How will regulation need to change to be fit for the 21st century?

The UK’s treasurer of the Navy established this hefty coffer, complete with multiple locks and known as the Chatham Chest, to provide a pension to mariners.

Most regulation has been counterproductive largely because it’s been framed through the rear-view mirror rather than through the windscreen

Alan Pickering, Bestrustees

Every seaman was required to pay in a small monthly sum from his wages. If he was wounded, he was entitled to a pension that was paid out of the fund for the duration of his injury.

The chest proved successful for some years, but eventually gained “an unenviable reputation for corruption and mismanagement”, writes historian Philip MacDougall in his book ‘Secret Chatham’.

An inquiry in 1608 found that money from the chest was being “lent by those who have no authority and borrowed by those who have no need”.

Does the regulator need more powers?

Fast-forward to more than 400 years later, and while the chest is no longer in use, the general risk of pension scheme mismanagement to members’ benefits remains, albeit to a different extent.

In August 2016, for instance, the Pensions Institute warned that businesses are exploiting members’ pension savings, then dumping their liabilities.

While little was done to regulate the money going in and out of the Chatham Chest, today’s Pensions Regulator is equipped with powers to police the pensions system.

But from BHS to the British Steel Pension Scheme, numerous high-profile cases involving large funds have raised regulatory questions, including whether the regulator needs to be beefed up.

If the pensions watchdog has more powers, will this really be the key to making regulation fit for the 21st century, or does the solution lie elsewhere?

Ian Neale, director at policy specialists Aries Insight, notes that “a lot of publicity is given to naughty boys’ behaviour”, and the kneejerk reaction is to want the regulator to have greater capacity to nip any future scandals in the bud.

“I think we need to be very wary about giving regulators even more power than they already have”, Neale says, arguing that “the result, unfortunately, can be that they get too powerful”.

The regulator “has more than enough powers to do its job”, he adds.

Relaxing the rules

Faith Dickson, partner at law firm Sackers, agrees that rather than having new powers, the watchdog needs to try and use the powers it has already got.

She calls for “more flexibility to allow schemes and employers to restructure pension liabilities to allow businesses that are otherwise viable to continue, and to allow schemes to pay more than PPF benefits”.

Regulated apportionment arrangements, for example, allow a company to restructure its pension promises in order to avoid insolvency.

As Dickson points out, the regulator has made it clear that this type of restructuring, used by companies like Halcrow and Hoover, must be kept to a minimum.

“The mechanisms that are being used at the moment are very complex and very costly and time consuming to implement,” she explains, adding that this unnecessarily restricts their availability.

However, if the regulator were to relax the rules in the future, could this enable some employers to wrongfully take advantage?

Francois Barker, partner at law firm Eversheds Sutherland, says it is all about striking a balance.

“If you loosen [RAAs] too far they become an abuse tool. If you don’t loosen them at all then there is a risk that they don’t operate in cases where they could usefully do good,” he explains.

The Work and Pensions Committee has previously suggested relaxing the requirement for insolvency to be inevitable within 12 months for an RAA to be approved.

But Barker notes: “If you ask most insolvency practitioners they will tell you that it’s quite hard to look much further than 12 months in terms of formulating a definitive view on corporate insolvency”.

DC regulation will take centre stage

Well-known insolvency cases have pushed defined benefit pension regulation into the spotlight in recent years, but the demise of DB is set to bring defined contribution regulation to the fore.

“The general point about 21st century regulation is whether it’s still too DB-orientated in a market that is increasingly DC-orientated,” says Barker.

The regulator “probably still spends disproportionate amounts of its time on DB regulation”, and “that’s where the big numbers are”, he explains. However, “as time goes on, regulatory focus will increasingly shift from DB to DC”.

More than 8m employees have signed up for a workplace pension since the introduction of auto-enrolment five years ago.

Barker says there will be a regulatory “proportionality issue in terms of catching every single employer and micro-employer who doesn’t comply with automatic enrolment”.

Auto-enrolment total minimum contributions are set to increase to 8 per cent from 2019, but it is widely accepted that this is still not going to be a sufficient amount, and will require further hikes.

“There will be a question in the longer term about whether those contribution levels are enough,” Barker says.

There will also be concerns about “how you police that, because [the regulator hasn’t] had to police any increase in contributions” yet.

Alan Pickering, chairman at Bestrustees, says that in the DC space he would like to see “regulation focus on quality of governance – whether that governance is at the scheme level or the financial services entity level”.

Pickering says: “Most regulation, although well-intentioned, has been counterproductive, largely because it’s been framed through the rear-view mirror rather than through the windscreen”.

He explains he is “a greater advocate for principle-based regulation rather than prescriptive regulation”.

Adapting to change

Nicola Parish, executive director for frontline regulation at the Pensions Regulator, says: “In the 12 years since TPR was set up we have witnessed dramatic changes in the political, economic and pensions landscape, including a rapid shift from DB to DC as the major channel for workplace pension savings following the success of automatic enrolment”.

She cites the regulator’s new powers to authorise and de-authorise mastertrusts as one example of how the regulator has developed to deal with some of these changes.

Parish also draws attention to last year’s launch of the TPR Future initiative, “taking into account the changes that have already happened and further challenges on the horizon”.

She explains that this will allow the regulator to design new regulatory approaches that are fit for purpose for the next five to 10 years.

Parish stresses that “we are using our available powers to take targeted enforcement action against those who are not meeting required standards".

However, she notes how a continued challenge for her organisation is the size of the landscape that it regulates, including the number of medium, small and micro pension schemes displaying mixed standards of governance. 

Regulation and costs

Transparency and costs are also particularly salient issues for the pensions industry, and the Financial Conduct Authority has started to take action.

In light of its asset management market study, the FCA recently referred investment consultants to the Competition and Markets Authority, while forcing fund managers to reveal transaction costs.

Neale agrees that “the process needs to be made more transparent”, because ultimately, “the cost of saving does need to come down”.

More generally, Neale says that “politicians are very impatient by nature, and they have a very limited time horizon… it’s critically important in the field of pensions regulation that if changes are to be made they’re properly and intelligently thought through and based on evidence”.

Neale cites the reduction of the money purchase annual allowance to £4,000 from £10,000 as an example of how “we’ve seen a number of policy initiatives implemented in legislation without solid evidence”.

He adds that these kinds of changes will only lead to a “further disincentive to save”.