The IORP II directive has finally been transposed. This directive has been the subject of much scrutiny and debate over the past two years but now we have clarity. All stakeholders must start the process of preparing for the significant changes required to ensure compliance with the directive.
The directive is designed to deliver a number of key benefits:
Better protection for scheme members through enhanced governance and risk management
Clear, relevant and more consistent communication to scheme members
Remove barriers to cross-border schemes
Ensure that trustees have the necessary powers and credentials to supervise schemes
The principles upon which this directive are founded all look sound. The cornerstone of the regulations is to ensure that trustees put in place effective systems of governance including:
Ongoing risk management
Internal audit function
Written policies and procedures
A digital communications strategy for members
Trustees are suitably qualified and experienced
Environmental, Social and Governance (ESG) factors are considered
Through these measures trustees and scheme administrators will have to ensure their scheme operates to a very high standard of governance and compliance, which should give the regulators and scheme members comfort that their pension benefits are being well managed.
The regulations are aimed at large Defined Contribution & Defined Benefit Group Pension schemes and they will present many challenges. The Pensions Authority are due to issue draft guidance notes in July 2021 which will be subject to consultation, with final guidance notes being issued in November 2021.
Given the scale of these changes, the costs associated with implementing them for individual schemes will be significant and this cost is likely will be passed on to the employer or the scheme members.
This in turn may force employers to look for a more cost effective and less administratively cumbersome solution to operating their own pension scheme.
The solution which is being heralded by the Pensions Authority is Master Trusts. This will allow multiple employers to sign up to one scheme and all regulatory and governance requirements will be met by the trustees of the Master Trust. The main rationale for this type of structure is that it will deliver enhanced consumer protection and economies of scale which will reduce costs for scheme members. In reality it will reduce the number of schemes in operation which is a key objective of the Pensions Authority.
However, there are downsides to Master Trusts.
They will be managed by a corporate trustee company typically a subsidiary of a large life company, so there are potential conflicts of interest
There will be little or no input from the employer or members in designing a scheme that is appropriate to its employee base
There will be reduced flexibility on pricing
There will be limited investment choice with a focus on default or lifestyle investment solutions
There are only a small number of Master Trust providers in Ireland which will mean limited competition in the market which is typically not a good thing from a consumer point of view
The employers existing scheme may have to be wound up in order to facilitate participation in a Master Trust.
A key component of the directive is that governance should be proportionate to the size, scale and complexity of the scheme. However, subject to the guidance to be issued by the Pensions Authority, smaller schemes including one member schemes are expected to comply fully with the regulations. Imposing such a level of governance on one member schemes in particular will make it impossible for the trustees to implement.
One member schemes must now adhere to the “Prudent Person” rules which will apply to trustees of these schemes. This means investments must be made in the sole interest of the member, properly diversified, avoid risk concentration and invest “predominantly in regulated markets”. Predominantly is deemed to mean at least 50% of the schemes assets. Heretofore, one member schemes had a derogation from these investment regulations.
But this is where it gets ugly.
In respect of the governance regulations, a temporary derogation has been granted to one member scheme for the next 5 years. At the end of this period they must comply fully with the regulations. However, from the 22nd April 2021, both existing and new one member schemes must adhere to the investment regulations immediately.
An open ended derogation has been granted to existing unregulated investments and borrowings held in one member schemes. However, any funds added to the scheme through contributions, transfers or the investment returns/sale proceeds from existing investments are subject to the Prudent Person rules and must be invested predominantly in regulated markets. This adds significant complexity to the situation and it creates a two tier system that requires detailed tracking of both existing investments and future investments.
For those who manage their own pension scheme and invest in particular asset classes, such as property, that choice is going to be removed in the vast majority of cases given the level of funds required to invest in property.
The attractiveness of occupational pensions is the enhanced employer contributions afforded to members over other pensions products such as PRSAs or Personal Pensions. Until such time as PRSAs are changed to allow for the same level of funding, what we will see is a lot of manoeuvring being done to maintain enhanced employer funding but avoid governance and investment restrictions. The regulations only apply to occupational pension schemes. So the likelihood is that one member schemes will be transferred to either PRSAs, Buy Out Bonds or retired into ARFs. Individuals could find themselves with multiple pension structures all over again which is not the desired outcome when trying to achieve a more simplified pension system.
Looking into the future, the pension market will most likely be dominated by Master Trusts which will be the main provider of employer sponsored pensions schemes. For those who want to operate a small group scheme for employees without the burden of all these governance and investment regulations, a group PRSA could be a viable alternative. One member schemes will be regulated out of existence over time. Hopefully the Pensions Authority will make the necessary changes to PRSAs to allow enhanced employer contributions to give consumers the choice to manage their own pension.
Blue Oak Counsel offer wealth management and investment advice to professionals
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