Considered in Grand Committee
That the Grand Committee do consider the Occupational Pension Schemes (Collective Money Purchase Schemes) Regulations 2022.
Relevant document: 28th Report from the Secondary Legislation Scrutiny Committee
My Lords, this statutory instrument will implement the authorisation and supervisory regime for collective money purchase schemes. These are commonly known as collective defined contribution, or CDC, pension schemes. These will be the first schemes of their type in the United Kingdom pensions market. A further statutory instrument, the Occupational Pension Schemes (Collective Money Purchase Schemes) (Modifications and Consequential and Miscellaneous Amendments) Regulations 2022, will be laid shortly to implement further consequential amendments required for existing pensions legislation to accommodate CDC schemes. These further regulations will be laid using the negative procedure.
Before I move on to the detail of this instrument, I will remind noble Lords of the purpose of this new type of pension. The United Kingdom pensions market we see today has been built around defined benefit schemes, where the employer underwrites the pension benefits paid to employees, or defined contribution schemes, where individual members bear all the investment and long-term risks and where there are no employer guarantees regarding what the member might receive at retirement.
CDC schemes provide an alternative approach in which member and employer contributions are pooled and invested with a view to delivering benefits at the level to which the scheme aspires. They offer potential benefits in economies of scale and the opportunity for greater investment in higher-returning assets than are usually associated with defined contribution occupational pension schemes. Their collective nature means that investment and longevity risks are shared across the whole membership, and as these schemes provide an income for pensioner members there is no need for members to make complex financial decisions at the point of retirement. The Government believe that this new type of pension provision will be more sustainable for employees and employers alike, and has the potential to offer better outcomes for pension scheme members.
I turn now to the statutory instrument itself. Noble Lords will appreciate that this is a necessarily detailed set of regulations. As a new type of pension scheme, it is critical that employees and employers can have confidence in CDC pension schemes. These regulations set out requirements for the process of applying for authorisation and further detail on the criteria that need to be met by CDC schemes in order for them to be authorised to operate.
The authorisation criteria include that the design of a CDC scheme must be sound and that it has sufficient financial resources to operate and deal with particular issues that may arise. There is also a requirement that only fit and proper persons are involved in particular capacities to do with making key decisions about the scheme. If the Pensions Regulator is not satisfied that all the authorisation criteria are met, it cannot authorise the scheme.
These regulations also set out requirements relating to the Pensions Regulator’s supervisory role. It can withdraw authorisation if it is no longer satisfied that the authorisation criteria are met. The regulations set out further detail on information to be provided to the regulator while the scheme is running, which will help it consider whether it is satisfied that the authorisation criteria for schemes continue to be met.
These regulations also provide more detail about the actions trustees must take if a scheme experiences a “triggering event”. These are certain events, set out in the primary legislation, that can pose a threat to the future of the scheme and the interests of members. If a triggering event occurs, the trustees must take certain actions or continuity options. A triggering event may lead to a scheme being wound up. Schedule 6 provides a detailed framework for winding up a scheme.
These regulations amend the Occupational and Personal Pension Schemes (Automatic Enrolment) Regulations 2010 to allow for an alternative automatic enrolment quality requirement for CDC schemes. They also amend the Occupational Pension Schemes (Charges and Governance) Regulations 2015 to implement an annual charge cap set at 0.75% of the value of the CDC fund, or an equivalent combination charge. Finally, they amend the chair’s statement requirements in the Occupational Pension Schemes (Scheme Administration) Regulations 1996 to reflect that CDC schemes will not have a default arrangement.
I now wish to acknowledge the considerable interest expressed in both Houses on CDC schemes during the passage of the Pension Schemes Act 2021. Many valuable contributions were made at that time regarding aspects of CDC schemes. A key concern was ensuring that CDC schemes treat their members fairly and, in particular, respect the interests of different generations. To help achieve this, Regulation 17 sets out requirements for CDC scheme rules to ensure that there is no difference in treatment when adjusting benefits between different cohorts or age groups of scheme members, or between members who are active, deferred or receiving a pension.
The importance of good communications to members of these new schemes was debated here and in the other place. Concerns were expressed that members should be given access to enough information to give them confidence to make informed decisions about their savings. Much of this is provided for in the negative regulations which have been published in draft and will be laid shortly. Alongside the regulations we are debating today, these will provide for transparency to allow for scrutiny of how a CDC scheme is operating.
The forthcoming negative regulations package will set out the disclosure requirements for scheme providers, with requirements to provide information relating to target benefits, including the actuarial valuation and a statement informing members and prospective members that benefits may be adjusted based on the actuarial valuation and are not guaranteed. CDC schemes will also be required to publish their scheme rules, including details of benefit design.
Debates on the Act also covered the powers of the Pensions Regulator to specify the requirements that should be met in respect of the financial sustainability of the scheme. Schedule 3 to the regulations sets out in detail the financial sustainability requirements for new 213CDC schemes, including the information required on application for authorisation and what the regulator must take account of in deciding whether it is satisfied that a CDC scheme has sufficient financial resources to meet the costs of establishing and operating the scheme, as well as sufficient resources to deal with the costs, as required by the Act, if a triggering event occurs.
Finally, concerns around the diversity of trustee boards, and what may be done to improve diversity, were raised during the passage of the Act. The Pensions Regulator has published a draft code of practice, which sets out that trustee boards should have policies on diversity and inclusion, including objective selection criteria, and that they should demonstrate that they have the ability to capture and monitor data on diversity and inclusion. I beg to move.
My Lords, I thank the Minister for her presentation, which was clear and to the point. I would like to raise two issues for consideration.
The first is the possibility of widening the scope for CDCs to smaller companies and how the Government view that. The current legislation has been written very much with Royal Mail in mind but if the CDC scheme goes well, others might want to follow suit, including smaller employers. But they would want to join something bigger; for example, a multi-employer or industry-wide CDC scheme or master trust CDC scheme. Will this require new primary legislation to allow multi-employer schemes, or does the Pension Schemes Act give the DWP sufficient power to do this? If it would require new secondary legislation, how long does the Minister think this might take? Does she share the view that multi-employer schemes are key to unlocking CDC? Not everyone has the resources or scale of the Royal Mail to do it for themselves. Please can she explain the process for multi-employer CDCs?
Secondly, can the Minister say something about retirement-only or decumulation CDCs and the position of the DWP on these? One of the discussions over the new pensions freedoms is that individuals take all the risk of managing a DC pot for themselves, including the longevity risk. In a pooled CDC retirement scheme, this is shared with others, so it is an attractive option for people to join at retirement. What is the scope for these and what is the position of the DWP on this? NEST has hinted that it might be prepared to look at it, but it would be helpful to know whether the Government look on these suggestions favourably. I look forward to the Minister’s response.
My Lords, I refer to my registered interests: I am trustee of the Telefonica pension scheme and the People’s Pension master trust. I thank the Minister for her helpful presentation of the regulations, and the DWP staff who kindly took the time to answer my many queries. My contribution is rather long. The only consolation is that it would have been even longer had I not had that discussion with colleagues.
Collective defined contribution schemes are clearly a welcome addition to the pensions landscape, whereby employees can, in effect, share their investment and longevity risks and remove some complexity from individual decision-making. But with only one employer committed to date, there is a risk that the regulations are bespoke for the Royal Mail scheme but may need adapting for others set up subsequently.
There is considerable uncertainty over the fuller impact of the CDC proposal, which is reflected in the detail of the regulations and the draft code. The code contains a list of matters more likely to satisfy the Pensions Regulator, but some lack a qualitative feel or benchmarks or triggers. Take the example of trustee governance. The draft code says that the regulator is
“more likely to be satisfied”
if there is clarity as to
“who decides in a scenario where both the employer and trustee have an interest”,
but it does not express a view on good practice in such scenarios.
A CDC scheme is set up under an irrevocable trust by an employer. In a single or connected employer scheme, sustainability can be influenced by employer behaviour and changes to corporate control and structure. A regulator’s expectations for the governance framework and the extent of trustee discretion are therefore particularly important. I ask the Minister: is it the intention to set out good practice expectations on the governance framework and the extent of trustee discretion?
The approach to authorisation, supervision and continuity reflects that for master trusts, but there are differences. For authorisation, it is the actuary who confirms the soundness of the scheme and issues the viability certificate. There are a lot of requirements for the actuary to meet before issuing a certificate, including a novel role in considering non-actuarial matters. Is this considered a materially extended level of obligation on an actuary when compared with other forms of pension schemes?
On benefits, calculations and adjustments, the regulator expects the trustees to make their legal advice available to the actuary. Can the actuary rely on the trustees’ legal advice when issuing a viability certificate? A certificate requires certain tests to be met: two gateway tests at authorisation and two live running tests after the scheme has begun operating. The first gateway is met if the estimate of the projected average annual increase in the first 10 years of benefits on a central estimate is no less than the estimated projected annual increase in the CPI. But why is that test is set on a central estimate basis with no element of prudence built into achieving the projected increase?
The other tests are intended to limit the amount of cross-subsidisation between members and the risk of excessive cross-subsidy. As the Minister herself said, fairness between groups of members—in particular, the fair treatment of younger members—is of considerable importance. On the information available, it is difficult to assess whether the proposed gateway and ongoing tests provide a confident measure of whether a scheme’s design is sound and fair, and whether they would be appropriate for all CDC schemes. Given their importance, could the code of practice or any guidance to supplement that code set out more clearly why these tests for controlling cross-subsidies will be fit for purpose in all authorised schemes?
A CDC scheme can have more than one section. For example, where an employer wants to pay different rates of contribution for particular employees, new employees or future accruals, or offer non-CDC benefits, they have to set up a separate section. However, in my view, separate sections can carry the potential for one section to weaken the viability of another—or even precipitate closure; for example, by reducing the size of the scheme membership and/or stemming the flow of new members. I think I understand that the potential to impact on the soundness of another section would not form part of the assessment for the authorisation of a new section; such an impact would be dealt with through the “significant or triggering event” process for those other sections. However, given that CDC schemes need to be sustainable over very long periods, and companies can change ownership or be restructured over shorter periods, that could be a regulatory weakness. If it is considered appropriate, can the Pensions Regulator defer the authorisation of a new section on the grounds of its impact on the sustainability of another section? What consideration is being given to permitting variation in the benefit characteristics in a CDC scheme without the need for opening a new section?
To be financially sustainable, a scheme must have reserves to meet the costs of dealing with a triggering event and implementing a continuity option. These requirements seem less robust than those required of master trusts. Reserves do not have to be ring-fenced and the employer is not explicitly required to contribute. No doubt the Minister will argue that a CDC scheme cannot take in member contributions or funds prior to authorisation and the financial sustainability criterion being met. This, therefore, implies that an employer such as Royal Mail must provide some financial resources for a scheme to be authorised.
There are some “buts”, however. It is not clear in what circumstances the regulator could require an employer to contribute to the reserves. The financial reserves required will change over time, as a scheme grows and becomes more complex, so what suits authorisation may not suit ongoing supervision.
Trustees have to identify other ways of meeting these scheme costs where they are not relying on the employer, such as building reserves from member charges or a service provider contracted on a fixed-cost arrangement, even if a triggering event occurs. The code does not require a pot of money or assets to be ring-fenced; the trustees can rely on other means, such as enforceable guarantees. But the strength of those guarantees or other means may depend on the strength of the employer. The employer covenant, trustee access and enforceability in insolvency will then all come into play and have to be monitored, but regulatory failure happens, even with the best of intentions and the most applied regulators. Yes, there is a prohibition on increasing member charges during a triggering event, but I ask the Minister—as I have in the past and no doubt will in the future—what happens if the reserves are not sufficient to meet the costs flowing from a triggering event.
Under a CDC scheme’s rules, the employer can retain the right to wind up or close a scheme, or add sections, but there is no requirement to contribute to reserves, where their decisions increase the likelihood of a triggering event in a particular section. I ask the Minister: would the regulator have the power to direct an employer to contribute to the reserves where an employer decision leads to a triggering event, if it is considered appropriate?
Where continuity option 3 to run as a closed scheme is implemented, there has to be a question about how long that position is sustainable. It is unclear when the regulator would consider it to be unsustainable, so I ask the Minister whether it is intended to set hard triggers that would flag to the regulator to consider directing trustees to wind up.
I am drawing slowly to a conclusion. The wind-up of a scheme and decollectivisation of benefits to individual discharge amounts will pose some challenges, and this will be a novel area. In my view, the regulations and draft code lack flesh on the process to manage members out of CDC. There needs to be a high level of confidence in and understanding of the calculation of members’ final discharge amounts. Communications to and support for individual members will be challenging, yet there is no explicit provision for defaulting members into guidance nor requirement for targeted support for pensioners defaulted into income drawdown. Is it anticipated that such matters will be covered in the code?
Under the regulations, no pensions or benefits must be paid by the scheme during the wind-up period, but Regulation 29(7) says:
“Where a person … would have become a pensioner beneficiary … during the winding-up period … the trustees must pay that person a periodic income”.
I struggle to fully understand the implications of those provisions, so I ask the Minister whether a person who would have become a pensioner beneficiary can opt out of receiving a periodic payment. Will such payments be treated as authorised payments, with implications for a member’s pension freedom or limits on future tax-incentivised contributions? I could not find the trail to the answer to those questions.
Finally, on charges, will the code give guidance in the absence of reference to a de minimis for small pots and on how charges in relation to performance fees will be fairly applied when a member seeks a transfer out?
My Lords, I join the previous speakers in thanking the Minister for her helpful introduction. To a certain extent, it was discursive, in that it brought in broader issues to set the context for these regulations. I suspect that, in this area, we just have to get on and do it before we truly understand what the problems are. The Royal Mail proposals act almost as a pilot: we do not know how this is going to work until we actually do it.
The advantage of speaking after my noble friend Lady Drake and the noble Baroness, Lady Janke, is that almost all the points that I had in mind to make have already been made. In particular, we have to move towards multi-employer schemes. We have to move towards schemes that are effectively in payment-only arrangements. They are not really encompassed within these regulations, and we hope that, in due course, we will be able to move forward. When I say, “in due course”, I really mean “soon”, but it is good to have the issues on the table, and I am glad that the noble Baroness, Lady Janke, made those points and I echo them.
I am glad that my noble friend Lady Drake asked all those questions, as they are all pertinent and important and need to be answered. I have one slight question about her use of the term “central estimates” and the suggestion that these decisions have been made using prudent estimates. The problem with prudent estimates is: prudence for whom? One person’s prudence could be a counterparty’s lack of prudence. That is one of the central issues that still needs to be resolved in how these schemes operate: whose interests are being considered, and how to offset the interests of one group against another.
My natural inclination in those circumstances is to use what we used to call “best estimates,” which have now been retermed “central estimates”. “Best estimates” perhaps captures the issue a bit more closely, but people did not like using that term, so we now have to learn to use “central estimates”. The point is that, as soon as you move away from a central estimate, you move towards favouring the interests of one group as against a counterparty group. That is one of the issues. The question was entirely reasonable, but it is a particularly difficult one to answer, which goes to the heart of how these schemes will operate in practice.
My third point is about the sheer complexity of this set of regulations. It is a bit depressing that there are going to be even more regulations. I have been told that, in practice, it is easier to establish a defined benefit scheme than one of these schemes; the procedural hoops that have to be jumped through to establish a scheme are easier for defined benefit schemes than for these new CDC schemes. Perhaps that is the right approach, but its effect is doubtless to deter organisations that might otherwise be attracted to developing this form of provision, because they are intimidated against doing it in practice. As is the nature of things, they will tend to be smaller, less professionally savvy groups of employers. That is why moving towards a multi-employer model is so important and urgent.
I think it reasonable to assume that other employers of the Royal Mail model are limited. This will work only if it is provided for a whole range of different sizes and natures of employer, including employers without strong human relations or whatever the staffing function is called, and employers without a strong union presence that can get involved in the development of this sort of scheme. In my view, that will happen only when we have a multi-employer model.
Yet we have these regulations. I can cope with understanding regulations on pension schemes—humble brag—and I find these a real struggle. To expect people to cope with these regulations from a standing start is a big ask. They are here now, and I am not for one moment suggesting that we send them back and ask for them to be redrafted, but it means that the onus passes to the Pensions Regulator, which will have to bear this in mind when it considers applications to establish this sort of scheme.
Obviously, the regulator has to comply with the law and protect members’ interests, but if it adopts a bureaucratic, nitpicking approach to how these regulations and requirements are met, we will have very slow progress on what is an important and useful development as a type of pension provision. We have to emphasise this to, and work with, the Pensions Regulator to ensure that it adopts a practical approach and enables other employers to think, “This isn’t going to be a nightmare; we can actually do this”.
My Lords, I thank the Minister for her introduction to these regulations and all noble Lords for their contributions. As some noble Lords will remember, we spent a long time debating the Pension Schemes Act in this House. We asked lots and lots of questions about the establishment of CDC pension schemes. When we asked questions of the Minister, at least some of the time the answer came back: “The detail will be in the regulations”. Now here we are; here are the regulations and they will implement the authorisation and supervisory regime for CDC schemes. It is not surprising that so many questions have come from my noble friend Lady Drake and other noble Lords, and I am afraid I have more to add to the list. I very much hope the Minister can answer them, because this is our last chance before the scheme is created and it is incredibly important.
Here are my questions, starting with the future of CDC schemes. In his foreword to the consultation document in 2019, the Pensions Minister, Guy Opperman, said:
“There were encouraging signs of a growing interest in CDC amongst employers and commercial providers, outside of the Royal Mail and CWU. I expect this will increase further”.
It is three years down the road, and still only Royal Mail has committed to establishing a scheme. The Government admit that future take-up is still unknown.
In her contribution, my noble friend Lady Drake highlighted some of the concerns that flow from devising the details of a scheme with only one employer in mind. The future will not be the same, of course. The noble Baroness, Lady Janke, and my noble friend Lord Davies of Brixton asked what happens if other employers want to join in future. It is my understanding that we would need additional legislation if we got developments such as unconnected multi-employer schemes or commercial master trusts operating CDC schemes. The Minister can confirm that.
In such scenarios, different risks would need to be considered. One would expect the regulations and the code of practice provisions on things such as financial sustainability and trustee discretion to be more robust. For example, I would expect to see a definite requirement to ring-fence reserves to meet the costs of a triggering event or implement a continuity option; or, for example, a strengthening of trustee discretion over things such as opening new sections or the appointment of the chair of trustees. Can the Minister confirm that these regulations and the draft code of practice under consultation will not be considered fit for purpose for unconnected multi-employer and commercial master trust schemes?
The Government have acknowledged that there is considerable uncertainty as to the impact of the CDC proposal. I take the point made by my noble friend Lord Davies that, when one starts something, of course one will never fully know until it is out there. However, it is probably because of that uncertainty that the regulations and the draft code are long and complicated —because they are trying to cover for a range of circumstances. In turn, I suspect that that will mean that the CDC scheme rules are likely to be long and require a high level of understanding by trustees and their advisers. That complexity adds to the importance of clear member communications, and good systems and processes.
However, because of the way in which the rules are framed—my noble friend Lord Davies is right—a lot of responsibility will have to be borne by the regulator on some complex technical issues. If CDC schemes grow in number, as is hoped, how will the regulator, given its increasingly complex pensions remit generally, build and maintain the necessary capacity and capability to authorise and supervise such schemes? This is highly technical stuff but with a lot at stake. How is the regulator going to be able to manage it?
Next, I want to turn to the fit and proper person test for trustees. These regulations, in Regulation 8 and Schedule 1, together with the code of practice, set tough fit and proper person requirements for assessing whether a person can be a trustee of a CDC scheme, especially around skills, knowledge and experience. I am clear about the importance of ensuring that members’ interests are protected by an informed, knowledgeable and balanced team of trustees. However, the detail in the draft code leads me to ask a couple of questions. Is the Minister at all worried that the bar is perhaps set too high for committed and conscientious member-nominated trustees to meet? Is it perhaps the policy intention to squeeze out member-nominated trustees from single or connected employer CDC schemes? Is it perhaps the intention to have CDC schemes run only by professional trustees?
I realise that the scheme rules are complicated but, if schemes end up relying increasingly on professional trustees, that potentially brings a different risk: groupthink. Corporate trustees are more likely to come from the industry and may be more concerned with compliance than looking beyond it to see emerging risks. Further, a single employer or connected employer CDC scheme is established under an irrevocable trust by an employer. Could the terms of such a trust fetter the discretion of the trustees to a point and remove the chair of trustees?
Then there is the key issue of financial sustainability, about which my noble friend Lady Drake asked some crucial questions to which the Committee needs clear answers today. I am going to go back a little in history and remind the Minister of a couple of exchanges during the passage of the Bill. I must say, I was a lot more articulate in my head at the time than I was when I read it in Hansard afterwards; it is amazing how much less impressive it is when one reads it later, but bear with me. In Committee, I put this to the Minister:
“I think I understood her to say that the regulator would not approve a scheme unless the sustainability criteria had been met and that they could be met only if an adequate amount of money was placed in, for example, escrow. Is she saying that a scheme would be approved only if the regulator was satisfied that enough money had been provided up front by the sponsoring employer to fund the continuity options in the event of a triggering event?”
“The answer to the question asked by the noble Baroness, Lady Sherlock, is yes, the money would be in an escrow account if needed.”
I pressed her further and asked:
“So could it never be the case that in the event of a triggering event, such as a wind-up, an employer pulling out or an employer downsizing, money would have to come from members’ contributions to fund the continuity option?”
The Minister’s answer was clear. She said:
“The answer to that question is no, it should not be.”—[Official Report, 24/2/20; col. GC 18.]
How can we be assured of that?
My noble friend Lady Drake had an exchange with the Minister on the same issue on Report. I hope that the Committee will bear with me if I quote again briefly. The Minister said:
“For the financial sustainability requirement at Clause 14 to be met, the trustees must provide evidence that they can access sufficient financial resources to cover the costs associated with setting up and running the scheme, as well as those associated with dealing with triggering events. If the regulator is not satisfied about the security of these resources and that they can be accessed as needed, the requirement will not be met and the scheme will not be authorised. It may well be that, in the early days of a CDC scheme, initial funding comes from the employer, but our approach does not just rely on employer-provided financial support; it enables trustees to draw on other options, including funds held in escrow, insurance policies or contingent assets. These should be available to cover any costs arising from a triggering event.”—[Official Report, 30/6/20; cols. 604.]
That raises a key question: how can the Minister assure the Committee that there will always be enough money available to meet the cost of a triggering event and implement the continuity strategy without recourse to members’ funds, as she promised on Report? Despite all our pressure, the Government chose not to require the reserves to be more obviously ring-fenced, as in a master trust. As my noble friend Lady Drake has pointed out, the requirements in the regulations and the draft code are pretty soft and unspecific. I look forward to hearing the Minister’s answer to her question as to whether there will be hard triggers—such as ratios—when we come to make those assessments.
I have gone on quite a bit but I think this is incredibly important. A lot of people will read this record—more than the number in this Room—because huge amounts of money will be at stake. If the Minister is asking the House in due course to pass these regulations, it is really important that we get some concrete reassurances on the safety of those members’ assets.
Finally on this issue, can the Minister assure the Committee that, when moves are made to extend the CDC authorisation to unconnected multi-employer schemes or commercial master trusts operating CDC schemes, the financial sustainability requirements will be more robust, given the nature of the risks and the increased scale that would bring?
The Pension Schemes Act 2021 created a whole new kind of pension scheme. That does not come along very often. These regulations are the only chance that the House of Lords will have to gain clarity on how those schemes will operate and how members’ assets will be protected. I therefore really hope that the Minister has come armed with some detailed answers. I look forward to her reply.
My Lords, I thank all noble Lords for their helpful contributions to this debate. Before the noble Baroness, Lady Sherlock, raised it, memories came flooding back of our discussions on the Bill, which were lengthy and in depth.
I start by raising the points made by all noble Lords; I will try to answer at the level and detail for which the challenge has been set down. The noble Baronesses, Lady Janke and Lady Sherlock, asked how we will ensure that the CDC scheme has sufficient financial resources to cover the cost of operating the scheme if things go wrong. As part of the financial sustainability and continuity strategy authorisation criteria, the scheme must show how members will be protected against impacts, including costs, if a triggering event occurs, and must satisfy the regulator that there are sufficient protections. The financial sustainability requirements include demonstrating that there are sufficient financial resources to cover the cost of establishing and operating the scheme as well as costs arising from addressing a triggering event. This must be available to be used as and when needed.
If the regulator is not satisfied that the criteria are met, it must not authorise the scheme. The scheme will also need to satisfy the regulator on an ongoing basis that it continues to meet the authorisation criteria; for example, if the costs associated with addressing a triggering event change, the scheme must be able to show that it has sufficient resources to cover this. The regulator can require information relevant to the authorisation criteria to be included in a supervisory return. It is a significant event if the scheme is unable or unlikely to be able to meet the cost of a triggering event occurring.
Again, the noble Baronesses, Lady Janke and Lady Sherlock, raised the appointment of trustees and asked how we will ensure diversity on the board of the trustees. Our primary focus is on ensuring that trustees in all occupational pension schemes meet the standards of honesty, integrity and knowledge appropriate to their role. The regulator’s draft code of practice, published in January, sets out that trustee boards should have policies on diversity and inclusion, including objective selection criteria, and should demonstrate that they have the ability to capture, process and monitor data on diversity and inclusion. This would need to be demonstrated to the regulator for it to be satisfied both that the scheme satisfies the authorisation criterion and that the scheme’s systems and processes are sufficient to ensure that it is run effectively. The regulator will continue to supervise trustee action in this area and has established a working group to look at data, research, best practice, practical tools and employer engagement. We will look at the outcomes from the working group and consider what measures are needed.
The noble Baroness, Lady Janke, asked about widening the scope of CDCs to other organisations and multi-employer schemes. Under the Bill, the powers to extend CDCs to multi-employer schemes by secondary legislation are subject to the affirmative resolution procedure—so the powers under the Bill are there. At this moment, we are developing our understanding of the models that stakeholders are interested in delivering, including multi-employer schemes, master trusts and decumulation-only models.
I move on to the contribution of the noble Baroness, Lady Drake; I am pleased to hear that our officials were helpful to her. She asked whether there are tax implications that might limit a member’s pension options once they are designated into draw-down at the end of the winding-up process, and made some interesting points about the tax regime and CDC schemes in wind-up. We will continue to engage with HMRC to ensure that the tax legislation works appropriately in those circumstances by the time one of these schemes is in a position where wind-up is being considered.
The noble Baroness also asked how, if a scheme decides to open a new section, the interests of members in the original scheme will be protected. A proposal for an undivided scheme to become a scheme divided into sections is a specified significant event. Trustees will need to notify the regulator of such a proposal and explain how the interests of members of the scheme have been taken into account. This will take place before an application to create a new section can be submitted. Schemes must be able to demonstrate that they can continue to meet the authorisation criteria on an ongoing basis, including whether the opening of another section would have an impact on the requirement that the design of the scheme is sound. If the regulator had concerns, it would challenge the trustees on why they wanted to pursue opening a new section without having a clear plan in place to protect the interests of members in the original scheme. If the existing section is to be closed to new members or accrual, the proposal to close it is a specific significant event and the decision to close it is a triggering event. Both must be notified to the regulator. The legislation sets out requirements for communication between trustees and the regulator in relation to the closure of a scheme or a section of a scheme.
The noble Baroness, Lady Drake, asked why we have not applied the de minimis measure to single or connected employer CDC schemes. We do not anticipate that the initial tranche of single or connected employer CDC schemes will have members with small pots. However, we will continue to monitor this and take appropriate steps if it becomes apparent that the de minimis measure is needed in CDC schemes. In any event, we will need to revisit the question of applying a de minimis measure or flat fees in CDC schemes if we extend such schemes more widely, including to multi-employer, sector-wide schemes and master trusts.
The noble Baroness made the point that employer contributions are not taken into account in the second gateway test and the first live running test. The tests are intended to ensure that members get fair value for the contributions they pay into the scheme. This means that, although the total contributions are pooled, these actuarial tests are designed to give members confidence that the value of their rights in the scheme will not fall below the value of the money they have personally contributed.
The other live running test takes a more holistic view using the employer and member contributions and seeks to identify excessive cross-subsidy between cohorts of members. It does this by comparing the contribution rate with rights to benefits expected to build up each year smoothed over a five-year period. If the benefits fall outside the window determined by reference to the contribution rate, the test is not met. This could be because contributions are a lot higher than expected benefits, which might indicate excessive transfer from contributing members to pensioners or deferred members, or the opposite, that is that contributions are a lot lower than expected which might indicate excessive transfer from pensioners and deferred members to contributing members.
The noble Baroness, Lady Drake, asked about trustees sharing legal advice on scheme rules. We will write with an answer to that.
She also asked what happens when there are insufficient funds to pay for wind-up. The regulations create an ongoing duty on trustees to ensure that there are sufficient assets to deal with the cost relating to a decision to wind up, which is a triggering event. They could, for example, be in the form of first call on employer assets.
The noble Lord, Lord Davies, said that the regulations are complex and asked how the regulator will cope. The regulator and the department have worked closely together in the development of the regulations and its code which will provide further detail on how the regulations are intended to work. The regulator will work closely with new schemes.
The noble Lord, Lord Davies, also raised a point on the use of central estimates and the complexity of the regulations. I agree with him. It is a big ask, but it is appropriate because it is important that schemes are well designed and well run.
I now turn to the questions asked by the noble Baroness, Lady Sherlock. She asked for confirmation that the regulations and the CDC draft code of practice under consultation will not be considered fit for purpose for unconnected multi-employer and commercial master trusts. The answer is yes. I have passed that one.
The noble Baroness asked how, as CDC schemes grow in number, we hope, and given the regulator’s increasingly complex pension remit, the regulator will be able to build and maintain the necessary capacity and capability to authorise and supervise CDC schemes. We have worked closely with the regulator on this matter and will continue to do so.
The noble Baroness also asked whether the bar is set too high for committed and conscientious member-nominated trustees to meet. I believe I have answered this on the point about diversity and making sure that people have integrity.
I apologise, I was not clear enough. My question is not about diversity in the sense that it is mostly understood; I was specifically asking whether the requirements had been framed in such a way as to be too difficult for member-nominated trustees to meet, with the effect that they would be driven out in favour of corporate trustees, which would lead to us not having a diversity of views. I was not referring to the other, more traditional, understanding of diversity.
The point is very well made. We will have to work with member trustees to make sure that they are trained and that they understand the requirements prior to taking on responsibilities. I will consult my colleagues and answer in more depth in writing.
The noble Baroness, Lady Sherlock, asked whether the policy intention is to squeeze out member-nominated trustees from single or connected employer CDC schemes. The answer is no. She also asked whether the intention is to have CDC schemes run wholly by professional trustees. Again, the answer is no. She also asked a further question: “A single employer or connected employer CDC scheme is established under an irrevocable trust by an employer. Could the terms of such a trust fetter the discretion of the trustees to appoint and remove the chair of trustees?” I am advised that this is not the case and that there is no change from other schemes.
The noble Baroness also asked whether I can assure noble Lords that there will always be enough money available to meet the cost of a triggering event. As part of the financial sustainability and continuity strategy authorisation criteria, the scheme must show how members will be protected against impacts, including cost, if a triggering event occurs and satisfy the regulator that there are sufficient protections. The financial sustainability requirements include demonstrating that there are sufficient financial resources to cover the cost of establishing and operating the scheme, as well as costs arising from addressing a triggering event. They must be available to be used as and when needed. If the regulator is not satisfied that the criteria are met, it must not authorise the scheme.
The scheme will also need to satisfy the regulator on an ongoing basis that it continues to meet the authorisation criteria. For example, if the costs associated with addressing a triggering event change, the scheme must be able to show that it has sufficient resources to cover them. The regulator can require information relevant to the authorisation criteria to be included in a supervisory return. It is a significant event if the scheme is unable or unlikely to be able to meet the cost of a triggering event.
The noble Baroness asked about member-nominated trust rules applying to CDC schemes. Generally, trustees are required to ensure that arrangements are in place and implemented that provide for at least one-third of trustees or at least one-third of directors at the trustee company to be member-nominated.
The noble Baroness, Lady Sherlock, asked would— I apologise, I am struggling to read this piece of paper. I will write to the noble Baroness and place a copy in the Library so all noble Lords understand.
The noble Baroness asked me to assure the Committee that, when moves are made to extend CDC authorisation to unconnected multi-employer CDC schemes or commercial master trusts operating CDC schemes, the financial sustainability requirements will be more robust, given the nature of the risks and the increased scale such schemes would bring. I can confirm that they will be appropriate to the risks.
I will write to noble Lords to clarify matters, when we have gone through Hansard, to make sure we have answered all the questions in the detail that they need. I appreciate the points that the noble Baroness, Lady Sherlock, made about this being the last chance in the regulations. As the noble Lord, Lord Davies, said, these are new schemes. I hope that, after we have passed these regulations, we carry on apprising noble Lords of their progress. We want all noble Lords to raise their concerns or ideas they have with us.
Before the Minister sits down, I am conscious of not going back to a supplementary question, so will be quick. On the small pots problem, I understand why it was said that it is not anticipated with, for example, nursery schemes, but we do not know what every scenario will be. I was seeking an assurance that these regulations do not set a precedent for removing de minimis protection for small pots, where needed. That is what I was looking for. I can see why a nursery scheme would address that, but it may not be the only solution.
I think I heard the Minister say that the regulator can consider the impact on existing sections when considering the authorisation of a new section, but could that be made clear in any letter? It is inevitable, as night follows day, that employers will want to change their pension arrangements at some point. This is just to be clear about the consequences, not to argue against what she was saying.
On the two points just raised by the noble Baroness, Lady Drake, the answer to the first is no, and we will write to the noble Baroness on the regulator and the sections and place a copy of that letter in the Library. I commend these regulations to the Committee and ask for approval to implement them.