The Pension Regulator’s found a new can of worms to open. This time it relates to a very local problem but creates some difficulties for those running and governing DC pensions. As the vast majority of money going into DC pensions is our money- coming from our salaries, this is important.

The issue

Currently it is very hard to put a value on a property and to value units in a property fund. In order not to liquidate properties at a false price, most property funds are currently in lockdown or “gated” as fund managers call it.

Trustees are nervous about allowing savers who’ve chosen property funds to pile more money into a fund that has uncertain value so they are beginning to divert money that would have gone to property into alternative assets that behave like property funds but are more liquid so don’t go into lock-down.

The Pension Regulator has this to say about replacing a property fund with an “alternative” fund.

Some trustees, having taken investment advice, are redirecting scheme contributions into alternative funds until the gated funds re-open. This could result in the alternative funds becoming default arrangements and therefore subject to legal requirements such as the charge cap (if the scheme is used for automatic enrolment) and the requirement to have a statement of investment principles for that default arrangement.

You may need to take legal advice to assess whether this is the case for your scheme. According to the DC code of practice, the position will depend on how the members who selected their investment made their choice. Were they aware and did they agree to their contributions being used in this way?

We believe that the only circumstances where a default arrangement would not be created are if either:

• members were made aware before they selected the original fund that contributions could be diverted to another fund in certain situations
• you contacted the members before diverting contributions and obtained their consent: please note that you should consider taking advice on the implications for your scheme before doing this

If you have discovered that you have unintentionally created a default arrangement by diverting funds you should immediately take steps to ensure this arrangement meets the legal requirements. These requirements include falling within the charge cap if the scheme is used for automatic enrolment and having a statement of investment principles that meets the requirements for a default arrangement.

Fund substitutions – can of worms

There are some real problems here. Firstly, most workplace pensions sit on fund platforms which rely on fund substitutions when things go wrong.

There are exceptions. We saw with Woodford that SJP did not need to substitute the fund , they just substituted Woodford as manager and got new managers to sort out Woodford’s mess. But most people exposed to Woodford  were directly invested in a Woodford fund and had to divert future monies to alternatives.

What tPR is saying is not just to do with property funds, it’s to do with any fund substitution and it’s saying to trustees that changing fund (not fund manager) is tantamount to making the new fund the “default”.

Trustees can get round this by telling members who self-select they have the powers to substitute or by giving the members who’ve made a selection the job of choosing for themselves. But both options are likely to be difficult. Trustees do not want to be seen to be accountable for substitutions, especially if when the old fund comes out of lockdown, it shows it was resilient and a better bet than the replacement. But nor do trustees want to have new defaults to report on (with all the hassle of policing charges and writing SIPPs). This is the can of worms.

So what is tPR worried about?

TPR says it is worried about members who specified how they wanted their contributions invested, finding that the trustees hi-jacked their choice (in breach of their DC Code of Practice)

But I suspect there is a wider issue of value for members, at play here. What tPR are doing is de-railing the process of fund substitutions by demanding each time this happens a “mini-default” is set up. Ultimately this would lead to any self-invested option that was replaced coming under the same rules as the scheme default.

This looks to me like the work of the DWP, who are keen to limit the capacity of workplace pensions to offer semi-governed fund options on platforms, with little responsibility for the outcomes of those funds.

So if you want to offer a Woodford style fund to workplace savers, you will forward have to tell members you are  accountable for how it does and tell them you have the right to  change it if things go wrong, or you will have to treat the substituted fund as a mini-default. Either way – your duty of care to the funds you offer under self-select has changed.

Broader issues for fund platforms.

Most money that goes through workplace pensions defaults to a single fund or option. However, the fund platforms used for self invested personal pensions are the other way round with advisers avoiding default solutions and promoting choice.

The issues of gated property funds, of Woodford and of all the unregulated UCIS funds that have given so much trouble are much more prevalent in this self-invested world.

In the past few days, the High Court has finally rules for Carey Pensions , saying that the management of the SIPP could not be held accountable for the value destruction caused by using funds selected on its platform by investors (usually under advice).

So while tPR is tightening the duty of care for trustees of workplace schemes, the FCA is seeing its capacity to enforce governmental requirements on non-workplace pensions reduce.

Differing approaches to self-investment

So to sum up- tPR are hinting at a regime where trustees take more responsibility for the outcomes of self-selection within workplace pensions (and occupational schemes in general) while the FCA are finding that contract-based providers are “off the hook”.

The FCA came in for some criticism earlier in the year (from me and the FT)  for not requiring IGCs the same reporting standards on self-select as on default funds.

I am more worried (post the Carey judgement) that contract-based pensions – especially those beyond the inspection of IGCs and GAAs will be under-regulated and that it will be FSCS and IFA policies that will be required to pay compensation.

But I am comforted that DWP/tPR are taking a tough position on the governance of self-selected funds – requiring trustees to be clearer about their duties and ensuring that where things go wrong, trustees are subject to the “default rules” and/or clear disclosures that they will be accountable for fund substitution when members take choices.

Conclusions for investors

If you are looking to manage your own fund portfolio then increasingly you will be able to do this within a master trust or within a contract based plan.

Not all master trusts offer self-invested options but expect many to move into this space as they try to increase their average account balances.

It looks as if the default legislation that covers workplace pensions is being used by DWP/tPR to protect members from illiquidity and high charges.

But there are other questions that arise, especially the statutory rights of members to 100% of their money on transfer and at normal retirement age. These rights appear to apply equally to single employer and multi-employer schemes.

So long as these statutory obligations remain (and I think they are exclusive to trust based schemes) then trustees are going to be very nervous of having any illiquid funds or illiquidity within its default. There is only one place to go for that liquidity and that is the sponsor. Which opens up another can of worms.