Pension scheme investments: looking through pooled funds to check for employer-related investments

Robert Tellwright

The rules on pension scheme employer-related investments (ERI) are changing.  The DWP announced yesterday (2 September) that it has laid regulations before Parliament amending the 2005 Investment Regulations so that, from 23 September, pension scheme investments in certain pooled funds are no longer excluded from the 5% limit on employer-related investments.  So what will this mean for trustees?

“You don’t look different but you have changed,” sang the Beatles in 1965, “I’m looking through you, you’re not the same”.  Thankfully, it’s quite rare for pop bands to sing about legislative changes in the pensions industry (a new challenge for the next round of X-Factor contestants, perhaps?).  But the Beatles really do a good job of explaining forthcoming changes to the rules on employer-related investments.

Trustees will soon find the Regulator “looking through” investments they hold in certain pooled funds, searching for employer-related investments amongst the fund’s underlying assets.  So even though these pooled funds won’t look different, suddenly they will have “changed” for the purposes of tallying up a scheme’s 5% limit on employer-related investments. 

At the moment, if trustees of an occupational scheme invest in a pooled fund which, in broad terms, is managed by a regulated manager and has a reasonable spread of investors and underlying investments, any assets held by the fund manager which would have been “employer-related investments” if held by the trustees themselves will not count towards the 5% limit.  However, the amending legislation laid by the DWP will remove this carve-out, so a proportion of employer-related investments held in such funds will be attributed to trustees through their unit holdings. 

The DWP has insisted this amendment is necessary to comply with the European IORP Directive, despite protests from the pensions industry around the problems this change could create. 

Any trustees who are already near the 5% limit and who are invested in pooled funds which are currently exempt from the regulations will need to take a close look at their unit holdings and work out whether the change in law will take them over the limit.  Trustees considering new fund investments will need to check the composition of the fund and work out how much of their investment will count towards the 5% limit. 

Trustees will also need help monitoring this situation over time – and herein lies the biggest issue.  Whilst fund managers may be willing to report to trustees if their holdings in securities issued by the employer’s group exceeds a certain threshold, it is very difficult for managers and custodians to monitor and report on this information on a day-to-day basis (let alone in real time as securities are traded). 

Also, trustees may not have control over the investment of all scheme assets.  AVCs or money purchase contributions will typically be invested at the direction of members.  So if a scheme’s membership starts to heavily favour a UK equity tracker fund, for example, in which the sponsor’s securities have a considerable weighting, the 5% limit could be further eroded.

This is all potentially concerning for trustees, who could face civil and even criminal penalties for breach of the employer-related investment rules.  At best, trustees are in for a Hard Day’s Night getting to grips with the new regime.  At worst, they could face a not-so-very-Magical Mystery Tour around the offices of their fund managers, working out how (if at all) compliance with the new regime can be ensured and monitored.

Robert Tellwright is an associate at Allen & Overy LLP.

Comments published on Pensions Talk do not necessarily reflect the views of Allen & Overy or its clients.

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