IORP II update - no January 2019 deadline for schemes
Liz Cole gives an update on how the EU Directive IORP II is likely to affect pension schemes once it becomes implemented into UK law.
The implementation deadline for IORP II requirements is looming, and the Department for Work & Pensions (DWP) has a difficult job trying to deliver workable changes to pension law amidst the most uncertain political environment in living memory. It is therefore really helpful that DWP have indicated there will be no regulatory cliff edge come January 2019. The Directive imposes obligations on the UK Government, but there will be no obligations on UK pension schemes until domestic law so provides, which will not be for some time.
EU Directive 2016/2341 (commonly known as “IORP II”) became European Union law at the beginning of 2017 and the UK Government is required to implement it into UK law by 13 January 2019. The DWP has been considering its implementation approach, including roundtable discussions with industry representatives, culminating in some regulations being laid in Parliament on 23 October 2018 transposing IORP II relating to scheme governance and to the EU’s cross-border authorisation framework.
However, please note that government business is currently subject to unusually high levels of uncertainty, particularly where it concerns European legislation, and there is greater potential for unpredictable and sudden changes in the current political context. So, while what follows is our understanding of how the DWP intends to proceed, it cannot be guaranteed that implementation will take place in this way.
The UK had a big say in the framing of IORP II, the text of which largely supports the UK’s direction of travel on pensions policy. Therefore, the UK already complies with much of it and it can be implemented without extensive new legislation. The directive is also being transposed in a minimal impact way that will be proportionate to the particular risk profile and complexity of different schemes. In dialogue with industry, DWP and the Pensions Regulator (TPR) will ensure that the expectations for different types of schemes are made clear. It is important that pension schemes have clarity about what is expected of them and sufficient time to make any changes with minimum cost and disruption. Government also intends to continue to exempt the smallest schemes from these requirements.
However, some changes to UK legislation and our regulatory framework are needed. Given the legal deadline for implementation (i.e. 13 January 2019), many trustees and sponsors have been concerned that a whole new raft of requirements could be brought in overnight. However, the DWP’s view is that pension schemes will not be expected to action any changes by January 2019 and that any changes to pension law and regulation will be implemented with phasing or implementation periods that will allow sufficient time for familiarisation and planning. The high level regulations mentioned above will be supplemented by a Code of Practice from the Regulator that will set out how schemes can proportionately comply with the new legislation that will be developed during 2019.
The two main areas where some changes to UK legislation and our regulatory framework are needed are scheme governance and member communications. However, DWP is seeking to ensure that any such new requirements are aligned with existing UK domestic policy plans and timescales. For the enhanced governance requirements there is significant correlation with existing requirements such as the DC chair’s statement and DB Funding Statement.
There is also read across with existing scheme processes such as risk registers, and independent assurance in respect of outsourced service providers. Related policy hailed in the defined benefit (DB) White Paper includes the DB Chair’s statement, and the Pension Regulator has in any event had an increased focus on governance standards in its 21st Century Trusteeship programme.
Any new requirements will support these existing and developing governance practices and will minimise, where it cannot avoid, any duplication of effort by pension schemes. DWP also intends to align its implementation of any other parts of IORP II with current or planned changes, for example within the regulations clarifying trustees’ fiduciary duties on scheme investment.
Scheme governance legislation
IORP II imposes various governance requirements, for example, for pension schemes to have risk management and internal audit functions. The DWP laid the above-mentioned regulations to implement IORP II’s governance requirements, which replace existing provisions regarding internal controls under the Pensions Act 2004 and require trustees to have an effective system of governance that is proportionate to the complexity and risk profile of their scheme. As part of looking at their system of governance, schemes will be required to carry out and document an own risk assessment. The regulations also require the Pensions Regulator to publish an updated Code of Practice to explain what is expected of trustees.
Although the legislation regarding governance systems is applicable from 13 January 2019, pension schemes are not expected to need to make drastic changes to their systems. A governance system is a term that is already familiar in the financial services industry and to personal pension providers. Many schemes are already demonstrating that they operate with effective corporate governance and ensure operational resilience, with proportionate systems of governance made up of lay and professional trustees, managers and outsourced providers.
As many schemes currently operate effective governance as a matter of good practice they will only need to begin formally documenting their existing practices in order to comply. The new requirements will be designed to enable those schemes that do not already have an effective system of governance to put one in place that is not unduly burdensome, but that instead reflects the risks to the running of that particular scheme.
The governance elements of IORP II closely align with the expectations outlined in the Pensions Regulator’s 21st Century Trusteeship programme. Current governance expectations are outlined in TPR Codes 9 (Internal Controls), 13 (DC schemes), 15 (Master Trusts) and 3 (DB schemes), although all these codes will be subject to review so that they accurately reflect the requirements of IORP II. Schemes may find it useful to review their current governance systems and ensure they fulfil existing requirements.
The new regulations provide a more robust legal framework for the system of governance which more closely aligns with the elements set out in IORP II. In line with their legal obligation, the Pensions Regulator will be undertaking formal consultation to review and update their Codes of Practice as soon as practicable. The Code of Practice will give practical guidance to trustees to explain how schemes need to comply with the new duty to establish an effective system of governance, and how to carry out an own risk assessment and document it.
The DWP has not yet decided on the precise timing of the implementation period. Options under consideration may include allowing 12 months from the first scheme year end date after publication of the Code of Practice, with the option for trustees to move this to align with existing systems and document production cycles if preferred, even if this extends past 12 months.
For the avoidance of doubt, schemes that are compliant with the governance duties that apply to Public Service Pension Schemes under the Pension Service Pensions Act 2013, and to authorised Master Trusts under the Pension Schemes Act 2017, are not expected to be affected by these changes as they are already considered to be IORP compliant.
Cross Border Schemes
Broadly, cross-border activity is when an employer in one Member State selects to base their occupational pension scheme in another Member State. The current cross-border authorisation framework was introduced by the original IORP Directive (EU Directive 2003/41/EC). IORP II makes some changes to the existing authorisation process including reducing the time the Pensions Regulator has to communicate with regulators in other Member States.
IORP II also introduces a new authorisation process for schemes wishing to undertake bulk transfers with a separate scheme located in another EEA state. This includes ensuring that the cross-border transfer is approved by a majority of members and a majority of the beneficiaries concerned or, where applicable, by a majority of their representatives. These changes will apply from 13 January 2019 and will ensure that UK law is up to date until we exit the EU, including during any implementation period.
IORP II contains a lot of detailed prescription on the information that pension scheme members should be given. Most notably it sets out detailed requirements for a “Pension Benefit Statement” to be provided to all members annually.
The IORP requirements in relation to member communication are expected to take into account the UK’s existing and proposed member communication requirements including, for example, the proposed “dashboard”, on which the DWP has recently issued a consultation.
Liz Cole, ICAEW Business Law Manager, Business Law Department
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