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Myners Review consultation
Following the publication of the Myners Report in early March the UK Government has instigated a short period of consultation on proposals ending on 15 May 2001.
The main impact on UK pension schemes of the Myners Review has two strands. Firstly, the proposed abolition of the Minimum Funding Requirement (MFR) with associated alternatives and, secondly, detailed proposals on the process of investment decisions. This immediate consultation is about only this second part. As the Treasury puts it: "An opportunity to comment on the precise formulation of the principles recommended in the Report".
As summarised by Danny Wilding in last month's news, the proposals for investment decision-making are wide-ranging and far-reaching. Most will conclude that the vast majority of the proposals are defendable when considered in isolation. There is room for improvement in investment processes. The main concern is the cumulative impact of the proposals, the lack of distinction between very large pension schemes and smaller schemes with different circumstances, and the burden of yet further mandatory disclosure that will not be understood by most pension scheme members.
UK Government Position
In recent weeks, the UK Government's main spokesperson on the Myners Review has been Melanie Johnson, Economic Secretary to the Treasury. The Treasury has instigated the current consultation plus a review of the Inland Revenue rules to attempt to simplify the tax regime. The Treasury is also expected to take the lead with the Department of Social Security on the abolition of the MFR in the next Parliament. Of course, the impending UK General Election will interfere with a hiatus and a recasting of the ministerial team. Thus, the timing is unfortunate.
The Treasury supports the Myners proposals, seemingly in their entirety. In launching the consultation Melanie Johnson said:
"The Government strongly supports Paul's Report and we will take forward his recommendations. His proposed principles on investment decision-making are simple and sensible statements of good investment practice".
The UK Government has announced it is to seek a voluntary code of conduct, and that pension funds will owe an explanation to their members of any departures from them. It has stated it will give the industry two years before it looks again at how the recommendations have been implemented, and whether mandatory legislation is required.
Some aspects of the proposed code of conduct of trustees are controversial and have provoked already significant debate.
Investment knowledge of Trustees
The Myners Report suggests high standards should be expected of trustees. This is indisputable. However, intensive investment knowledge for trustees would be hard to achieve on most schemes. It is contrary to the thrust of the Member Nominated Trustee Regulations of the Pensions Act 1995 and possible further strengthening of that legislation. The Myners Report suggests more use of investment sub-committees as a helpful way to negotiate this for some schemes.
Melanie Johnson supported this: "Trustees should become sufficiently familiar with investment issues to make these decisions effectively, and should delegate those decisions they are not in a position to make".
Notwithstanding this, it will remain inevitable that trustees will rely heavily on independent investment advice, although we agree the objective that they should heighten their ability to assess critically such advice.
Remuneration for Trustees
The Myners proposal that trustees should be paid unless there are specific reasons to the contrary has attracted much attention. Most trustees of UK pension schemes are not paid at present apart from paid time off work for meetings and, possibly, expenses incurred. There are an increasing number of professional trustees employed by some schemes (especially those in wind-up) and this may be set to increase.
Paul Myners appeared to try and diffuse this issue somewhat at the recent NAPF Investment Conference by stating there was nothing in his proposals that said that Trustees "must" be paid. He said: "I ask you just to keep open the possibility of pay". He insisted that he had not recommended professional trustees compulsory training or examinations. While strictly true, this does represent a dilution of the tone of his Report.
The proposal to strengthen the Statement of Investment Principles is appropriate as are the detailed suggestions. The current requirements are weak. However, the inclusion of projected investment returns in each asset class may be detrimental. In reality, the returns will be vastly different from projected and may mislead members to believe the investment strategy has not been effective.
It would be preferable for the Statement to be available for any member who requested it as at present rather than automatic distribution to all members. Information overkill would not be beneficial.
Performance Measurement of Consultants
The NAPF has just published a helpful document in this regard. This is called "The trustee/asset consultancy relationship - a guide to good practice". Clear terms of reference for consultants would be beneficial. However, meaningful measurement of the effectiveness of their advice will remain hard to achieve, and is not brought closer with this publication. A form of measurement taken as representative or meaningful, but which is not, would be extremely damaging.
Mandates and Benchmarks for Investment Managers
The need for a clear agreement covering objectives, benchmarks, risk parameters etc is paramount. The proposal that the "mandate will not be terminated before the expiry of the valuation timescale other than for clear breach of the conditions of the mandate" is too strong. It must be up to the trustees what the terms of termination of the investment manager agreement is. Without encouraging short-termism, nothing should remove the right of trustees to switch managers if they so choose. The same applies for professionals employed by the trustees in any other capacity: actuaries, administrators, bankers, solicitors etc. It would be distortion for investment managers to have special treatment.
In particular, many investment managers have a high turnover of investment personnel and trustees may believe that, even though the manager has operated within the terms of the agreement, there is sufficient instability and lack of demonstration of success that a change is warranted. Trustees rarely change investment managers for the sake of it, due to the significant cost. This proposal should be omitted, or scaled down. It is agreed, however, that investment managers should know clearly how they will be judged and this is a matter for the trustees and the manager to agree at the outset.
The comments from the UK Government on this proposal have been hopeful.
Many trustees may find it difficult to "consider explicitly the construction of each index" and other details of the proposals on appropriate benchmarks. They will rely heavily on advisers for these points. These details should not need to be disclosed to members who would not understand them, even if there it is required for trustees to have considered them explicitly.
It is agreed that active fund managers should be given the freedom to pursue genuinely active strategies.
Assessment of Trustees
The Report proposes the trustees should "make a formal assessment of their own procedures and decisions as trustees". Who would make such an assessment? The Report envisages significant extra disclosure from trustees to the members which should suffice. The Report also suggests trustees should "arrange for a formal assessment of performance and decision?making delegated to advisers and managers". Trustees review their advisers on a continual basis and trustees should be the sole judge of whether they are satisfied with the level of advice they are receiving. How they judge this should surely be up to them rather than be reflected in a code of conduct.
Private equity
It is agreed that trustees should consider private equity investment as they should all major asset classes and investment opportunities available. It is matter of debate how much private equity investment in its various forms trustees of pension schemes should undertake. Trustees are under a statutory obligation to invest with prudence. Trustees must remember the requirements of the Trustee Act 1925 and the Trustee Investment Act 1961.
Private equity investment has a part to play for larger pension schemes. More analysis and consideration by large funds could lead to a larger amount of such pension scheme investment as part of a wider equity strategy. However, it is less practical for smaller schemes, mature schemes and schemes investing in pooled funds. Time constraints, illiquidity and higher investment costs are all important mitigating factors - particularly for smaller funds.
It should be respected that trustees may choose to not invest in this asset class and it is certainly not appropriate to force them to do so.
Overall comments
The ability for trustees to spend time on more detailed investment decision-making depends partially on the size of scheme. More detail is justified for a £1bn fund than a £10m fund. The Myners Report does not really distinguish between the two.
It should be accepted that smaller schemes may choose to consider matters in less detail than larger funds on the grounds of practicality and cost-effectiveness. The potential gain from a positive decision is less in absolute terms. The code of conduct should accept this.
Care must be taken not to make trusteeship so onerous that very few people wish to be Trustees.
The problems highlighted in the Report must be seen in context. As stated in the Report, UK occupational pension schemes have been a success story. The practice of investing heavily in equities compared to most other developed countries' pension schemes, has served UK pension schemes well. Thus, although asset allocation has not at times been optimal, it has been largely successful. Other European countries are gradually moving towards the UK style of equity weighting in asset allocation.
Colin Richardson, April 2001.