Paul Williams of Baker McKenzie draws upon his experience in South Africa to argue that, in time, the UK’s master trusts will be seen as financial products, not pension schemes – and regulation will have to adapt.
This shift has seen a fundamental transfer of risk from employer to employee. With DC, employers have no skin in the game, and so view pensions as just another aspect of remuneration that they want to provide as inexpensively and painlessly as possible.
Master trusts are the market’s response to this demand – they offer economies of scale and a significantly reduced governance burden on the employer’s part while still offering the familiarity of a trust-based environment.
Members will become savers who will care more about the return on their investments than about the niceties of the legislative structure
There will not be a wholesale move to master trusts – a combination of paternalism and the size and/or complexity of some own-trust schemes will ensure that – but the lure of the master trust will be too great for most, and in a decade the pensions industry will look very different.
South Africa aims for 200 schemes
I can say this with confidence, as precisely the same thing has happened in South Africa. The country went through the shift from DB to DC pension provision earlier than in the UK.
A decade ago there were around 13,000 pension schemes, most of them small, most of them offering DC benefits. The market’s reaction to this was the umbrella fund, which is the local version of a master trust.
Such has been the draw of umbrella funds that there are now only 1,500 funds. The local regulator, which has become a firm supporter of consolidation, wants this to come down to as few as 200.
Consolidated schemes present some fundamentally different challenges from own-trust schemes, notably consolidation risk, systemic sponsor-based conflicts of interest, and a reduction in employer and member engagement.
To date, however, umbrella funds have been regulated in the same way as employer-sponsored funds. At times it has felt like trying to fit a ballet shoe on to a prop forward’s foot.
Products, not schemes
Things are changing though. The South African financial sector is currently undergoing a legislative overhaul: major new regulation aimed at improving market conduct across the board in the financial sector will introduce a principles-based and outcomes-focused approach to regulating financial institutions, and will replace industry-based legislation with activity-based legislation.
The new regulation treats pension schemes as financial institutions and the benefits that they provide as financial products. Viewed from a UK occupational pension scheme perspective, this seems radical.
In reality though it is the logical conclusion of the dominance of umbrella funds. The new legislation will allow umbrella funds to be legislated as what they really are: financial products marketed and operated by financial services providers.
The waters are still a little muddy though. Through consultation it has become clear that a one-size-fits-all approach is not optimal for the pensions industry and that the existing pensions legislation will need to be largely maintained for the remaining employer-sponsored funds.
To recycle the earlier analogy: a rugby boot does not fit a ballerina any better than a ballet shoe fits a prop forward.
TPR could learn from other nations
While it is clear from the master trust authorisation regime and the recent consultation (Future of Trusteeship and Governance) that the UK’s Pensions Regulator recognises the risks, as well as the advantages, of master trusts, it still very much views master trusts through the “occupational pension scheme” lens.
Arguably this is right: one of the attractions of master trusts is that they offer a trust-based environment, but this may well change as they become the norm. Members will become savers who will care more about the return on their investments than about the niceties of the legislative structure.
The South African experience suggests that, in time, this will be the case and that we may think of master trusts as more akin to financial products than occupational pension schemes. We have an interesting journey ahead.
Paul Williams is a senior associate at Baker McKenzie
