Pension Schemes Bill [HL]

Baroness Drake Excerpts

Report stage (Hansard - continued): House of Lords
Monday 19th December 2016 Lords Chamber

Moved by

[Baroness Drake]

6: After Clause 8, insert the following new Clause—
“Scheme funder of last resort
Notwithstanding the provisions of section 8, the Secretary of State shall make provision for a funder of last resort, to manage any cases where the Master Trust has insufficient resources to meet the cost of complying with subsection (3)(b) of that section.”

[Baroness Drake (Lab)]

My Lords, a key purpose of the Bill is to protect the pension pots of ordinary people from being raided in the event of a master trust pension scheme failing. At the moment, the considerable costs, including administrative costs incurred when a failing scheme is wound up and the members transfer to another scheme, are borne by the members themselves through the charges imposed. The intention of the Bill is to prevent that happening in future. It places a capital adequacy requirement on authorised master trusts to have available sufficient resources to meet such costs in the event of failure and provides for members’ pots to be transferred to another master trust. The Government argue that, in the event of a scheme failure, the capital adequacy and transfer regime will always work. There is no provision if it does not.

The provisions in this Bill, while welcome, cannot guarantee that there will always be sufficient resources available to a failing scheme to finance the costs of wind-up or that another master trust will always willingly pick up all the pieces and costs. No regulator is infallible. The amendment introduces a requirement on the Secretary of State to make provision for funds of last resort to manage those instances of failure. It does not prescribe what that provision should be—for example, a pension scheme with a last-resort public service obligation, or an obligation on master trusts for tail-risk insurance. But without such a provision, the Government cannot claim as they have that from the day it becomes law the Bill will protect scheme members and their pots from the costs of managing failure.

The reasons for this amendment are several: the Pensions Regulator will need to rely significantly on the judgment of its supervisors to assess whether a master trust meets the requirements for ongoing authorisation, to assess not only against current risks but also future risks and make judgments on when it is necessary to intervene. It will not be regulating a legacy system but the future evolving and expanding system, covering millions of members for a very long time. The Bill places a prohibition on using members’ pots to fund a wind-up, but that does not mean that it will all sort itself out. If providers go insolvent, who ultimately will ensure that the wind-up and transfer actually happens? Pots could be left in limbo for many months. Even if the trustees have a legal duty to make such a transfer, they will not be able to pay for advice and administrative services to enable it to happen.

The year 2008 taught us that even the grandest institutions with strong reputations can fail. No regulator can guarantee to remove all risk, and the Pensions Regulator is no exception. However exceptional, a situation could arise whereby a failing master trust will not have sufficient resources on wind-up. Regulator assessment of capital adequacy requirements may simply have been wrong. I hope that that never occurs, but the Government cannot guarantee that it will not. Administrative disarray, failure of controls in the outsourcing to third-party administrators, major computer failure or other failures can hike up costs and cause costly delay in wind-up.

I recently read The Prudential Regulation Authority’s Approach to Banking Supervision of March 2016, and paragraph 44 says:

“The PRA’s supervisory judgements are based on evidence and analysis. It is, however, inherent in a forward-looking system that … there will be occasions when events will show that the supervisor’s judgement, in hindsight, was wrong”.

The resolution regime when a trust fails provides for transferring members’ pots to another master trust. The Government are relying on the industry to always step up to the plate, but they cannot be certain that it always will. I am sure that there are master trusts now that are already concerned about what that means and will not want to commit to being part of a panel or carousel of providers which will always guarantee to accept the transfer of members. They may consider the unknown future exposure to costs or the liability for the administrative errors or failures of a failed scheme too unpalatable. They may want to cherry pick, leaving a less-profitable section of the members stranded. It is not difficult to imagine the sorts of problems that could occur. The Government cannot assume that the increase in scale achieved from accepting a transfer of members from a failed trust is a sufficient incentive for another provider to always volunteer to rescue.

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[Baroness Drake]

I thank the Minister for his response and will address some of the arguments he put. The amendment does not introduce a sledge-hammer: it leaves the provision to the Secretary of State. It does not require a large infrastructure to deliver such a provision. It can be as straightforward as requiring master trusts to have tail-end risk insurance. It can use a precedent that is used in many other areas of identifying a provider or operator who carries the public service—

[Lord Freud]

I should make it clear to the noble Baroness that we looked closely at tail-end risk insurance. It works within the legislation and the regulator can accept it. We have not made it a major issue at this stage because, at the moment, no such insurance is available in the market. That may change, of course.

[Baroness Drake]

Perhaps I may finish my point. I understand what the Minister has described but is he saying that the Government will consider a provision such as tail-end risk insurance?

[Lord Freud]

I am saying that the clause is carefully drafted to allow tail-end insurance as part of the capital adequacy when the regulator looks at what is required. We are not in a position to do any more at this stage because that particular insurance is not available in the market. It may well become available in the market as people see the requirement.

[Baroness Drake]

I come back to my point that I am seeking not to tie the Government down to a particular provision or how they choose to interpret it, but to answer the question that no Government or regulator can guarantee that they can remove all risk of regulatory failure. In the Bill at the moment—unless the Minister wishes to contradict me—I can find no provision as to where responsibility would fall in the event of such failure occurring and there is not the funding to deal with the wind-up and the transfer.

I do not accept that it increases the chances of moral hazard. The Bill gives the regulators considerable power to set tough requirements. Indeed, the whole purpose of the regime is to address the moral hazard of introducing a profit motive into a trust-based arrangement. The existing regulation and legislation does not deal with that. However much we iteratively discuss this—I welcome the Minister contradicting me—in the event of a regulatory failure and a trust that does not have the means to finance wind-up, there is nothing in the Bill to show how a member is protected.

[Lord Freud]

I am grateful to the noble Baroness for inviting me to intervene again. Under the Bill, if there are costs, they will not fall on the members, so who is she trying to protect? As to my point about the sledge-hammer, if we could have found tail-end insurance, which the noble Baroness mentioned, it would have been cheaper. Other ways that I can think of are quite expensive. It is not appropriate to suggest a solution that is not available.

[Baroness Drake]

The Government are asserting that the costs will not fall on the member because they have put in place a prohibition to say that the costs will not fall on the member. However, if the member is in a master trust of some size which has to go into wind-up, and there are not the resources to deal with that wind-up, there is no answer to the question of who will bear the costs. An answer has to be given, and this amendment is asking the Government to put in place a provision to give effect to that prohibition and say that there will be an alternative provision to ensure that the costs do not fall on the member. I do not believe that the Minister has answered the questions. There are millions of people with potentially billions-worth of assets under the regime, and this is a fundamental question which remains unanswered.

[Lord Freud]

The noble Baroness has been so generous and I will take the opportunity to go over this because it is slightly back to front from normal. This is not like a defined benefit scheme worth billions of pounds which are at severe risk. This is about the costs of moving the money that is attached to individual people to another master trust. It is a completely different order of risk. I know that she is coloured by what she has seen in the defined benefit world, but this is quite different. It is a much smaller risk. As I have said, in any case the costs do not fall on the members and the mitigation issue is disproportionate.

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[Baroness Hollis of Heigham (Lab)]

My Lords, I hope that my noble friend will pursue this point because, unless the Minister can give a categorical assurance, this is the only way to ensure that the Government take the issue seriously and pursue a remedy that is appropriate to the risk that she has outlined.

[Baroness Drake]

I thank my noble friend for her support. I am not coloured by the defined benefit experience at all because I am quite capable of distinguishing between the two. I am sure that I understand the risk posed in this draft legislation. However, I come back to the point. The Government may wish to assert that the costs of winding-up and transferring could be considerable if the records are in disarray, if no master trust is willing to pick up the pieces, or if other problems occur. The Government can assert as a matter of policy that the costs will not fall on the member, but there is nothing in this Bill to copper-bottom that they will not. I feel that the Minister has not answered that question. I am not proposing a sledge-hammer and I am not tying the Government’s hand, but they must introduce a provision which states that if the policy is to prohibit increasing members’ costs when a wind-up after a failure occurs, in extremis if there is regulatory failure that provision will come into effect. I am not persuaded by the Minister’s reply and on that basis I wish to test the opinion of the House.

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Moved by

[Baroness Drake]

25: Clause 38, page 27, line 11, after “charge”” insert “can include, where appropriate, transaction costs, and subject to that,”

[Baroness Drake]

My Lords, there are four key references to administration charges in this Bill: Clauses 12 and 27, the continuity and implementation strategies for addressing how members’ interests will be protected in a triggering event; Clause 33, the prohibition on increasing members’ charges during a triggering event period; and Clause 40, the statutory override power of any term of a relevant contract on administration charges.

The power of the Secretary of State and the regulator to demand information on, and intervene on, the level of administrative charges, is a key part of the armoury in this Bill for protecting members’ pots. Clause 38 gives a definition of administration charges: that it,

“has the meaning given by paragraph 1 of Schedule 18 to the Pensions Act 2014”.

That schedule relates to the power of the Secretary of State to prohibit or cap administrative charges, as illustrated by the 0.75% cap on charges, excluding transaction costs, on workplace pension scheme default investment funds. But there appears no explicit reference to transaction costs in the definition of administrative charges in paragraph 1 of Schedule 18 to the 2014 Act, and no explicit reference to transaction costs in Clause 38.

The purpose of this amendment is to make it clear that any reference to administration charges in this Bill can include transaction costs, so ensuring that the Secretary of State and the Pensions Regulator have the fullest powers of intervention needed to fully protect members’ charges in master trusts. The transaction costs are an important determinant of the net return into the saver’s pot.

In recent weeks, including since this Bill was introduced into the House, three reports have been published. One addressed disclosure of transaction costs and two provided sustained evidence of continuing dysfunction and weak competition in the pensions and asset management industry. On 5 October 2016, the FCA published a consultation paper proposing rules to improve the disclosure of transaction costs in workplace pensions. Given the potential for multiple parties to be involved in managing pension investments and for transaction costs to be incurred at different levels, the FCA considers it essential that any rules of disclosure,

“enable the flow of information to the governance bodies of those schemes”.

It proposes that all those managing investments should report administration charges and transaction costs to pension schemes and intends to publish its rules in the second quarter of 2017.

On 13 December, the DWP and FCA published their joint review of industry progress in remedying poor-value workplace pensions, following the 2013 OFT report that revealed that more than 333,000 members of workplace pension schemes were still suffering annual management charges in excess of 1%. The review also found that most providers had not fully reviewed the impact of transaction costs in their value-for-money assessments and had no immediate plans for such a fuller review. Providers using in-house investment management services were singled out for particular criticism.

In November, the FCA published its Asset Management Market Study interim report, which provided a hard-hitting critique of the “sustained, high profits” that the industry has earned from savers and pension funds over the years—fund management firms, which three in four British households rely upon to manage their pensions.

The remedies proposed by the FCA include requiring investment managers to adopt an all-inclusive single charge for everything; an up-front estimate of transaction costs; and raising the fiduciary bar for the general obligation to treat customers fairly to a new requirement to act in the best interests of investors. The report also contains a withering critique of “active management”. A recent article in the FT pulled together all the adjectives deployed by the FCA:

“Underperforming, overpaid, too profitable, too expensive, too opaque, too unaccountable and too conflicted”.

The report is quite extraordinary. It compares the net return on a £20,000 investment over 20 years to show the impact of charges. Assuming the same return before charges, in a typical low-cost, passive fund, an investor would earn £9,455 more on a £20,000 investment than an investor in a typical active fund. This figure rises to £14,439 once transaction costs have been taken into account. In an exquisite example of laconic drafting, the FCA reports:

“We find that there is no clear relationship between price and performance—the most expensive funds do not appear to perform better than other funds before or after costs”.

The report makes it clear that seemingly small differences in fees and transaction costs can lead to significant losses for investors over time but finds that more than half of ordinary investors are still unaware that they were paying fund charges, let alone what they are.

I hope that the Government will force a pace on transparency and act to control unfair fees and transaction costs incurred by people who are saving, often through their workplace pensions, and an increasing number through these master trusts. But insofar as the Bill addresses the authorisation, supervision and resolution regime for master trusts, this amendment makes it clear that any reference to administration charges in any provision in the Bill can include transaction charges, so ensuring that the Secretary of State and the Pensions Regulator have the fullest powers of intervention needed to protect members’ savings in master trusts, particularly during triggering event periods. I beg to move.

[Lord Freud]

My Lords, the effect of Amendment 25 would be to widen the definition of administration charges for the purposes of Part 1 of the Bill, so that it is capable of including transaction costs. It may be helpful if I explain that we considered the inclusion of transaction costs when developing this policy. We concluded that the provision that has been made in the Bill under Clause 33, including prohibiting an increase in administration charge levels after a triggering event, was sufficient to minimise the risks faced by savers in master trust schemes.

The term “administration charges” may prompt Peers to believe that the prohibition in Clause 33 applies to only a narrow range of costs and charges faced by members. This is not so. Among the charges intended to be caught by the administration charge definition are fees on set-up, entry, exit, and regular and ad hoc fees paid not only to administrators but also many fees paid to governance bodies, regulators, asset managers, investment consultants, lawyers, accountants, auditors, valuers, bankers, custody banks, platform providers and shareholder service providers.

In the majority of cases, trustees do not currently have access to information about transaction costs. Including them within the scope of the prohibition under Clause 33, therefore, would place many trustees in a difficult position. I can assure noble Lords that we acknowledge the need for improved transparency and understanding by trustees about the transaction costs which the members of their schemes will bear.

Noble Lords will remember that, during the passage of the Pensions Act 2014, my department accepted a legal duty to make regulations requiring that transaction costs would be given to members of occupational pension schemes and be published. The Financial Conduct Authority took similar duties with regard to workplace personal pensions at the same time. Again, I acknowledge and thank my noble friend Lord Lawson for his input into the process of developing that part of the Act. I appreciate that some Peers may be disappointed that we have not yet discharged that duty, but in mitigation I should explain that there has never been a single agreed definition of transaction costs nor a way of calculating them. We have made progress in defining transaction costs, but until recently we made less progress on a way of calculating them. This is because many transaction costs are not explicit costs which appear on a scheme’s balance sheet but implicit “frictional” costs from trading, which need to be calculated. The wide variety of approaches to calculating transaction costs are not simply disputes about the odd one-hundredth of a percent but quite significant differences in methodology, which can result in transaction costs differing by a factor of five.

We clearly need to ensure that trustees of occupational schemes and the independent governance committees of workplace personal pension providers have complete, consistent and standardised cost and charges information before they can report it to members; at this point, they do not. The key stepping stone to putting this information into the hands of trustees and independent governance committees was laid down when the Financial Conduct Authority published in October of this year a consultation on proposals requiring asset managers to disclose information about transaction costs to trustees, and a detailed methodology for calculating those costs. Following the outcome of the FCA’s consultation, we currently plan to consult on the publication and onward disclosure of costs and charges to members in 2017. In conclusion on this point, I can assure Peers that we remain wholly committed to discharging this duty in the course of this Parliament. We want pension scheme members to have sight of all costs and charges, regardless of how they are incurred, and to give members the confidence that there are no other hidden costs and charges.

The noble Baroness, Lady Drake, made us aware of the interim findings of the FCA’s Asset Management Market Study, published last month, which found weak competition in the market and proposed remedies through the introduction of an all-in charge and standardised disclosures to all investors. These are timely findings, because noble Lords may also be aware that the Government announced this month that they would be examining the level of the 0.75% charge cap on administration charges in the default funds of schemes used for automatic enrolment and whether some or all transaction costs should be covered by the cap. This work will be undertaken in 2017 as part of the review of automatic enrolment. It will involve comprehensive engagement with a wide range of stakeholders, including asset managers, which will be important given the potentially complex nature of transaction costs. The outcome of the 2017 exercise will help to determine whether there is a need to amend the definition of administration charges in Schedule 18 to the Pensions Act 2014, and at that point we will consider whether we should also cover transaction costs in the master trust legislation.

I reassure noble Lords that in practice we do not believe that transaction costs are a loophole that will be exploited to drive up charges to the detriment of members. Noble Lords will be aware that the vast majority of defined contribution pension schemes, including master trusts, are invested via investment platforms in pooled funds in which the trustees of the scheme will be just one among many investors. Given this pooled and intermediated nature of pension fund investments, it is highly unlikely that a triggering event experienced by just one of the investors in the fund would drive up the ongoing transaction costs from remaining invested in the fund. Taking these points into account, it does not appear necessary to bring transaction costs into the charge prohibition measure in the Bill.

Before I conclude, I ought to acknowledge that this is the last time I will stand before your Lordships on a Bill as a DWP Minister, although it is not quite my last appearance in the role, because we will have some fun on Wednesday discussing universal credit—I hope we will. On Third Reading in the new year, and when the Bill potentially returns to the House for further consideration after it has been looked at by the Commons, I will be leaving your Lordships in the very capable hands of my noble friend Lord Young—the junior member of the Freud/“Jung” combo. I thank him for all the support and time he has given me, and I am sure that noble Lords will continue to afford him the same courtesy and patience that has been displayed thus far.

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[Baroness Bakewell of Hardington Mandeville]

My Lords, I wish to associate myself and our Benches with the comments that have already been made. We have always found the noble Lord, Lord Freud, extremely accommodating towards us as far as he has able to be so, and I will have something further to say when we come to universal credit. I have taken over this role only fairly recently but I thank the noble Lord for all the help he has given us during the passage of this Bill.

[Baroness Drake]

I thank the Minister for his reply. It is helpful to have his wider statement on the record because this issue of transaction costs is still very controversial. I hope that the FCA’s report increases the Government’s sense of urgency regarding the need to address this issue and to introduce regulation—notwithstanding problems with definition—with master trust regulation benefiting from that as well.

Perhaps I, too, may take the opportunity to make a personal comment because I think this is the last time that I will be talking to the Minister in his current role, although he may not be talking to me at all following the vote. When he was at the Dispatch Box, I always felt that if I had a good argument, argued it well and had a good evidential base, I had a fighting chance that, first, he would listen and, secondly, that he would see whether it was possible to accommodate my concerns. He often made me do my homework and made me work hard on occasions, but that was a fair exchange. However, if I had a good point and good evidence, I knew I would get a fair hearing. That is important in this House. It incentivises one to pursue the argument and the case because one knows that one will get a fair hearing. The Minister is a wonderful example of someone who will listen and consider the arguments.

He has always been friendly, courteous and considerate in giving access to his civil servants and information—very often so that I can improve my knowledge base and not ask awkward questions; on other occasions to fuel my knowledge base to allow me to ask awkward questions. Either way, I was grateful for that.

I hope he takes some rest and has fun—he has worked very hard and deserves some fun—and that we see him back soon, bringing his intellectual skills to the House. I thank him for the statement on charges. I shall still push on transaction charges because millions of people get a rough deal but do not know they are getting a rough deal, which is even worse. I beg leave to withdraw my amendment.

Amendment 25 withdrawn.