Do the new charges cap limits for default funds also apply to "mapped funds" where automatic substitutions of fund are made? We consider the scope of the regulations related to the cap limits and outline how trustees and providers can remain compliant.
On 6 April 2015, the Occupational Pension Schemes (Charges and Governance) Regulations 2015 (the Regulations) came in to force. These cover a range of charge controls and governance measures pertaining to defined contribution (DC) pension schemes. This includes imposing a cap on the charges of default arrangements of qualifying schemes. However, the Regulations provide a particularly broad definition of “default arrangement” for these purposes and opinion differs as to whether these legislative measures capture fund “mapping”.
The Regulations are primarily intended to control the level and range of charges in DC pension schemes which are used by employers to meet their automatic enrolment duties. This includes capping charges in the default arrangements within qualifying schemes at 0.75 per cent annually of funds under management, or an equivalent combination charge. This is designed to protect members and employers from situations in which they might otherwise be unable to adequately control and/or monitor member-borne charges, fees and/or expenses.
Importantly, the Regulations also apply to the type of charges and structures that are allowed regardless of compliance with fee levels, in addition to the overall level of charges that can be made.
“Mapping” occurs where members of an existing fund are automatically transferred into a substitute fund, in the event that members do not actively choose an alternative replacement fund.
The charges cap imposed by the Regulations applies to all types of “default arrangement”. The issue that arises is whether replacement funds, following a mapping exercise, are to be regarded as “default arrangements” in this context. The statutory definition is ambiguous. The general position is that a “default arrangement” is an arrangement under which contributions are allocated to an investment fund which members have not expressly chosen.
The scope of the Regulations
Clearly, the cap is broadly intended to apply where members have not made an active investment choice. However, it appears that the Regulations have the potential effect of covering mapped funds.
Although the replacement fund may conform to the same type of fund (or “wrapper”) as the original, technically the members may not have actively consented to the particular fund to which their contributions are subsequently allocated. Instead, the trustee(s) and/or provider will have decided which particular fund is used behind the “wrapper”. Therefore, active consent to the underlying fund might not have been given by the members expressly.
In a situation such as this, the trustee(s) and/or provider may have chosen to substitute a broadly equivalent fund but this may still be a “default arrangement”, despite the fact that a decision to map the funds may have been taken in the members’ best interests.
The statutory tests aim to capture arrangements which have been, or are, used in a similar way to a true default. This is consistent with an overriding policy intention that members and employers have greater control over scheme charges and that auto-enrolment DC schemes should generally provide better value for money. For these reasons, it seems that the breadth of the Regulations may be deliberate.
The risk for trustees and/or providers that do not seek to comply with the cap is that the Pensions Regulator may issue a Compliance Notice and, ultimately, a Penalty Notice. Such a penalty may be as much as £50,000. Members could also seek to bring claims against trustees for any financial losses arising from any failure to comply with the Regulations. Such compensation could be significant.
The Regulations also require a statement by the chairman of trustees confirming that charges incurred by members represent good value. Failure to comply may result in fines of between £500 and £2000.
In addition, The Pensions Regulator has indicated that trustees and managers of occupational DC pension schemes will be asked to confirm whether or not they comply with new charge controls in their scheme return to The Pensions Regulator.
The more prudent approach for trustees to take is to assume that the charging cap applies to mapped funds, subject to legal advice to the contrary. This would be particularly prudent given that trustees are required to positively confirm compliance with charge controls to The Pensions Regulator.
If a significant risk of non-compliance is identified, steps must be taken to communicate members’ options and to seek their express consent to contributions where these exceed the cap imposed.
In the meantime, it is reported that interested parties, such as the National Association of Pension Funds, have written to the Department for Work and Pensions (DWP) to seek urgent clarification of the Regulations.
Author: Alan CadmanThis information is intended as a general discussion surrounding the topics covered and is for guidance purposes only. It does not constitute legal advice and should not be regarded as a substitute for taking legal advice. DWF is not responsible for any activity undertaken based on this information.