As mastertrusts consolidate to stay viable, the pensions watchdog is looking at updating its regulatory frameworks, Sara Benwell explores
Defined contribution schemes are consolidating and many of the smaller legacy DC schemes are vanishing.
Great news, right…?
Possibly not. It’s hard to find anyone who thinks that consolidation is a bad thing in principle. Because with scale comes affordability, value for money, more efficient administration and great communications.
This is probably why the Pensions Regulator is delighted. Andrew Warwick-Thompson, the watchdog’s executive director for regulatory policy, says: “The important thing is that 86% of members are now in only 120 schemes, all with 5,000 or more members.
“This is the point at which we think schemes start to be scalable. So we’re pretty supportive of the fact that most people are going into big, well-managed schemes.”
Darren Philp, director of policy and market engagement at The People’s Pension, agrees. He says: “The way we do DC in the UK is sub-optimal – we’ve far too many small schemes, and we know that smaller schemes lack the buying power and the size to really drive value for money.
The way we do DC in the UK is sub-optimal”
“There’s a huge legacy of schemes that have set up for different reasons. Many of them are probably dormant or director-level schemes. But it makes it very difficult for the Pensions Regulator to regulate these schemes and, as it has consistently said, it is worried about whether these schemes can really offer good member outcomes.
“If the Regulator is having to put out codes of practice that say trustee boards should have a chair and/or the trustee board should actually meet – that’s worrying in itself.”
So what’s the problem? Well, the cracks appear when you take a look at where the small schemes are going.
Much of the time, they will be transferring into mastertrusts. And this is tricky because for every one great mastertrust out there, there are another ten that are not so good.
Husky Finance, a company that specialises in helping small employers choose the right scheme for auto-enrolment, has rated providers and found that of the 105 or so in the market, only nine are safe bets.
And the other providers going after auto-enrolment business range from the downright dubious to smaller schemes where it’s not likely that they have the durability or scale to last.
There may be some natural consolidation in the marketplace as mastertrusts find they cannot keep up with the increasingly stringent regulations and judge that continued participation in the market is not worth the effort.
Duncan Buchanan, president of the Society of Pension Professionals and a partner at Hogan Lovells, explains: “There are probably more than 100 mastertrusts being set up, usually with some commercial aim and they all will have been set up over the past five years, since auto-enrolment started. Unless we can reach critical mass or exit velocity, the fees they’ll be able to charge under the charge cap won’t cover the costs of administration.”
Unless we can reach critical mass, the fees they’ll be able to charge won’t cover the costs of administration”
The charge cap is set at 0.75% of funds under management, but most mastertrusts have fixed costs of operation, so unless they can build up sufficient funds under management to cover these costs there will be a shortfall.
At this point, Buchanan thinks providers’ enthusiasm will start to wane. “People that have set these mastertrusts up are investing their own money in the shortfall, but people will lose interest if the fund isn’t covering that.
“How long are you going to keep putting your money in to subsidise the administration costs of a mastertrust that perhaps is never going to reach that critical mass? You’re not – you’re going to say ‘right – we’re pulling the plug’.”
If schemes start to pull out of the market it will not only cause an administrative headache for employers, already overburdened by auto-enrolment, it could also put savers off entirely.
Catastrophic results for savers
Of course, not all mastertrusts leaving the market will necessarily do so in an orderly fashion. We could also see some of the smaller schemes going bust. This would be catastrophic for savers.
Buchanan says: “I have concerns that it will take a number of years for mastertrusts to settle down. It could be a bumpy journey, with a few car crashes along the way, and if I were the Regulator I’d be worried that if there were a car crash of a large mastertrust it could get quite messy.
“The charge cap doesn’t cover the cost of winding up. I’ve wound up DC occupational schemes and it’s not a simple process. Someone has to administer the scheme and you have to find a new home for the individuals and deal with communications and it all costs money.”
It could be a bumpy journey, with a few car crashes along the way”
And the Regulator is worried, too. Warwick-Thompson says: “We suspect a large number of the smaller mastertrusts that come to market are probably not going to be there for the long run.
“And there are concerns as to what happens if they fall over. How do we intervene to rescue those schemes’ members and, indeed, the employers that may be using them for auto-enrolment purposes? If we put in an independent trustee to wind down the mastertrust, that trustee would be remunerated from the assets of the scheme.
“There’s no employer standing behind these schemes, so you can’t say to the employer they must pay. The only source of money then is the members’ pots.”
Philp agrees: “Basically, the question is who pays for the wind-up. If there isn’t a robust enough organisation behind the mastertrust, and if you don’t have an orderly wind-up plan, then there’s no free money out there to unpick this, so it could come directly from members’ pension pots.
So if the problem is so stark, why isn’t the Regulator doing anything about it?
Well, it has introduced a voluntary assurance framework for mastertrusts. But the problem is in the word voluntary. And so far the number of schemes that have taken it up are rather low.
Worse, the website is updated irregularly so many employers are left trying to research providers themselves. And HR directors often do not have the knowledge to decide which ones are good and which ones may be problematic.
In particular, they are unlikely to know which questions to ask to decide whether a mastertrust has sufficient assets under management to be viable in the long term.
The government will bring in legislation on mastertrusts as soon as practically possible”
So why isn’t the Regulator making the framework compulsory? Unfortunately, even if it wanted to, it can’t. As Warwick- Thompson explains: “It is not in the power of the Regulator, within the current regulatory framework, to make the Mastertrust Assurance Framework (MAF) compulsory.”
But the law could be changing. Speaking in a House of Commons debate, Harriet Baldwin, economic secretary to the Treasury, responded to a question from Rob Marris, MP, asking about the worrying lack of regulation surrounding mastertrusts.
She said: “I can let him into a little secret… the government will bring in legislation on mastertrusts… as soon as practically possible.
“We aspire to find very soon the first appropriate vehicle that could be scrutinised by both chambers [of Parliament] to bring in the regulations relating to mastertrusts and auto-enrolment.”
This is exciting news for the industry. In fact, during the exchange in the Commons, Marris summed it up quite nicely. “I thank the minister very much for that swift response to my plea. It is perhaps one of my first successes, and now she has indeed set my pulse racing.”
It is clear that the Regulator also wants more consolidation in the mastertrust market. Warwick-Thompson, as its executive director for regulatory policy, says: “The priority is to make sure that people who are auto-enrolled into mastertrusts are safe and that they and their employers can trust mastertrusts to be safe, durable and well run.”
And even the mastertrust providers are keen for more regulatory powers. Xafinity, the People’s Pension and Aegon have all come out in favour of change.
Philp says: “The Regulator can only regulate in accordance with the powers that the Department for Work & Pensions and Parliament have given it. So I’d like a proper debate about this, and I’d like the DWP actually thinking about what power the Regulator needs to regulate this market properly. And it’s far better to do it now in advance than to try and unpick a mess down the road.”
Recently, Warwick-Thompson hinted to Pensions Insight that a mandatory framework is being explored, saying: “There are a number of options that are being considered with government at the moment. One option might be that mastertrust assurance or something like it becomes compulsory.”
However, Philp argues that a compulsory framework would not go far enough. He says: “We’ve seen a mild regulatory push on this through the introduction of the MAF. That framework is all right in terms of making sure that organisations have proper procedures, proper controls, that type of thing. But it only gets you a part of the way there.”
One option might be that mastertrust assurance or something like it becomes compulsory”
Instead, he would prefer for the Pensions Regulator to be given “more stick” when it comes to mastertrust governance.
He explains: “The Regulator pushed a voluntary assurance framework on this and that’s probably the best it can do given its remit and its powers, but we would like it to have more powers to develop a proper regulatory regime for the sector.”
Warwick-Thompson suggests that this could be on the table. He says: “There have also been discussions that the way in which the Regulator operates in relation to mastertrusts might become more like the way the Financial Conduct Authority approves group personal pensions providers.”
Of course, the ultimate decision for how the regulatory landscape might change lies with Parliament.
As Warwick-Thompson puts it: “Clearly any change in the legislative or regulatory framework would be a matter for pensions minister Ros Altmann and for Parliament – but these are all things that the Regulator is actively involved in discussions about with the FCA and with DWP – to see what proportionate and necessary steps might be taken.”
What now for schemes?
So change is definitely in the air. But given that it is not yet clear what the changes in legislation might look like, or when they might happen, schemes that are considering wrapping into a mastertrust will want to consider very carefully which one they choose.
The three main things they may want to consider are durability, value for money and whether a scheme is well run.
And even though regulatory uncertainty exists, this doesn’t mean smaller, trust-based schemes should not be looking to consolidate, particularly since the Regulator would seem to be turning its attention on them next.
Warwick-Thompson says: “Our second priority will be to consider what we do about the folk who are left behind in closed, possibly sub-scale DC schemes and to ensure that they just don’t become second-class savers, that they aren’t left behind by the pensions reforms.”
One question is whether the Regulator might decide to go the whole hog and force schemes to consolidate if market forces don’t do the job.
At this time Parliament has not felt that it is appropriate to take that kind of intervention”
Warwick-Thompson certainly is not ruling it out. He says: “I think it’s been well rehearsed before that in some other jurisdictions around the world there has been a regulatory and indeed legislative push for consolidation.”
He points out that the Australians have actively sought to consolidate their market, the Irish are looking at proposals to consolidate their market, and the Dutch regulator has been active in seeking to consolidate.
Warwick-Thompson says: “In the UK, the former shadow pensions minister Gregg McClymmont sought to introduce amendments to the last Pensions Bill that would have given the Regulator powers to consolidate sub-scale schemes. So these are all things that have been discussed but at this time Parliament has not felt that it is appropriate to take that kind of intervention. Who knows what will happen in the future?”
Clearly the future is by no means certain. But now is the time for pension fund managers to have a long, hard think about where their scheme might sit in an ever-consolidating world.