Wider default definition will land more funds in charge cap net

In April 2015, a 0.75 per cent charge cap will be imposed on default arrangements for auto-enrolment, intended to protect people that have not made an active investment decision from higher fund charges.

In practice, it will probably be the case that there will be at least two investment funds subject to the charges cap

Nicola Rondel, Hogan Lovells

According to the paper Better workplace pensions: Putting savers’ interest first, released last week, which includes draft regulation and a consultation, the cap will apply to all member-borne charges and deductions, but excludes transactions costs.

According to the paper the default arrangement will cover:

• any arrangement into which workers’ contributions are defaulted;

• an arrangement into which 80 per cent of the employers are actively contributing on a relevant date; and 

• an arrangement into which 80 per cent of workers first made contributions after the relevant date.

The paper stated: “This will require trustees to monitor on an ongoing basis the proportions of members invested into various funds used by the employer to see whether any one arrangement meets the default fund definition.”

Nicola Rondel, of counsel at law firm Hogan Lovells, said the definition of a default arrangement is very wide, so it can pick up a fund in which members have chosen to invest.

“In practice, it will probably be the case that there will be at least two investment funds subject to the charges cap,” she said.

Phil Duly, associate at consultancy Barnett Waddingham, said the cap will extend to a commonly used fund for schemes that has been around for a long time.

"For a scheme with a long history, it could be quite an undertaking for trustees and employers to have a look at which funds need to be assessed against the charge cap and which don't," Duly said. 

Widening implications

Some trust-based schemes may have a problem complying with the charge cap, depending on their investment structures. “It is likely to occur with large schemes that don’t use unitised funds,” Duly said.

“[It will occur] where the trustees are deducting the expenses of the investments and the pool of members funds from which they deduct is variable. Then they can’t say with any certainty at any point in time whether they will meet the charge cap.”

He added this could lead to greater use of unitised funds as it would be an undertaking to keep track of the average charge levy to members.  

The measures will also apply to money purchase benefits. Rondel said that some defined benefit schemes could be considered a qualifying scheme if they have members making additional voluntary contributions.

The government also stated it would be the legal duty of the trustees and managers in occupational schemes and providers in workplace personal pension schemes to comply with the charge cap.

“The justification is that providers will know which of their products are being used as qualifying schemes, but I don’t think that will be the case,” said Rondel.

She said the provider may not have the information required to know which product is used as the default arrangement. 

Although transaction costs have been excluded from the charge cap, trustees will be expected to report on them. 

Tim Smith, senior associate at law firm Eversheds, said the difficulty for trustees will be obtaining that information from asset managers. 

"The government and [Financial Conduct Authority] need to be doing more to actually require disclosure of all transaction costs by those parties in the investment chain," he said.

"It is one thing putting the requirement on trustees and providers, but if they can't actually get that information..."