, and we should be happy to expand on any aspect of this response or related issues at a follow-up meeting or by further correspondence. Yours faithfully John Chilman Chairman of the Trustee Board Railways Pension Trustee Company John Mayfield Chairman of the Audit Committee Railways Pension Trustee Company