Imposing capital adequacy rules on master trusts will require considerable care, experts say

Requiring master trusts to hold a certain amount of capital would ensure that, in the event of failure, there should be no need to dip into members' pension pots to pay for the cost of winding-up the scheme or transferring the assets to another scheme.

The UK government is due to publish a Pensions Bill setting out "strict new criteria" for master trusts later this autumn. The Department for Work and Pensions (DWP) was unable to confirm to Out-Law.com whether this would extend to capital adequacy standards, although the topic was discussed in depth during industry meetings over the summer, according to the pensions press.

Pensions expert Mark Baker of Pinsent Masons said that the "optimal model" for such a framework might be the one currently in use by providers of self-invested personal pensions (SIPPs), or "a variation on it which takes account of the differences in wider regulation of SIPPs and master trusts". However, transplanting the financial regulators' rules to the workplace pensions world would not be straightforward, he said.

"Master trusts are generally geared up to the workplace pensions market, servicing employer need for auto-enrolment compliant pension schemes," he said. "Many of these are aimed at small employers, and employers of low-paid workers. The membership sizes and overall asset sizes vary markedly between different master trusts but, in general, the individual member pot sizes remain relatively small."

"By contrast, SIPPs are a retail solution which often – although by no means always – target the more affluent end of the spectrum. The low paid are not an obvious target market. Therefore, there will be different consequences of scheme failure as between SIPPs and master trusts. And even if we can get the transplant right, the rules will still take some work as not all master trusts are alike," he said.

Pensions expert Tom Barton of Pinsent Masons added that the capital adequacy regime for SIPPs "was and remains controversial, so we need to take care when applying it to new areas".

Master trusts, which enable pension scheme providers to manage a defined contribution (DC) scheme for several employers under a single trust arrangement, have become increasingly popular over the past couple of years due to the success of the government's automatic enrolment workplace pension programme. Smaller employers, which are now legally required to automatically enrol their workforce into a suitable workplace pension scheme but which do not necessarily have the resources to operate a pension scheme of their own, may look to a master trust to manage their pension arrangements.

However, master trust arrangements are generally subject to a lighter touch regulatory regime than contract-based group personal pension schemes (GPPs), which are regulated by the Financial Conduct Authority (FCA). Master trusts can obtain independent assurance of their quality, measured against a voluntary assurance framework developed by the Institute of Chartered Accountants of England and Wales (ICAEW), although there is no legal requirement for them to do so.

The government announced a Pensions Bill in May as part of the Queen's Speech, which sets out its plans for the coming parliamentary session. This bill will contain "essential protections" for members of master trust schemes, by requiring trusts to demonstrate that their schemes "meet strict new criteria before entering the market and taking money from employers or members", according to explanatory notes published alongside the speech. It will also give the Pensions Regulator new powers to "authorise and supervise" master trusts.

The SIPP capital adequacy requirements were introduced to address similar issues that arose in relation to these products. They were developed by the FCA and its predecessor, the Financial Services Authority (FSA), over a number of years with the latest version coming into force on 1 September 2016. The rules require SIPPs to hold additional capital to cover the risk of failure, based on the size of the firm and the risks associated with the underlying assets.

The difficulty, according to financial regulation expert Simon Laight of Pinsent Masons, is that capital adequacy regimes "take years to calibrate correctly", as shown by the length of time it took to develop the rules in relation to SIPPs. The FSA first began consulting on the 2016 changes in 2012, he said.

"There are so many ways of assessing the different types of risks and how you calculate the capital buffer in relation to those risks," he said.

Tom Barton said that as the government and regulators were focusing their attentions on improving the standards of master trusts, they should be careful not to overlook solvency issues attached to employer-run DC trusts. As part of good governance, trustees should have plans and resources in place to ensure the orderly wind-up and transfer of the scheme liabilities if the employer was to become insolvent, he said.

"Expenses clauses, scheme indemnities and unallocated reserve provisions may provide some form of funding, but this could well involve members paying for the wind-up and transfer out of their own pots," he said. "And there may be trickier examples of schemes where there is no obvious authority for trustees to access member money to pay for the cost of wind-up and transfer - in which case, who foots the bill?"

"These are difficult issues to address for DC schemes and, at the very least, mean that DC trustees should be thinking about discontinuance arrangements in the same way as master trust trustees," he said.