During the second reading of the Pension Schemes Bill, Steve Webb, the pensions minister, told the House of Commons that the complexities of drawing up the Bill had made him “more sympathetic” to there being a single pensions regulator. Today there are two: The Pensions Regulator (TPR) and the Financial Conduct Authority (FCA). But perhaps there is a more fundamental point to consider: irrespective of the delivery structure, is regulation the most effective tool with which to control the pensions industry?
What is regulation for?
The majority of savers are investing in products they do not fully understand, which are governed by a jungle of complex rules and tax regimes that, collectively, almost nobody understands. Savers are, therefore, putting their trust in the industry, and they need to be protected in situations in which the industry has a knowledge advantage (i.e. information asymmetry). For almost all savers, this excludes very little. A less subtle description would be to say that they need protecting from the industry’s self-interest, its inefficiencies and, in some cases, its predatory instincts.
And so, for decades, regulators (not just domestic) have been imposing multiple layers of rules upon the industry, in the hope that this will improve the latter’s relationship with consumers. They have failed: much of the financial services industry is viewed with distrust. This matters because it acts as an impediment to catalysing the savings culture that the UK so desperately needs, both to fuel investment and provide retirement incomes. Rule setting and “prudential oversight” should be de-emphasised.
A new approach required
The blunt instrument that is (an ever-increasing volume of) traditional regulation is unsuited to engendering trust – that cannot be created through regulation. The industry, meanwhile, is drowning under a Niagara of complex rules, and it is ultimately customers who pay for the regulatory burden.
Rather than impose top-down regulation upon the industry, regulators should reposition themselves behind consumers and professional trustees, to share their experiences when interacting with the industry. Observations should then be used to shape regulatory initiatives (and interventions) to drive the industry to establish a sense of common purpose with its customers, thereby encouraging it to boost its efficiency, by reducing costs. In addition, the industry must improve its customer service and ensure that customers are treated fairly. And market competition must be seen to work effectively.
An important first step would be to professionalise the execution of governance and other fiduciary responsibilities, and codify fiduciary duties into law - akin to the codification of directors’ duties in the Companies Act 2006. Such a move would be consistent with the Law Commission’s recent recommendation that there should be a statutory duty on contract-based pension providers’ independent governance committees to act, with reasonable care and skill, in members’ interests.
Trustees should be licensed, once they have satisfied tough training requirements. To reinforce accountability, they should be held personally liable for any governance failings. Their role should include demanding total transparency in respect of all industry charges, costs and fees, and product simplification. Company scheme trustees, for example, could be encouraged to provide evidence that their members are not being disadvantaged by a lack of scale (the UK has tens of thousands of sub-scale schemes with unnecessarily high costs per member), as well as holding fund managers and investment consultants to account. As for private savers, only the top ten per cent of earners (who own nearly half the nation’s wealth) would need to be energised to change the industry’s behaviour.
The long-term objective should be to reframe the language and legislation in terms of fiduciary duty and good governance. This terminology is already familiar in the occupational pension scheme arena, where it is more the underlying ethos that may be lacking, particularly in respect of contract-based schemes.
Unfortunately, some of today’s regulators are not equipped, operationally or culturally, to usher in such a period of regulatory enlightenment and innovation. It would require a willingness to experiment and take risks, and requires a familiarity with how to catalyse behavioural change, necessary to bring about an alignment of interests between industry and consumers. This would be a major departure from their traditional (classic public sector) behaviour. Retooling today’s regulation factory (an industry unto itself) would meet opposition from other vested interests – the legions of third party service providers and consultants whose livelihoods depend on it.
Simplify the structure
There is a way to simplify the regulatory structure along the lines of the different types of scheme: defined benefit (DB) and defined contribution (DC). Today, the FCA regulates the sales and marketing of contract-based DC personal pensions (including annuities) and is, therefore, concerned with the business relationship between the industry and its retail customer. Conversely, TPR regulates workplace pensions schemes, both DB and DC, looking after the interests of active and deferred scheme members, as well as pensioners. Its focus is mainly on employers, scheme trustees and managers; the context is one of voluntary provision of pensions by employers.
Thus, TPR and the FCA are looking after the interests of different beneficiaries (scheme members and individuals), with different types of relationships between sponsor or provider and beneficiary (voluntary and contractual business). Rather than merge TPR and the FCA, which would import into the FCA a portfolio of unfamiliar corporate relationships, accompanied by over £1 trillion of DB liabilities, it would be better to leave the slowly withering DB schemes within the TPR’s remit. All DC schemes should be placed in the FCA’s domain, including group personal pensions (currently regulated by TPR), so that there would be not overlap in regulatory “client” relationships.
The FCA could also accommodate any collective DC schemes that may emerge from the pension minister’s Defined Ambition project. The original intention of risk sharing between employers and employees has morphed into risk pooling solely among employees (these can be seen as employer-facilitated “with profits” schemes).
It would make sense to fold the Pension Protection Fund (PPF) into TPR. These two bodies share a common client base and confront similar issues, and TPR could do with access to the PPF’s modelling skills. In addition, given the growth in the transfer of pension schemes’ risks (particularly longevity) to insurance companies, closer co-operation is required between a TPR/PPF combine and the insurance companies’ regulators.
TPR and the FCA could then be left to focus on two distinct communities, monitoring different risks (DB and DC) and requiring different forms of communication.
Strong governance required
To be clear, changing the framework through which regulation is delivered is not enough. Consider the track record: LAUTRO became the PIA, to become the SIB before being renamed the FSA, now the FCA; this lacks an air of finality. The root problem is that the very concept of top-down regulation is flawed. What is required is authoritative, professional governance, with teeth. But where to start?
The Government is consulting on proposals to improve the governance of the Local Government Pension Scheme. The LGPS is by far the largest funded public service pension scheme. This ought to be a golden opportunity to lead by example.
Today, the LGPS provides a perfect case study of how not to govern an occupational pension scheme. The three key drivers of scheme viability (benefits, asset performance and wages, which determine contributions) are overseen by three disparate groups: central government (which sets benefits), local government (responsible, via administering authorities, for the funding strategy and investment performance), and employers (who set wages). Characterised by a marked absence of clear accountability and responsibility, this tripartite arrangement is reminiscent of the pre-crisis (now-defunct) Bank of England, FSA and HM Treasury oversight of the banks. The consequences of the LGPS’s lax governance is evidenced by the catastrophic financial condition of some of its funds, which are beyond the point of no return.
Unfortunately, the government’s proposals are riddled with political considerations, notably in respect of “localism”. Not only will there be a Scheme Advisory Board (its shadow forerunner has 23 members, four observers and five sub-committees, with more than 80 members and observers), but each of the 89 funds in England and Wales will have its own local pension board. Are hundreds of people really needed to provide good governance of a single occupational scheme?
So, if good governance is to supersede regulation, we need to look elsewhere for an efficient model. Consider Canada: there, the largest funded public service pension scheme (CAN$219bn in assets) has a single governance committee, with five members.
The UK has to get real about embracing both economies of scale, and independent oversight by experienced, professional governance boards, driven by a fiduciary duty to put the beneficiaries first. Authoritative and informed governance would leave the industry with little choice but to change its behaviour. Then the need for regulation would significantly diminish.
This article first appeared in CSFI’s Financial World magazine, December 2014.
Michael can be contacted on [email protected]. Twitter: @Johnson1Michael
 An approach first proposed by Paul Thornton, in his report A Review of Pensions Institutions; an independent report to the DWP, June 2007.