Red tape puts occupational schemes in a sticky spot

A new raft of regulation from the DWP presents a complex challenge for a number of leading pensions schemes and the possibility of EU-driven compliance requirements adds to the worries, says Andrew Bradshaw of Sacker & Partners.

The recent publication of a new set of regulations by the Department of Work & Pensions (DWP) has given some of the UK’s largest occupational pension funds a real headache.

Also, while Europe struggles with the fallout from the credit crunch, it continues to flex its muscles when it comes to pensions: two European directives are in the pipeline which could have an impact on any pension funds that have ‘alternative’ investments or use derivatives.

Changes to the self-investment rules

Occupational pension schemes are subject to a general rule that no more than 5% of their assets can be invested in their sponsoring employers.

The investment regulations currently include an exemption for any investments by an operator of a collective investment scheme provided the operator is FSA authorised and the fund has a sufficiently wide investment base.

Despite representations from the pensions industry, the DWP has taken the view that in order to comply with the EU’s IORP Directive this exemption will be removed from 23 September 2010.

Whilst not unexpected, this is disappointing news. It could give some pension funds a real challenge as they try to work out how to ensure that they do not inadvertently breach the employer-related investment rules. It is particularly worrying for trustees as any breach of the self-investment legislation could in theory result in fines or even imprisonment.

Risk of breaching regulations

There may be further guidance from the DWP but, in the meantime, those pension funds at risk of breaching the self-investment limits and which have previously taken advantage of the collective investment scheme exemption will need to re-consider their position. In particular, trustees will need to look at what practical steps, if any, their fund managers and custodians can take to ensure that the trustees do not inadvertently fall foul of the revised regulations.

In addition, as expected, the current transitional provision which allows certain schemes to retain employer-related investments in excess of the 5% limit has been removed from 23 September 2010.

Alternative investment fund managers directive

A new EU directive could significantly restrict the ability of UK pension schemes to invest in hedge funds, private equity funds and other alternative investment funds which do not comply with the directive.

Hopefully some of the more draconian provisions will be removed or watered down, although there is no guarantee of that. Under the current proposals:

• Pension funds could effectively be banned from investing in funds which do not have EU authorised fund managers and which would not therefore meet the requirements of the AIFM directive.
• EU-based funds will be subjected to increased disclosure and transparency requirements.
• The scope of the funds intended to be caught by the AIFM is not clear. It could include any collective investment scheme, ie it may not simply cover hedge funds and private equity funds.
• There will not necessarily be an exemption for current investment holdings once any transitional period has elapsed. This means that pension funds could effectively be forced to sell any fund holdings that are non-AIFM compliant.

The European Commission and Parliament are currently attempting to hammer out a compromise with a view to the directive being adopted in the autumn.

Those funds with a significant proportion of their assets referable to EU investors are likely to find a way to comply with the directive. This could however, involve re-structuring costs, which would in all likelihood be passed on to investors, and potential changes to investment strategy. There is also a concern that those non-AIFM compliant funds with a small proportion of EU investors may decide to pull out of the EU.

Central clearing of derivatives

The European Commission has recently published a consultation on derivative and market infrastructures. There are concerns that should these proposals be implemented they could result in increased costs and risks for those UK pension funds that use derivatives.

It is unclear whether or not these proposals will be implemented but occupational pension schemes across Europe will strongly resist any proposals which could detrimentally affect their ability to negotiate bespoke over-the-counter derivative contracts.

It looks like a busy few months for occupational pension schemes as they attempt to grapple with the new self investment regulations and the possibility of new unwelcome EU driven compliance requirements.

Andrew Bradshaw is partner in the investment unit at Sacker & Partners