DC mastertrust consolidation: The long-term outcome

There is already evidence of consolidation and a strong likelihood that a number of current mastertrusts will not apply for, or fail to get, authorisation after October 1 2018.

The issue for the mastertrusts that remain will be how to compete effectively for new business

There are two key drivers for this. A tougher regulatory regime; and a drive for new business in an increasingly competitive market in which size will matter.

Expect the watchdog to flex its muscles

From October 1 2018 DC mastertrusts will be required to apply for authorisation. There are five criteria that the Pensions Regulator will focus on, namely the 'fit and proper person' test, systems and processes, the continuity strategy, the status of the scheme funder, and financial sustainability.

Once a scheme is authorised, the regulator has wide supervisory powers, including powers to impose fines that escalate daily (up to £10,000 per day after 10 days), 'pause orders' and, ultimately, power to withdraw approval. A pause order can effectively freeze the scheme’s ability to admit any new members or accept new contributions – something that would be catastrophic for a commercial mastertrust.

How the regulator will exercise its powers remains to be seen but it is clear from recent regulatory actions in the context of chair statements that it is willing to exercise its powers to fine.

Therefore, when it comes to issues that directly affect the security of members’ benefits, we should expect the regulator to flex its muscles.

Given the new and harsher regulatory environment, it is expected that more of the smaller mastertrusts will be looking to be 'consolidated' – this has already started.

The issue for the mastertrusts that remain will be how to compete effectively for new business. From 2012 to 2018 there was a tide of new business as employers looked for ways to satisfy their auto-enrolment duties.

DC governance high on agenda

While there is still an increasing flow of contributions during the transitional period, new business will probably only come from three places: new employers looking for an auto-enrolment solution, other mastertrusts and transfers from employer sponsored DC arrangements.

Turning to this last point, the regulator has made it clear that it is supportive of the consolidation of both defined benefit and DC pension arrangements.

In the DC context, it is the governance of such schemes that the watchdog is most concerned about, particularly the governance of small and micro schemes where there may be neither the skills nor the resources to ensure good governance and achieve good member outcomes.

Moreover, the recent flurry of fines in respect of chair statements will certainly have spooked trustees of some smaller schemes.

For sponsoring employers and trustees of small schemes, one legal hurdle to the transfer of a DC pension scheme to a mastertrust has now been removed.

Prior to April 6 2018 DC bulk transfers without consent required an actuary to certify that each transferring member’s benefits would be “broadly no less favourable” after a transfer. 

Cost remains key when transferring

From April 6 2018 there is no longer a requirement for actuarial certification in relation to “pure” DC to DC bulk transfers.

Instead, under the new regulations, such transfers will be possible where either the receiving scheme is an authorised mastertrust; the transferring and receiving employers are associated undertakings, and the members are current or former employees; or prescribed independent advice conditions are met.

Notwithstanding the removal of this legal hurdle, transferring from an 'own scheme' to a mastertrust is not necessarily an easy decision for trustees. Members lose the comfort of an employer-sponsored scheme and discretions will be exercisable by unconnected trustees.

Costs will be a key factor for consideration and where a charge cap applies prior to the transfer, it will continue to apply in the receiving scheme in most cases.

Ultimately, trustees will need to satisfy themselves that a transfer is in the members’ interests. In these circumstances, inevitably, the bigger mastertrusts that can offer lower investment charges, more professional governance and an inclusive post-retirement solution will be the first choice for many employer scheme transfers and are likely to drive consolidation in the DC space.

Jennifer Bell is a partner and Daniel Shaw is a senior associate in the pensions practice at international law firm CMS