Broadening DC investment opportunities – new obligations for DC pension schemes

The government is consulting on draft regulations requiring trustees of schemes that provide DC benefits other than additional voluntary contributions (relevant schemes) to:

• Disclose and explain their policy on investment in illiquid assets in the default arrangement statement of investment principles (SIP).
• Disclose and explain their default arrangement asset class allocation in the annual chair’s governance statement.

The draft regulations also exclude certain “well-designed” performance fees from the scope of the DC charge cap.

The consultation follows a consultation in March 2022 on the broad policy proposals – see our legal update for more details.

Disclose and explain requirements – illiquid investment policy

Trustees of relevant schemes will be required to state in the SIP for the scheme’s default arrangement whether or not the investments held by the default arrangement include illiquid assets. These are defined as “assets which cannot easily or quickly be sold or exchanged for cash”. Where any of the default arrangement investments are in a collective investment scheme, the trustees must look through to the underlying assets held by the collective investment scheme.

If the investments do include illiquid assets, the default arrangement SIP must also include:

• A description of the age profile of those members in respect of whom investments are held in illiquid assets.
• An explanation of whether investments are held directly in illiquid assets or via a collective investment scheme.
• An explanation of the types of illiquid assets in which investments are held.
• An explanation of why the trustees have chosen to invest in illiquid assets, including their assessment of the advantages to members of investing in illiquid assets when compared to investing in other asset classes.
• An explanation of whether the trustees have any plans to increase their investment in illiquid assets in the future.

If the default arrangement investments do not include illiquid assets, the SIP must include:

• An explanation of why the trustees have chosen not to invest in illiquid assets.
• An explanation of whether the trustees have any plans to invest in illiquid assets in the future.

This requirement will apply from the earlier of (a) the first occasion that the default arrangement SIP is updated after 1 October 2023 and (b) 1 October 2024.

Identical requirements will apply to trustees of collective DC (CDC) schemes that are being used for automatic enrolment (qualifying CDC schemes) save that as CDC schemes do not have a default arrangement, the policy must be included in the main scheme SIP.

Disclose and explain requirements – asset allocation

Trustees of relevant schemes will be required to carry out an annual calculation of the percentage of assets in the default arrangement(s) allocated to each of the following asset classes:

1. Cash.
2. Corporate bonds and UK gilts.
3. Listed equities.
4. Private equity.
5. Infrastructure.
6. Property/real estate.
7. Private debt.
8. Any other assets.

Where assets are invested in a collective investment scheme, the trustees must look through to the underlying assets held by the collective investment scheme. The results of the calculation must be included in the annual chair’s governance statement. That section of the statement must be published on a website that is publicly available free of charge.

Again, identical requirements will apply to trustees of qualifying CDC scheme, but in relation to all scheme assets.

These requirements will apply in relation to the first scheme year ending on or after 1 October 2023. They will apply to all relevant schemes and qualifying CDC schemes rather than just to schemes with over £100 million in assets as was proposed in the March 2022 consultation.

Performance fees

Under current legislation, member-borne charges in qualifying CDC schemes and in the default arrangement(s) of relevant schemes that are being used for automatic enrolment (qualifying schemes) must not exceed a specified annual cap (broadly, 0.75% of the value of the member’s pot). The draft regulations will amend the definition of “charges” to exclude certain “specified performance fees”. A performance fee will be a specified performance fee if it meets the following conditions:

• It is payable by the trustees to a fund manager in relation to investments managed by the fund manager for the purposes of the scheme.
• It is calculated only by reference to investment performance, whether in terms of capital appreciation of those investments, the income produced by those investments or otherwise.
• It is only payable when (a) investment performance exceeds a pre-agreed fixed or variable rate or (b) the value of the investments exceeds a pre-agreed amount.
• It is calculated over a pre-agreed time period.
• It is subject to pre-agreed terms designed to mitigate the effects of short-term fluctuations in the investment performance or the value of the investments.

This change is expected to come into force on 6 April 2023. Transitional arrangements will apply where a scheme is using the facility to “smooth” performance fees over a five year period that was introduced in October 2021.

In addition, trustees of qualifying schemes must carry out an annual calculation of any specified performance fees incurred in relation to the default arrangement(s) during the scheme year and assess the extent to which those fees represent good value for members. They must also, in the annual chair’s governance statement, set out the amount of any specified performance fees incurred in relation to the default arrangement(s) as a percentage of the average value of the assets held by that arrangement during the scheme year. That section of the statement must be published on a website that is publicly available free of charge. These requirements will apply in relation to the first scheme year ending on or after 6 April 2023.

Once again, identical requirements will apply for qualifying CDC schemes, but with regard to any specified performance fees incurred in relation to the scheme as a whole during the scheme year.

Statutory guidance

Trustees will be required to have regard to statutory guidance produced by the government in complying with the asset allocation disclosure requirements and the exclusion of specified performance fees from the charge cap. The government is consulting on a draft version of this statutory guidance. This is designed to ensure that trustees have a comprehensive understanding of the new requirements. Among other things, it provides further details on the seven asset classes and on when a fee will meet the definition of a specified performance fee, and includes a recommended approach for how schemes could present their asset allocation in the annual chair’s governance statement.

Next steps

The consultation closes on 10 November 2022.