Brian Holden argues that the current model of the part-time, non-specialist trustee cannot continue indefinitely

Governance seems to be the pensions buzzword of the moment. Pension schemes are rapidly changing the way they operate and planning for the future. There are many different opinions on how to best prepare for the future. But there seems to be agreement on one point - the increasing complexities of the present systems of regulation, supervision and governance must give way to a more dynamic approach. Can governments, regulators, employers and trustees/pension boards take proactive steps in this direction in order to ensure the continuation of good quality pension schemes and without prejudicing the interests of the beneficiaries?

The governance of pension schemes does, of course, depend on the specific framework of an individual country. This also applies to the roles of the regulators and supervisors. Despite the existence of these different national systems, there are some common objectives - for example, to safeguard and invest pension scheme assets in the interests of the beneficiaries. Yet, many schemes still lack a clear and transparent business plan.

One issue that has highlighted trustees’ exposure to conflict of interest is their ability to assess the strength of the sponsoring company covenant. In the UK, the Pensions Regulator has given trustees strong encouragement to seek professional advice, but many trustee boards still prefer to rely on their own knowledge of the company. The argument is that on many trustee boards there are individuals with financial expertise and comprehensive knowledge of the company, who are able to form an adequate view of the strength of the employer covenant by relying on periodical briefings from senior management. This approach is hardly objective and independent.

There is also a governance issue. Trustees who come from the company management may know a lot about their part of the business, but those who know a lot about every part of the business will find it impossible to avoid the risks of trying to balance conflicting interests. Do they want the best for the company or the members and pensioners? The two agendas do not mix easily and political pressures can make it difficult for a chairman of trustees to negotiate robustly if they are not independent.

Some people argue that this is why trustee boards need independent advice and to appoint an independent financial adviser. But trustee boards cannot afford to take a back seat.

In the UK, for example, it is clear that the Pensions Regulator wants to see significant change in the way trustees/pension boards operate. But can trustee boards be expected to change quickly? In recent years pension schemes have faced strong regulatory changes, with the focus primarily being on the trustee board. Part of the trustee board’s role is to absorb all the knowledge they can regarding the scheme, sponsoring employer, advice, legislation, the pensions environment, and to draw conclusions regarding decision making, risk, the employer covenant, funding and so on. The Pensions Regulator wants to revolutionise the way (trust-based) schemes are run, placing ever increasing expectations of trustees.

A typical trustee board member is a part-time volunteer, non-specialist in pensions and usually with other responsibilities outside their pension scheme and industry. So perhaps the question we need to ask is: “Are we expecting too much of trustees as lay people in taking on these ever-increasing onerous responsibilities?”

With the changing regulatory environment, the increased complexity of the investment markets and the requirement to generate higher returns to meet liabilities, there are even more pressures on trustees to focus greater attention on all things pension related.

One possible solution is to adopt the practice of fiduciary management that is increasing in popularity in The Netherlands. This system involves outsourcing the design, implementation and oversight of a pension scheme’s investment programme to one party - the fiduciary manager. Much of the popularity of this approach derives from the fact that it dramatically frees up trustees’ time allowing them to concentrate on setting, and monitoring, the scheme’s policy leaving the details to the fiduciary manager. This can allow the trustees to concentrate on the bigger picture.

However, while fiduciary managers are playing a greater role in The Netherlands, the Dutch trustee board - just like the UK trustee board - is essentially where the buck stops because the trustees cannot delegate responsibility. Having overall responsibility is a fact that cannot be ignored, but adopting the fiduciary management practice may well be an approach that eases the burdens on trustees thereby allowing them to develop and implement overall scheme controls and the big picture.

Can the principle of outsourcing be taken a step further? For example, can the trustee function itself be completely outsourced? Could this be the model for the future? Ideally, there would have to be adequate provision for member involvement at a supervisory level and full accountability, and any such arrangement would have to fit in with any (revised) national legislation requiring member involvement.

A difficult issue is the need for trustees to fully understand financial information about the sponsoring company. This is often sensitive by its nature and puts ‘lay’ trustees in a difficult position.

So, can the trustee function be outsourced to a professional sole trustee while retaining an acceptable level of member involvement and scrutiny? The responsibilities can be given to an independent corporate trustee as a full-time trustee. This could be a very attractive alternative since the ‘sole trustee’ would have the necessary expertise and employ suitably qualified people. Many trustee functions could be standardised, bringing a high level of governance at an affordable cost.

But would there be any drawbacks? The professional sole trustee would be detached from the sponsoring employer and the members. This gap has to be bridged since understanding the employer and employees is crucial. Links need to be established with member and employer representatives.

Member and employer involvement can be achieved by establishing a board of governors, which could be constructed along the lines of existing representative trustee boards and could work well. This need not duplicate effort since the governors would be a reporting and reviewing body and not an operational and decision-making one.

And could this approach be implemented under legislation? The legislation would have to be changed - but for the better. Revised legislation could set down precisely what trustees are responsible for - comprehensive and rather complex regulation would not become a major issue because professional trustees should be able to apply their expertise. Associated legislation could set out what governors are required to do - including any rules for member and employer representation.

There is another advantage to this revised model. Many companies moving from defined benefit schemes have switched to defined contribution schemes. This contract-based provision removes the need for trustees, but at the cost of less accountability and weaker governance. Many of these companies feel that the onerous requirements of current regulation are unacceptable within the existing model. If so, then the corporate sole trustee model, together with an integrated supervisory employer/employee function, is an attractive alternative.

The trust system and the principles of trusteeship are still very relevant to the good governance of occupational pension schemes. But, it is when we seek to incorporate a structure of lay involvement into the system that the debate becomes less clear because of the ever-increasing onerous responsibilities.

Trustees are faced with the growing complexity of the regulatory and investment environment. To manage the increasing complexity of their role, they must recognise that they need to change the current model by which they manage their principal responsibilities.

Brian Holden MBE, trustee lifecoach and chairman, TRM Advisory Service, Trustee Risk Management Limited

Topics