Pension Schemes Bill [HL]

Baroness Drake Excerpts

Monday 21st November 2016 Lords Chamber

Moved by

[Baroness Drake]

18: After Clause 8, insert the following new Clause—
“Scheme funding: triggering events
Where—(a) a triggering event under section 21 occurs; and(b) the scheme has insufficient resources to meet the costs mentioned in section 8(3)(b); and(c) a prohibition under section 33 applies;the Secretary of State shall make provision for a compensation fund or for the funding to be provided by another source as a last resort.”

[Baroness Drake (Lab)]

My Lords, Amendment 18 proposes a new clause that, put at its simplest, seeks a compensation fund or provider of last resort when a master trust fails and there are not enough resources to meet the costs of wind-up and transfer. It is the in extremis protection, ensuring a last line of defence for members’ funds if the capital buffer required under Clause 8 or the proposed continuity option provisions in Clause 24 fail.

Setting regulatory operational capital requirements for master trusts is important but does not guarantee the security of members’ benefits or rights. I am sure the Minister will reassure us that the Government intend to be robust. The trouble is that we are not sighted on the robustness of the capital adequacy or transfer-out regimes—indeed, neither is he at this point—because so much of it is still left to further policy decisions and regulations. Concepts such as “sustainable”, “sound” and “sufficient financial resources” are undefined in the financial sustainability requirement in Clause 8. There are no draft regulations for us to consider. There is no provision in the Bill for what happens if the regulatory regime fails to ensure that sufficient financial resources are available in the event of a master trust failure.

The Constitution Committee points out in its letter to the Government of 11 November that Clause 24, dealing with wind-ups and transfers-out, is an example of the Bill delegating the power to make regulations that will determine substantial policy issues when a draft of the regulations is not available and the Government have yet to determine their policy. This regulatory regime will be applied to an existing market that has developed in a variety of ways. The Government cannot guarantee that they will have time before its introduction to create and hold the benign behaviours needed to protect scheme members. The impact assessment acknowledged uncertainty about the Bill’s impact because substantive policy decisions will not be taken until the secondary legislation stage. Indeed, such is the amount of further work to be done that the authorisation regime will not come into effect until 2018. The Bill does not make clear what happens if no potential receiving scheme is able or willing to accept the benefits of the members on transfer. The scheme records may be in disarray. The actual costs of wind-up and transfer will not be known or knowable in advance.

Under Clause 33, there are prohibitions on the charges the master trust and the receiving scheme can impose on the members transferring, or on imposing any new charges to meet costs for which a receiving scheme is liable but which were originally incurred by the transferring scheme or as a result of the transfer. If the actual costs of wind-up are very high, the terms of the clause may deter other suitable master trusts from accepting a transfer in whole or in part.

The impact assessment explains that the prohibition on increasing member charges during wind-up and transfer will work because the money to pay for these costs will be met by the access to funding or capital reserves held in accordance with the new financial stability reserve requirements in Clause 8. Yet no regulator can guarantee that those will always be sufficient. Indeed, the impact assessment reasoning is restated by the noble Lord, Lord Freud, in his letter of 14 November. However, neither the Bill, the impact assessment nor the Minister’s letter inform us what would happen if, in a particular failing master trust, the capital reserve requirements proved insufficient for whatever reason. The Bill proposes no contingency plan for the failure of a master trust the records of which are in disarray, which has insufficient financial resources to comply with its duty when a triggering event occurs, and for which no master trust is willing to accept transfer of members’ benefits. What will happen in those circumstances? How will all the members’ funds be protected against increased charges? What liability for or immunity from the past provider’s mistakes will a receiving scheme have? What plans do the Government have for ensuring that bulk transfers between master trusts can legally proceed in an efficient and timely manner to ensure continuity of coverage for members of failed master trusts?

The suggested timetable in the Bill indicates that the new regime will come into full effect in 2018, after most remaining employees have auto-enrolled, so it will be some time before it is in place. However, the retrospective casting of the Bill—which I support—means that for existing unauthorised schemes, the scheme funder is liable for wind-up and transfer costs when a triggering event occurs on or after 20 October 2016. What if that funder has insufficient resources, is a limited liability company or is insolvent? Where would wind-up and transfer costs be recovered from?

In his letter of 14 November, the noble Lord, Lord Freud, comments that in such a situation,

“we would expect the normal considerations in terms of insolvency and court proceedings to apply to this financial debt as to any other”.

That prompts a series of questions for the Minister. What does that mean? Who would bring the proceedings and how would they be financed? If the members of such a master trust were transferred, would the receiving master trust be covered by the prohibition in Clause 33 on increasing charges? The noble Lord, Lord Freud, further comments in that letter:

“We do not expect the number of trusts who will find themselves in this position … without solutions for their members to be high. We anticipate that the market will wish to consolidate”.

That leads to a more general question: how exactly is it to be determined which is the appropriate master trust to be the receiving scheme in a wind-up under Clause 24? How will a potential receiving scheme be identified? Presumably, the regulator will not leave it to other schemes to do some self-organised divvying up. It could be problematic under competition law for a panel of providers to self-organise the divvying up of schemes. Will there be a formal regulatory allocation process, and if so, what will it be?

People need to be reassured that the Bill will provide them with protection in practice. At the moment, that ultimate reassurance is not there. The amendment does not prescribe the model but it fixes the principle of a last resort provision. I recognise that work needs to be done. There are matters to be considered—how to protect against moral hazard; how to ensure that market players do not game the process to cream off the best members; the need to look behind a triggering event to identify evidence of cherry-picking; and the funding underpin for a last resort provision—but there is a compelling need for a compensation or last resort provision, as proposed in the amendment. Without it, the Government cannot credibly assert that the Bill will do what is claimed in the opening line of the Explanatory Notes: protect all savers. I beg to move.

[Lord Flight (Con)]

My Lords, it is actually extremely unlikely—in fact, virtually impossible—that members will suffer if the manager of a master trust gets into difficulties. The assets attributable to the pension fund members are segregated from the assets of the manager. How valuable or otherwise they are will depend upon how well they have been managed and, if there is more than one fund choice, which fund people have chosen.

Secondly, it is clear that the Pensions Regulator will and is intended to play the brokerage role. If it perceives that a master trust manager is in trouble, it will quickly sort out who is going to take over that business. It has value because fees are attached to managing the money, which other master trusts will happily pay. There is even some source of revenue coming back to the master trust in trouble as it is bailed out.

I am afraid that this sort of plaintive request for a compensation fund does not have my support. I thought we had collectively agreed that we did not want another compensation fund. Adding it at the end, almost out of principle, when the chances of it ever being used are virtually zero, is not particularly constructive.

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[Lord Freud]

My noble friend has put very bluntly what I was trying to say in a subtle and gentle way. If the landlord or another supplier to the scheme finds itself out of pocket, for instance, that is what will happen. It will go through the normal insolvency process, but it is not the job of the Pensions Regulator or the Government to be concerned about that. Our concern is purely with the members’ pots. Are they protected and is there a process to transfer them to someone who can look after them properly? I hope that is what I have been able to explain in an overlengthy reply. I hope it has enabled the noble Baroness to withdraw the amendment.

[Baroness Drake]

I shall try to pick up some of the Minister’s points. There was a lot of detail in his reply. I am conscious of the time. I shall start with the risks that we are trying to mitigate; there seems to be a lot of confusion about them. The risk this Bill is trying to mitigate is that the costs associated with managing scheme failure and winding up the scheme fall on the members, so their pots are drained to pay for them. Their pots are not protected. We are talking not about the equivalent of a DB benefit provision or a Financial Services Compensation Scheme provision on an annuity, but about the specific risk that the Explanatory Notes and all the associated documents from the Government in support of the Bill identify that it is seeking to mitigate. Members’ pots should not be raided to pay for a master trust failure.

The Minister set out in great detail how the authorisation regime, the supervision regime and the scheme failure resolution regime will work very effectively to protect the members against that risk. That was very clearly laid out. I complimented the Explanatory Notes and other documents at Second Reading. It is possible to clearly follow the regime proposed. However, the regulatory regime cannot ensure that the capital adequacy and supervision regime will always ensure sufficient resources in the scheme to finance the cost of failure in respect of wind-up and transfer costs. That is the risk we are trying to deal with. It is not the function of a regulator, whether it is the PRA, the FCA or anything else, to eliminate all risk. It cannot possibly do so, unless there is an unlimited guarantee from the taxpayer always to remove risk in a regulated system.

This amendment seeks to address what happens when the regulatory system around capital adequacy or resolution through transfer of another scheme does not work. As the noble Baroness, Lady Altmann, said, at the moment there is only one place to go, which is back to the members’ pots, which will be drained.

If I heard the Minister correctly, he said that there would be no liability for debt placed on the receiving scheme in a transfer situation, so he is saying that if there are insufficient resources in the failing master trust they cannot be offloaded on to the receiving scheme on transfer. They are still floating around to be paid for, so we cannot put them there and we cannot put them on the financial resources in the capital adequacy regime because that has failed, so we are still waiting for someone to pick up these costs because the only thing exposed at the moment is the members’ pots. In that situation, no regulator can guarantee whether there is a suitable master trust that will pick up all the members. It may want to cherry pick some and leave a rump behind. We do not know how this will play out. What has to be possible is that the capital adequacy and supervision regime does not always work and, if there is any one occasion when it does not work, the prohibition clause—Clause 33—cannot work because prohibition on increasing member charges when a failure takes place can operate only if someone provides the resources to fund that prohibition on increasing the charges.

There is no provision in the Bill or in any other policy document from the Government that states that, if a scheme fails in extremis and there are not the resources in place, there is no one to fund the prohibition order on increasing charges as a result of managing that failure other than the members’ pots.

[Lord Freud]

I want to be very clear. There was a useful dialogue between me and my noble friend Lord Flight. I would like to repeat what I said. I am not saying that no one will lose money if something goes wrong; what I am saying is that it will not be the members because their pots are protected.

We have bankruptcy or insolvency proceedings for other people when they get into financial trouble, but that is a separate matter. The members are protected. What we are worried about in this Chamber is the position of the members, and Clause 33 provides that fundamental protection. It is not open to the failing scheme funder to raid those pots; that is prohibited, and we have a regime to prevent it happening.

Just because someone somewhere loses money around this process does not mean that we need a compensation regime. I want to make that utterly clear, because there seems to be a concern to see that nobody can lose money. If people mess things up, they may lose money—but members will not lose money.

[Baroness Drake]

I accept the clarification from the noble Lord. The amendment—which at this stage is partly probing, although underlying it is a principle that is a matter of substance—was not intended to prescribe the model. It does not say it has to be a compensation fund—it could be a provider of last resort—but there needs to be an explicit provision in the Bill that makes it clear what happens to protect the members’ pots when the supervisory and capital adequacy regime fail in a failing master trust. I do not believe that the Bill addresses that at the moment. I am not arguing for a particular model; I am arguing for a principle of absolute clarity as to how members’ protection against exposure to meeting the cost that I described—the risk that the Bill seeks to mitigate—will be addressed in an in extremis position.

It is not a plaintive request—I say to the noble Lord, Lord Flight, that I am not a plaintive request person. I am standing here quite firmly because potentially 7 million people are going to be affected and, over time, there will be trillions of pounds under management. This matter is worthy of interrogation, rather than us simply hoping.

[Lord Flight]

The issue is an administrative one, in that you have people’s pension fund money, and the manager has got into trouble and, let us say, gone into liquidation. What administration would make sure that a new manager takes over and continues to investment-manage those pots of money? There have been suggestions that the Pensions Regulator himself should be empowered, or maybe required, to act as a broker with regard to such arrangements, but that problem has not yet been solved. That, surely, is the practical issue, not people losing money out of their pension pots.

--- Later in debate ---

[Baroness Drake]

I thank noble Lords for the supportive argument on the point that I am trying to make. I should pull this to a close. It is not that the proposals in the Bill around authorisation, supervision and resolution on failure are, of themselves, something one would want to challenge—although there is the issue of how they and some of the policy will work in practice—it is what happens in the situation that the noble Baroness, Lady Altmann, set out, when one has a failure, costs are incurred in dealing with that failure and insufficient financial resources are available. How are the members’ pots protected in those situations? The reasoning in the impact assessment is that the prohibition in Clause 33 works because there will always be financial resources to fund it, but it is not clear, in the terms of the Bill, that there will always be financial resources outside of accessing the members’ pots. However, I beg leave to withdraw the amendment.

Amendment 18 withdrawn.

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[Baroness Bakewell of Hardington Mandeville]

My Lords, I thank the noble Lord the Lord Speaker for putting the House right on that; the error was pointed out to me this morning. I shall speak briefly to the amendment.

All the information requirements relating to scheme processes as set out in Clause 11(4) are integral to a thorough assessment of a master trust’s capacity to run a scheme effectively. Therefore, it should be mandatory for regulations to include provision about the regulations. Master trusts must be effectively run so that members can be sure that their money and futures are secure. Security around master trusts is key to their success. It is much too important to be left to possible regulation; it needs to be enshrined in the Bill. I look forward to hearing what the Minister has to say about the amendment, and I support all the other amendments in the group.

[Baroness Drake]

My Lords, I shall speak to Amendment 21 and other amendments in the group. Amendment 21 would make it a process requirement under Clause 11 on authorised master trusts when making investment decisions to consider,

“environmental, social and governance risks”,

Most investments in master trust schemes will be longer term and therefore exposed to longer-term risks. Consideration of those risks, which include such factors as climate change, unsustainable business practice and unsound corporate governance, is integral to the long-term sustainability of the investments held. The assessment of these risks should not be seen as an ethical extra but, rather, potential vulnerabilities to the sustainability of the scheme which should be properly understood.

The Pensions Regulator code of practice strengthened guidance for trustees on consideration of ESG risks, but it is not legally binding and there is no direct penalty for failing to comply. At a recent pensions conference, Andrew Warwick-Thompson, the executive director of the regulator, warned trustees against complacency when assessing ESG issues within portfolios. He commented that the regulator expects trustees to take ESG issues into account, saying,

“I would urge any trustee or asset manager out there who still thinks these things don’t matter to wake up and smell the coffee”.

He referred to research by Professional Pensions which showed that only 18% of responses from trustees, fee managers and pensions professionals thought trustees should be obliged to take ESG issues into account.

If many in the industry are reluctant to make an assessment of ESG risks, it is hardly an auspicious basis for optimism that a voluntary code will work. As the regulator himself commented:

“We need to guard against complacency here”.

There is increasing evidence showing that companies which perform well on ESG produce better returns for investors. Poor corporate practice has a real effect.

Master trusts have already grown exponentially against the background of a regulator having insufficient powers, relying instead on exhortations to trusts to embrace the voluntary master trust assurance framework. That did not work. With this Bill the Government are trying to put things right. The regulator expects ESG risk to be assessed. The amendment moves beyond expectation to a process requirement that trustees actually consider these risks. I ask the Minister: will the requirements under Clause 11(4)(d) include a specific requirement to assess ESG risks?

Amendment 22 requires an authorised master trust to have processes in place for the identification, reporting, managing and minimising of any conflict of interest. How to manage conflicts of interest in a master trust is an, as yet, unresolved problem. It is difficult to assess how this Bill will resolve it because of the policies still to be decided. In 2012 the Pensions Regulator, when investigating potential conflicts of interest in master trusts, commented:

“It is very hard to understand how and when they are acting as agents of the provider and when they are acting in the best interests of the member”.

In 2013 the then Office of Fair Trading raised concerns that some trustee boards were not sufficiently independent of the master trust provider to avoid conflicts of interest and always act in beneficiaries’ best interests. The Occupational Pension Schemes (Charges and Governance) Regulations 2015 introduced stricter requirements on master trusts and although welcome, they are not sufficient to address potential conflicts of interest. Trustees of occupational pension schemes are required to have a process in place to identify and manage any conflicts of interest and there is a regulatory DC code which recommends minimum controls. But they do not meet the conflict of interest challenges in a master trust.

Market pressure, combined with sound regulation, are important tools in the fight against conflicts of interest. The only trouble is that in the pensions market there is little pressure coming from the supply side, the scheme member—a proposition we have rehearsed so many times in debates in this Chamber and in the other place.

The Government’s impact assessment identifies the particular risks that master trusts pose, which compellingly support specific regulation for identifying, reporting and managing conflicts of interest. Master trusts develop new types of business structures which alter the relationships between members, employers, trustees and providers, on which occupational pension law and regulation is largely based. There is no requirement to include member or employer representatives on the board, and providers have a significant influence over who they appoint.

Many master trusts have been set up with a profit motive—something that existing occupational pensions’ regulation does not cater for. As the OFT observed, this is a concern and a complex area as these companies have obligations to their shareholders and other stakeholders and, as with any company, seek to make a profit. IFAs and fund managers may be part of the provider group that set up that master trust.

The trust deed in a master trust can inhibit the trustees from acting in the best interests of members if the rules fetter their powers. The master trust multi-employer characteristic can increase complexity and, with it, the potential for conflicts of interest. The products they provide are not covered by ECA regulation.