Spring 2017 Pension Update Shedding some light Analysing developments in the pensions sector In this issue DC Risk A sleeping dog? 1 Safeguarding Trust Assets 4 DC Codes of Governance What do they mean in practice? 5 IORPS Directive 6
DC Risk A sleeping dog? Recent years have seen many employers manage the risks associated with their defined benefit ( DB ) pension schemes by closing them to future accrual and establishing replacement defined contribution ( DC ) schemes. In general, those DC schemes are ticking along quietly and most finance directors believe pension risks have now been largely contained. However, DC schemes carry with them an array of different and often latent risks which trustees and employers may not be aware of until years after problems begin. Specifically, these risks cover issues such as investment, administration and retirement. Retirement 1. The advice gap It is clear from legislation and related Pensions Authority guidance that trustees are expected to make arrangements for the payment of benefits as they fall due and provide benefit option statements to members when they reach retirement. However, trustees are not subject to very prescriptive obligations in terms of preparing members for retirement. At a regulatory level, the focus seems to be more on tasking trustees with administrative functions associated with paying benefits. While trustees can, and should, provide members with basic information on their retirement options, they cannot stray into providing financial advice to members. This seems to be recognised in the Pensions Authority s Trustee Handbook which recommends that trustees encourage members to seek advice when considering their retirement options. The reality is that members will require financial advice, not only at point of retirement but also in the five to ten years leading up to that date. There is a debate brewing within the industry about who has the responsibility for filling this advice gap. At one level, DC schemes are about individuals taking responsibility for their own retirement savings so it is for them to seek, and pay, for any associated financial advice they may need. The difficulty employers and trustees have in getting DC members to take ownership of their retirement planning in DC schemes often stems from the fact that a DC scheme is a benefit provided through the employment relationship. Therefore, many members assume that the trustees or employer are taking responsibility for ensuring they get an adequate pension and are often very ill-equipped for the difficult decisions they face when it comes to retirement. This is why communication and engagement with members is so critical in a DC context. If the employer expects members to use the DC scheme to take control of their own retirement savings then that message needs to be clear from the outset and communicated to members consistently. Where it is not clear whether an employer is adopting a paternalistic or individualistic approach in helping members prepare for retirement, trustees should engage with the employer to get an understanding of what the employer s perspective is on that issue. If the employer wishes to adopt a paternalistic approach, then arrangements and processes should be put in place to ensure that members are well prepared when the time comes to make those important financial decisions. What those arrangements should look like will vary from organisation to organisation. It may simply involve employers paying for or subsidising financial advice for employees at point of retirement. At another level, it could involve organising retirement clinics on site where DC members can meet with financial advisers periodically as they get closer to retirement. As DC trustees generally will not be in a position to pay for the advice members will require, they will need to engage with employers on this issue. While there would be a cost to employers in putting such arrangements in place, those costs need to be viewed in the context of potential claim costs which employers may be exposed to if retirement risks are not properly managed. 1
2. Age Discrimination It is generally acknowledged that the current average level of contributions to DC schemes are not going to be sufficient to provide members with adequate pensions in retirement. As a result, there is a risk that there will be a growing trend in the years ahead of employees not being able to afford to retire. This trend emerges against a changed legislative landscape where mandatory retirement ages must be objectively justified. Where employers now seek to enforce contractual retirement ages and employees find that they cannot afford to retire, this is likely to prompt discrimination claims against employers. The Employment Equality (Abolition of Mandatory Retirement Age) Bill 2016 was debated in the Dáil on 23 February 2017. This opposition sponsored Bill proposes that, save in the case of employment in An Garda Siochána, the Defence Forces and other specified emergency services, it shall not be lawful to set or contract an age for the compulsory retirement of an employee. While this Bill is unlikely to become law in its present form, it is indicative of increased opposition to employees having to leave a job simply because they have reached an age set by their employer. We are already beginning to see a growing number of age discrimination claims relating to retirement ages. A variety of defences have been used by employers to objectively justify mandatory retirement ages, including health and safety and promoting workforce cohesion. However, the case law makes it clear that the sort of defences which will succeed are very case specific, not only to the employer but also to the particular role in question. For these reasons, employers are best advised to put in place appropriate arrangements which will assist in raising awareness of employees intended retirement plans. Some employers might also consider extending retirement ages to align them with increases in the State pension age. However, doing so throws up a number of legal and other issues which will need to be carefully managed. 3. Investment lifestyle transitioning and market risk The importance of implementing best investment practices are never more required than when members move close to retirement and are involved in a once in a lifetime transition of their retirement funds from group DC schemes into post-retirement retail products. If members investment switches are made late or not made at all then any loss in value associated with such errors is much more difficult to recover from. Members may naturally look to the trustees to make good such losses, with potential consequences for employers who indemnify those trustees. Also, once members have decided how they wish their DC pot to be applied at retirement there is likely to be a gap between disinvestment from the scheme and reinvestment into an ARF product, for instance. Again, any significant movement in asset values, or any change in investment strategy, while that transition from one investment to another is taking place may cause members to suffer losses, or not to achieve the desired outcome. Those losses could be avoided if that out of market risk had been minimised. It is vitally important, therefore, for trustees to ensure that they have robust procedures in place with their administrators and investment managers to minimise the risk of any such errors or delays. 2
A more difficult decision for trustees is whether they stray into the retail and post-retirement market to try to secure discounted charges for members with a preferred provider. The scale and purchasing power a large DC scheme brings with it may enable trustees to secure such preferential rates for members. Some argue that trustees duties to safeguard trust assets extend to ensuring members get value for money when it comes to accessing their DC pots on retirement. Unless the terms of the particular trust deed create such an obligation, in our view, it is not correct to extend that duty into the post-retirement world. At that point, members are drawing down their benefits so those assets cease to be trust assets which trustees have a legal duty to safeguard. If you have any queries on the issues addressed in this article, please contact: Ian Devlin Partner +353 1 6644 219 iandevlin@eversheds-sutherland.ie That said, if trustees go down the road of offering members access to a preferred provider, they need to be very careful in how that option is communicated. Members need to understand that it is their decision how to apply their DC pot on retirement, with the support of appropriate financial advice. It is likely that the whole area of financial advice at retirement will become subject to much more scrutiny in the years ahead, particularly in light of the Pensions Council s report last year on ARF charges. Whether this report prompts any legislative reforms remains to be seen. In the meantime, what trustees and employers can strive for is that members are well educated on the options available to them at retirement, and are able to ask the right questions in understanding the retail products on offer. 3
Safeguarding Trust Assets So you are a trustee or you indemnify a trustee. Do you know if your trust fund is being properly safeguarded? Safeguarding trust assets where trustees are individuals These days, trustees are so focused on selecting the right basket of investment for a scheme s profile they may overlook one of their key obligations: to safeguard the scheme s assets. In this article Fiona Thornton reflects on this basic duty and how, unwittingly, trustees who are individuals may be failing to ensure that their assets are lawfully held and transferred on a change of trustees. A primary duty of trustees is to place the trust property in their own names and under their own control. Title to the assets must generally be vested in the trustees as a body and it is not enough for only one of the trustees to exercise control or hold the title to the assets. This duty may be varied by the express provisions of the particular trust deed. Trustees are, as a matter of law, precluded from holding investments in the name of the Trustees of the XYZ Scheme. A trust is not a separate legal entity and therefore cannot hold assets in its own name. Unitised Funds Most unitised funds are not used to dealing with individual trustees and do not record the investor as the individual trustees (either choosing to record the owner as the scheme or the trustees of the xyz scheme ) despite neither being a legal entity capable of holding the investments. Although it is not legally correct, it appears the managers do not seem to mind doing this and it makes their life easier. The Subscription Form It is key to ensure that the correct legal owners are described on the subscription form for the funds. If the fund then chooses, as a matter of practice, to record them as trustees of the xyz scheme, then that is up to the fund, but provided the trustees have subscribed in their own names (and properly transfer ownership on change of trustee), they should technically be complying with the trust deed even if the fund is using a short cut to record ownership in its registry. Deeds of Appointment The issue is slightly more complex for individual trustees as they may be required by their trust deed to hold investments in a certain way. On a change of trustees, there may be legal issues around whether contracts entered into by one set of trustees are enforceable by successor trustees. A contract, such as an investment subscription agreement, may be in one set of trustees names and successor trustees may not be bound by it or the retiring trustee not discharged in respect of his/her obligations when he/she retires. Failure to ensure that the contract applies to successor trustees may put the trustees and their sponsor/the fund at risk if the manager does not discharge its functions properly. These issues can be solved depending on the language in the deed of appointment, by using a particular form of words. It is important for trustees, especially individuals, to arrange for a review of existing contracts to establish the names in which the trustees contracted with third parties, remedy any historic issues and put procedures in place to ensure that any prior bad practices are not repeated. If you have any queries on the issues addressed in this article, please contact: Fiona Thornton Consultant +353 1 6644 326 fionathornton@eversheds-sutherland.ie 4
DC Codes of Governance - What do they mean in practice? Corporate governance embodies the idea that if an organisation s managing board implements an appropriate set of processes which it adheres to and monitors diligently, better outcomes will result. In Ireland the overall concept of corporate governance has trickled down from publicly listed companies right through to not for profit organisations which have adopted the governance code for community and voluntary organisations. In relation to defined contribution ( DC ) schemes, the Pensions Authority (the Authority ) has fully embraced the importance of good corporate governance. The Authority perceives that members of well-run occupational pension schemes will be more likely to save, make reasonable decisions and, ultimately, have a better outcome than those belonging to a scheme where defined principles of good governance are an afterthought. Over the course of 2016, the Authority published a total of 11 individual codes of governance for DC schemes covering a range of important issues. The codes are not statements of law that prescribe distinct processes for every eventuality but are intended rather as guidelines designed to assist trustees to meet the standards of practice that form the basis of good governance and administration. They set out standards of behaviour, activities and control processes that the Authority expects trustees to adopt to demonstrate their commitment to serving the best interests of members and other beneficiaries. The codes are therefore structured as reference documents to enable DC trustees adopt a constructive and proactive approach to the running of their schemes. Each code provides some practical guidance on how trustees can give effect to its principles and the Authority advises that they supplement, and should be read in conjunction with, the Trustee Handbook. Practical Effect of the Codes While the codes are not legally binding, compliance is nevertheless treated with significant importance by the Authority, as publicly expressed by one of their senior officials last year: While compliance with the codes is not a statutory requirement, they have been issued pursuant to the Authority s statutory function under section 10 of the Pensions Act and in our view a failure to comply with a code may be indicative of a breach of duty under trust law or the Pensions Act. The Authority clearly contemplates being proactive in monitoring compliance levels. If you are a DC trustee or sponsor a DC scheme it is expected that you are familiar with the codes and take steps to ensure you discharge your role in compliance with an appropriate standard of corporate governance as tailored to the needs of your particular scheme. Where applicable, the Authority have also demonstrated a willingness to apply the principles espoused in the Codes in respect of individual defined benefit pension arrangements. Of particular concern should be the code relating to data protection, a subject which up to now has been something of a blind spot for many trustees. In the context of members personal information pension scheme trustees act as data controllers and must therefore take appropriate measures with regard to how such information is shared and processed. The Authority have stated that they expect that trustees will comply with the Data Protection Acts. In Ireland, the Office of the Data Protection Commissioner is responsible for ensuring compliance with the Data Protection Acts. While a failure to comply with the Data Protection Acts may result in reputational damage, it could also result in a fine of up to 100,000 if convicted on foot of proceedings brought and prosecuted by the Data Protection Commissioner depending on the nature of the offence. If you have any queries on the issues addressed in this article, please contact: Robert Vard Associate +353 1 6644976 robertvard@eversheds-sutherland.ie 5
IORPS Directive The Arrival of IORPS II Over two years after initially being proposed, the new IORPs Directive 2016/2341/EC ( IORPs II ) was adopted by the European Parliament on 14 December 2016 and came into effect on 12 January 2017. Member states will now have until 13 January 2019 to incorporate IORPs II into national law. Background The original IORPS Directive was adopted in 2003 and sought to introduce a harmonised European framework governing the activities of institutions for occupational retirement provision ( IORPs ) and to promote the creation of a European market for cross-border pension schemes, an objective which was only partially achieved. In March 2014, the European Commission published a proposal for a revised IORPs Directive with four main objectives: i. ensuring good governance and risk management of IORPs; ii. providing members with clear and relevant information; iii. removing the barriers to cross-border IORPs activity; and iv. ensuring that national regulators have appropriate tools to effectively supervise IORPs. Final Text Key Improvements from the original proposal Key improvements in the final text include: i. Funding requirements for cross-border schemes although the initial requirement for cross-border schemes to be fully funded at all times has been retained, the final text now provides that where this condition is not met, appropriate measures must be taken without delay to ensure that member benefits are adequately protected. While the language is slightly unclear, it would appear to allow cross-border schemes to be underfunded for limited periods provided some form of recovery plan is put in place to protect members. ii. Requirements for pension benefit statements the original text contained prescriptive requirements in respect of the content of annual benefit statements which have been dropped. Instead, Member States are given scope to determine the exact information to be required, subject to certain minimum requirements. iii. Trustee qualifications and experience requirements the requirement for professional qualifications has been limited to auditors and actuaries and the requirement for adequate knowledge and experience can be met on a collective basis by the trustee board rather than individually as was originally required. iv. Solvency requirements a new recital has been added to the Directive ruling out the development of solvency requirements for pension schemes at an EU level. The recital acknowledges that such models are not realistic in practical terms and not effective in terms of costs and benefits. Key Provisions of IORPs II General principles The text of the Directive includes a number of general principles to which trustees and administrators must have regard in the context of operating IORPs. The Directive requires IORPs, where relevant, to have regard to the aim of having an equitable spread of risks and benefits between generations in their activities. This principle is drafted broadly and will be open to interpretation when the government implements the Directive into Irish law. However, it is clear that both trustees and employers will need to take this issue into account when contemplating certain activities and this could lead to some interesting considerations, particularly in the context of scheme restructurings. The Directive also requires those operating IORPs to take environmental, social and governance issues into account when assessing the long term impact of investment decisions. 6
Member communication IORPs will be required to provide annual benefit statements to both active and deferred members. This represents a significant change to the current position under the Disclosure Regulations which only require trustees to provide deferred members with limited information and only at their request. Trustees should therefore review their administrative processes now to ensure that the new requirements can be managed effectively. Effective governance Ensuring more effective governance of IORPs is perhaps the main focus of IORPs II. Certainly a significant portion of the Directive is now devoted to governance matters. All IORPs will be required to have an effective system of governance which provides for sound and prudent management of their activities. In this regard, the Directive identifies a number of key functions which every IORP will have to put in place including: a risk management function aimed at identifying, measuring, monitoring and reporting on the risks to which the IORP could be exposed Cross-border activity Promoting cross-border activity and supporting a pan- European pensions market was one of IORPs II s key objectives. It is therefore perhaps surprising to find that the fully funded requirement for cross-border schemes, seen as one of the major obstacles to cross-border activity, has been retained. However, as mentioned earlier, the Directive appears to allow for periods of underfunding provided the trustees ensure that member benefits are adequately protected. While it remains to be seen exactly how this provision will be interpreted, if this view is correct and finds its way into Irish law, cross-border schemes could become a more feasible and attractive option for certain employers. Depositary Member States have been granted a discretion as to whether to require IORPs to appoint a depositary to hold scheme assets. If Ireland elects to include such an obligation when implementing the Directive into national law schemes would face additional costs associated with having to appoint a depositary. an internal audit function to evaluate the adequacy and effectiveness of the IORP s internal control system and other elements of its governance including outsourced activities an actuarial function where appropriate In addition to the functions outlined above, IORPs will also be required to prepare and maintain a remuneration policy covering all those persons who effectively run the IORP, carry out key functions and whose professional activities have a material impact on the risk profile of the IORP. Finally, although the requirement for professional qualified trustees was dropped from the final text, there will still be a requirement for a trustee board to collectively have suitable knowledge, experience and qualifications. 7
Conclusion The extent of the impact of the new provisions to be introduced under IORPs II will depend on the manner in which the government interprets and seeks to implement its principles into national law. The new requirements imposed on occupational pension schemes and the trustees running those schemes, may be a factor in accelerating scheme consolidation. Both trustees and employers should review the operational structure of their pension schemes and consider how the new requirements are likely to affect them. If you have any queries on the issues addressed in this article, please contact: Peter Fahy Partner +353 1 6644 206 peterfahy@eversheds-sutherland.ie David McKeating Solicitor +353 1 6644369 davidmckeating@eversheds-sutherland.ie 8
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