Trustees of defined benefit pension schemes must keep a firm grip on the
tiller of first principles, however calm or turbulent the water is. Before
trustees choose from the array of complex investment options they need to know
the legal background to their decision.
A range of legal requirements shape the way trustees invest, but two have a
practical impact at the strategic level, assuming the scheme runs its own
portfolio rather than investing with an insurance company.
Considering the employer
When trustees set an investment strategy the law requires them to consider the
position of all those with an interest in the scheme. Clearly, the interested
group includes all the scheme members. But in the light of the two Pensions Acts
in particular, it also includes the employer, as it has an obligation to meet
the cost of the benefits. So when trustees review their strategy, they must
consider the views of the employer’s finance director, as they contemplate
future sets of company accounts.
But when it comes to their final decisions, trustees must make them with
robust independence from the employer and members’ partisan interest. After all,
the legislation hands the scheme investment power to the trustees to exercise
unilaterally, even where the scheme rules say that the employer is to have a
Interestingly, the key to the high-profile Telent case was an unrecognised
conflict of interest that the Pension Corporation had over investment strategy
and the proposed use of the scheme investment power.
Trust law requires trustees to take advice on matters that, understandably, they
know little about. For the majority this includes big picture questions about
investment strategy (for example, active versus passive, asset allocation,
choice of benchmark) and day-to-day tactical decisions about which specific
holdings will best serve the strategy.
At the tactical level that duty is strongly reinforced by pensions and
financial services legislation, which forces trustees to delegate the daily
business of managing their assets to an authorised fund manager.
The trustees’ statement of investment principles (SIP) a document they are
required by law to draw up and keep under review brings together the themes of
the employer’s views and taking advice.
The SIP is a high-level statement of the trustees’ policy on such things as
investment risk, expected returns, the types of investments they will hold, and
in what balance.
Trustees must now also prepare and update a companion document the
statement of funding principles (SFP) about how they plan to meet the
statutory scheme-specific funding standard and any other funding objectives they
There is a statutory requirement for both documents that, in most cases, the
trustees consult the employer about the contents. Following a court case,
‘consult’ means being genuinely ready to receive and consider the employer’s
views in an unhurried way. But it does not mean the trustees have to acquiesce
to what the employer wants.
It is also mandatory for trustees to take professional advice on both
documents; for the SIP from an appropriately experienced investment adviser and
for the SFP from the scheme actuary. This will generally be high-level strategic
advice about what the trustees want to achieve and their means to get there.
Scheme governance is a headline topic for all schemes at the moment, not
least because the Pensions Regulator is keenly interested in it. The SIP and the
SFP are two of a wide range of documents with policies and procedures on all
aspects of running a scheme that are coming into being.
What is encouraging about governance is that, viewed in the right way, it is
not a sterile compliance exercise but a way of taking an open look at a scheme
with a view to improving its performance all round, including investment.
The right course
They must also have robust and scheme-specific discussions with them about all
aspects of investment to make sure they explore all reasonable options and come
to patently well informed decisions.
Whether that means having a risk budget of a certain amount, going active or
passive, or opting for liability-driven investment, depends on the conditions at
sea and the course the investment consultants help to set.
Clive Pugh is a director at Temple Trustees
Does Darwin's theory apply to taxation? Colin ponders...
The EC has been instructed to draft a European Union (EU) directive authorising an EU financial transaction tax, which would apply to ten of the EU’s 28 member states
Accountancy watchdog the FRC has dropped its investigation into the former chief financial officer of Tesco, nearly two years after the supermarket was engulfed in an accounting scandal
Colin imagines how Apple's logo might change in the wake of the EC's ruling over its Irish tax arrangements