Pension trustee skills, capability and culture: a call for evidence
On 11 July 2023, the DWP and HMT issued a call for evidence to support the development of policy options for improving the skills and capability of pension trustees and removing barriers to trustees’ ability to make effective investment decisions.
In this response
We welcome the opportunity to respond to this call for evidence. In addition to answering specific questions which are pertinent to our practice, or which we believe could give rise to issues in practice for our clients, we have provided some initial general comments.
Trustee skills and capability
An occupational pension scheme trustee’s duties are derived from a number of different sources. Trustees are required to comply with trust law, case law, both pensions specific and relevant non-pensions legislation and regulatory requirements, as well as the terms of their scheme rules. Examples of relevant non-pensions requirements include company law (if the trustee board is incorporated), anti-money laundering and data protection obligations.
Given the sheer volume alone of pensions specific legal and regulatory requirements, being an occupational pension scheme trustee is a significant undertaking. When assessing trustees’ skills and capabilities, it is important to do so at board level. This applies equally where schemes have professional trustees appointed and where they do not, as professional trustees themselves have different skill sets. In our experience, it is the blend of diverse skills and backgrounds which help to make trustee boards most effective.
This is recognised by the Pensions Regulator’s (TPR) 21st century trusteeship review, its draft general (previously called “single”) code of practice, and its recent push to increase board diversity and inclusion.
The power to make investment decisions rests with the trustees under both trust law and pensions legislation. Under the Investment Regulations, scheme assets must be invested in the “best interests of members and beneficiaries”, but that does not necessarily mean maximising investment returns at all costs or, conversely, making investments that are risk-free.
Trustees must exercise any power for the purpose for which it has been given. For example, the purpose of the investment power in a DB scheme is, broadly speaking, to invest to generate returns in order to provide the specific levels of benefits promised. So, whilst trustees need to ensure sufficient investment returns, it does not follow that they must maximise investment returns for each individual DB member.
Trustees also have a duty of care when investing trust assets, which is often called the “prudent person” test. In summary, this requires trustees to take such care as an “ordinary prudent” person would take if they were making an investment on behalf of someone they felt “morally bound to provide” for. Whilst the “prudent person” test does not go as far as to say any investment must be risk-free, trustees must consider any potential risk in making any investment decisions.
For DB schemes, the current legislative and regulatory direction of travel is tending to steer trustees towards more risk-averse investments, even where the scheme is open to new members and new benefits continue to be built up. See our consultation responses to the new funding and investment regulations 2023 and TPR’s draft DB funding code of practice respectively. The importance of appropriate risk management is also emphasised in TPR’s DB funding and investment guidance, which goes into detail about how trustees should understand and mitigate investment risks. Whilst there is no legal requirement to follow TPR’s guidance, it is considered good practice.
Trustee skills and capability
Question 1: Do trustees know what the knowledge and understanding standards expected of them are?
Question 2: Do trustees currently meet the knowledge and understanding requirements expected of them? Are some types of trustee better than others?
The trustee knowledge and understanding (TKU) requirements seem to us to be well understood and comfortably met amongst the various trustee boards we advise.
In line with our General Comments, in our experience, trustee boards are most effective when there is a mixture of skills, providing a good balance of views and leading to more effective decision-making. This includes both schemes where there are professional trustees involved and where there are not.
Some of the schemes we advise delegate specific tasks to sub-committees, such as investment and corporate event planning, and those sub-committees often include individuals with specific expert knowledge who are not trustees. Whilst the ultimate decision-making rests with the trustees, having weighed up relevant factors, this input can be extremely helpful.
Given the vast array of legal and regulatory requirements occupational pension schemes are subject to, trustees are not and should not be expected to be pensions experts. In fact, there is a danger in trustees attempting to be self-reliant, which we are aware can happen owing to concerns around incurring the cost of external professional advice, particularly amongst smaller schemes.
A trustee’s role includes their duties to their members and other beneficiaries, knowing when to get expert advice and from whom, and having the confidence to challenge those advisers effectively. In our experience, such challenges come from across the trustee board, including from member-nominated trustees. To this extent, trustees are akin to a board of directors overseeing a company.
Trustee boards provide an essential link between scheme members and the sponsoring employer(s), especially where the scheme is mature with a high number deferreds and pensioners. Having individuals on the trustee board who understand the business and its history, from both the employer and members’ perspectives, can be invaluable.
Finally, we are supportive of TPR’s drive towards greater diversity and inclusion on trustee boards. Creating an environment where all trustees are inspired to contribute, their opinion is valued, and they are encouraged to challenge can only be beneficial.
Question 3: What are the barriers to improving trustee capability? What do you think government should do to ensure that all trustees meet the standards expected of them? Does trustee liability put off potential trustees?
The main barriers to improving trustee capability are often time and resource. Unless they are employed by a sponsoring employer, although volunteers, member-nominated trustees may not benefit from paid time off to fulfil their trustee duties. Being an occupational pension scheme trustee can be a major undertaking, so this could act as a deterrent to some.
To date it does not seem to us that potential personal liability deters lay trustees from being trustees. Where we have helped trustee boards run selection processes there has usually been a healthy number of candidates.
No doubt professional trustees will identify any particular concerns they may have here, as TPR expects higher standards from them.
Question 4: Do trustees (including Master Trust trustees) have the right knowledge and understanding to invest in the full breadth of investment opportunities? If not, what can be done to improve this?
Having regard to the trustee boards we advise, we do not believe there to be any issue with the level of TKU required for effective investment decision-making. It is one of the most highly regulated aspects of an occupational pension trustee’s role.
As highlighted in our General Comments, trustees must comply with certain requirements when exercising their investment powers, including pensions legislation and their scheme rules. Also, rather than being experts themselves, trustees are legally required to take formal investment advice and to rely on that advice under the Investment Regulations. However it is worth distinguishing between DB and DC arrangements in terms of the degree to which schemes can and should consider a broader range of investments.
DB funding levels are assessed for valuation purposes by reference to the market value as at a particular point in time. The Pension Schemes Act 2021, and draft regulations under that Act, are set to introduce a new requirement for DB schemes to have a funding and investment strategy, including a journey plan towards low dependency as the scheme reaches significant maturity. Reflecting the messaging in its Annual Funding statements in recent years, TPR’s draft revised DB funding code likewise expects schemes to be taking on less risk as they mature.
If trustees were to be encouraged to invest in a broader range of investments, including productive finance, changes would be needed to the new funding approach to ensure consistency. Thought would also need to be given to suitable checks and balances, for example, where this type of investment might not be appropriate and how any short-term liquidity issues could be managed.
In relation to the specific question in respect of master trusts, we advise across the full spectrum of DC master trust arrangements. The individual experience of master trust trustees is rightly varied but board composition usually includes at least one and often more trustees who are highly experienced in investments, typically professional trustees with an investment or consulting background who have advised on the full range of investment opportunities in previous roles.
Investment in illiquid assets may be more palatable in a DC default arrangement, in particular where that fund is of sufficient scale to assume the risk and can easily disinvest for liquidity purposes. Offering illiquid assets in self-select funds would require careful consideration.
Finally, we wonder just how readily available the sorts of assets the Government has in mind currently are, although this is a developing area. For example, the limits to DC pension investment opportunities in some illiquid assets were recently recognised in the Government’s response to its consultation on the long-term investment for technology and science initiative, and the ensuing British Business Bank’s call for proposals for new funds or investment structures.
Question 5: Is there enough understanding of advice around the consolidation of schemes?
We have advised many DB schemes over the years where sponsoring employers within the same corporate group have sought to consolidate their pension schemes into one scheme and more recently in buy-out situations, as well as DC schemes on transfers to master trusts. When called upon to get up to speed on the complexities surrounding such transactions, in our experience, trustees adapt quickly when suitably advised.
Many current occupational pension schemes are the product of past scheme mergers resulting from corporate activity, with many larger schemes having a number of distinct benefit sections. So, the basic concept of scheme consolidation is not new, although the vehicles potentially entering the market are offering novel solutions.
Although a general awareness of potential consolidation is no doubt useful, anything beyond this (including advice) would only be meaningful for scheme trustees for whom consolidation in the near future is a realistic prospect. See our thoughts on Question 8 for more detail.
However, on the subject of consolidation, the trustees and employers we come across are passionate about their pension schemes. Many businesses really pride themselves on having their own occupational pension scheme which they view as a distinguishing feature when it comes to recruitment. This includes employers whose pension schemes are relatively small. In turn, many small schemes are well governed and their trustees very capable. We would therefore disagree with any suggestion that all small schemes should necessarily be heading towards consolidation.
Question 6: Do you think that the government should require all trustees to provide information to enable TPR to keep a register of all trustees?
This would be in keeping with the approach of other regulatory bodies, for example there is a register of charitable trustees.
However, how and for what purpose TPR would use this information would need to be thought through and properly communicated. For example, would it be used to monitor TKU compliance? If so, there would need to be available resource to keep this under review and to take regulatory steps where needed.
Question 7: If the government were to require this information, would it be best achieved through the scheme return or through a separate trustee return?
Given that an individual might be a trustee of several schemes, a trustee specific electronic register would seem to be the most straightforward of the two options.
Question 8: Do current accreditation frameworks provide a high enough bar to equip trustees who become accredited to properly fulfil their role, including in making investment decisions?
Trustees will no doubt provide useful input here, in particular, professional and master trust trustees.
That said, we do not believe there is a need for a general accreditation process. It could create a two-tier system and sits in direct conflict with the drive towards greater diversity and inclusion. As explained in our General Comments and in response to Questions 1 and 2, trustee skills should be assessed at board level, as the sum of its individual parts. This is because, in our experience, the most effective trustee boards are those where there is combination of skills and different backgrounds.
However, we do think that the Trustee Toolkit and other educational information provided by TPR could be improved. A one-size-fits-all set of training modules is not necessarily conducive to driving up standards. Having to complete the entire Toolkit within the first six months of appointment can also be an extremely daunting task for a new trustee, especially as a lot of the themes will not be relevant to their role at the time.
With changes in pensions law and regulation (including case law) happening so frequently, trustees would no doubt find a more dynamic Toolkit helpful, eg delivering short, interactive and engaging content on an up-to-date basis. A bitesize podcast or video would also be more digestible to some than a written document. Delivering training in this way would complement existing written materials and help make TPR’s materials more inclusive.
Trustees do not need to know everything pensions all at once. Trustee training should be dynamic and responsive to relevant changes and developments, both driven by a scheme’s own circumstances and external sources. Whilst trustees should have a degree of awareness of relevant pensions developments on a macro level as part of their TKU, that training should simply serve as a trigger, with trustees only required to delve deeper when it becomes pertinent to their scheme. Otherwise, trustees could spend precious time acquiring knowledge which will never be needed. Trustees should also be able to call upon and rely on input from professional advisers, including their legal advisers, to supplement their knowledge.
Well-run schemes have regular trustee meetings and training generally takes place as part of that, both on a high-level (eg key developments on the horizon) and a more in-depth basis when required. Trustees we advise also carry out regular self-assessments to identify gaps in relevant skills and areas of TKU which then feed into training plans. But training always resonates most when particular issues are being dealt with in practice, rather than as a theoretical exercise.
Question 11: Should there be more rigorous requirements for those acting in the capacity of a professional trustee? What sort of requirements / standards should professional trustees be meeting? Should there be mandatory accreditation?
Question 12: How would you define a professional trustee for the purposes of legislating for all professional trustees to be accredited?
We expect professional trustees will provide useful input here. Professional trustees come from varied backgrounds and bring different skills to the table. As such, any proposed accreditation programme will need careful thought.
Trustees who hold themselves out as having a particular skill or expertise are already held to a higher standard of care. Trustee protections in scheme rules also tend to make this distinction, as do the anti-money laundering requirements where a trustee is carrying on business.
TPR’s definition of professional trustee, as set out in its professional trustee description policy, seems sensible.
Question 13: What are your observations on the external support trustees are given to make investment decisions, particularly in relation to unlisted equities?
Question 14: What changes could be made, including to the regulatory environment, to improve trustee support in relation to unlisted equities?
Question 16: What changes could be made to investment management to support pension scheme investment decision-making?
We are not convinced that any changes are needed (see our General Comments and remarks in relation to Questions 1,2 and 4). Trustees are already generally required to take advice before making investments. Some schemes also have individuals with relevant expertise sitting on their investment sub-committee or providing guidance to the overall trustee board.
TPR could perhaps collaborate further with the FCA to ensure the FCA’s rules and guidance take account of any specific concerns about the support being given to occupational pension scheme trustees.
Barriers to trustee effectiveness
Question 18: Is fiduciary duty a well-understood concept? Do current regulations and guidance support trustees to make investment decisions which seek higher returns for members? If not, what changes would be useful?
A trustee’s investment obligations are derived from trust and pensions law, as well as the scheme’s rules themselves. As explained in our General Comments and feedback on Question 4, these investment obligations, including the need to invest in the best interests of members, are well understood by the trustee boards we advise.
Given occupational pension schemes’ trust law origins, existing investment obligations allow trustees a certain degree of flexibility when making investment decisions. Creating a single definition of “fiduciary duty” therefore potentially risks removing some of that flexibility.
As regards DC schemes, by definition, members invested in a default fund will not have given their consent to the underlying assets. As such, default funds are generally invested in less risky assets. Some changes to the existing law would most likely be required if such funds are to be invested in illiquid assets, especially given the constraints imposed by the charge cap.
Finally, it is worth noting that under the current law there is no duty on occupational pension scheme trustees to consider the benefit to the wider UK economy when exercising their investment powers. Indeed, depending on the circumstances, doing so could be contrary to their duty to invest in the best interests of members.
Question 19: Do trustees currently make investment decisions in the long-term interests of pension savers? If not, what barriers are there to trustees making investment decisions in the long-term interests of savers?
Question 20: How do trustees balance investment returns, costs and charges, and services when making decisions in the long-term interests of savers?
Question 21: Do trustees’ fiduciary duties discourage investment in alternative asset classes? If so, please explain with examples.
Question 22: Is the way in which trustees exercise their fiduciary duties preventing trustees from seeking the best returns for pension savers? If so, what is causing this?
Long-term interests will come into play when trustees are making investment decisions, especially in DB schemes where pensions are likely to be payable many years into the future. But DB trustees also need to have sufficient liquidity available in the short-term, so there is inevitably a careful balancing act.
What is appropriate and where precisely to draw the line (between eg risk, returns, costs and charges, and services) will depend on the benefits being provided by the scheme, its maturity, whether it is open or closed in the case of DB, and its particular circumstances generally. This is why professional advice is so essential.
We do not regard trustees’ fiduciary duties as discouraging investment in alternatives. The key is whether suitable alternatives are available and whether the trustees’ investment advisers would recommend this as a suitable way forward for the scheme in question at the relevant time. Activity affecting the wider economy can be an important factor when it comes to scheme investments, eg last year’s LDI crisis led to increasing uncertainty resulting from a one-off market event.
As already alluded to, it is also important to bear in mind that the current legislative and regulatory direction of travel is moving DB schemes away from riskier investments. The charge cap in DC default arrangements is also likely to be limiting available options.
Question 24: Would trustees find it helpful if they received more direction from regulators when assessing their investment decision making? In addition to our work on Value for Money we are also interested in whether the advice for trustees provided by regulators via training and guidance supports our objective to shift the focus from cost to value?
For the reasons already given, investment decisions have to be scheme specific and there is no one-size-fits-all solution. As a general observation though, as with any asset, over-investment in a single class runs the risk of over-exposure.
We support the value for money framework and the helpful information it should provide to schemes and sponsoring employers. However, subject to our comments in response to Question 8 about training made available by TPR, we feel that both DB and DC trustees currently receive sufficient regulatory guidance.
Question 25: Do lay trustees have enough time and support to perform their duties effectively? Do professional trustees? If not, what changes would support this?
See response to Question 3 regarding the possible barriers, in our view, to becoming a trustee.