Is the trustee model still fit for purpose?
Pardon the Interruption
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The collateral crisis that developed in September has led to questions about trusteeship and governance. In the 21st century, is it still practical for funds to be governed by trustee boards?
The trustee cycle is too slow, the need for collective decision-making is further slowing the process down, and in the meantime, markets move – these were some of the complaints raised after the 2008 financial crisis. Fourteen years on, the same criticisms are being levied again, so is it time to ask: does the trustee model still work?
Both the Work and Pensions Committee and the Lords Industry and Regulators Committee questioned whether the Pensions Regulator should rely on trustees to manage the risk of LDI while at the same raising concerns over governance standards, particularly among small schemes.
Covid-19 has forced the industry to modernise
Many in the industry will readily admit that there can be issues with the way pension funds are run by trustees.
Clive Gilchrist, a trustee executive at Bestrustees, agrees the trustee meeting cycle is slow, but believes most funds, particularly large ones, have delegated authorities that enable day-to-day operations. “They worked,” during the recent crisis, he says.
While some small schemes in pooled funds have reportedly had problems during the recent crisis, most pension funds using LDI are medium to large, according to the Pensions and Lifetime Savings Association.
Schemes were not entirely unprepared for a crisis – Covid-19 has been a useful test when lockdowns prevented in-person meetings. Had the liquidity crunch occurred pre-Covid, there would have been even bigger problems, Gilchrist says.
Before March 2020, many asset managers insisted on wet ink signatures and hard copy forms for transactions, but Covid meant they now accept digital signatures, “though in some cases dragged kicking and screaming into the 21st century”, Gilchrist says. “Delegated authority would have been useless without the right signature on the forms.”
Is the problem just about collecting signatures?
For some, the issues run deeper than that. Bart Heenk, managing director at governance firm Avida International, criticises trustee boards for being calendar rather than market or risk driven.
“They are therefore not in a position to make decisions in a crisis. Unfortunately for pension schemes, decisions taken in a crisis are far more impactful than decisions taken in ‘normal’ times,” says Heenk.
An inability to react swiftly to unforeseen events means important decisions are delegated to an in-house executive team or an external provider, he notes.
“But, and this is a big but, not all external providers and sometimes even internal teams are always working in the best interest of their clients,” he argues.
Reliance on actuarial and investment consultants can compound the issue, with Heenk warning that consultants could start influencing the decision making. With advisers’ income depending on complexity, they “have a tendency to overcomplicate things”, he says.
So is it still right to have trustee boards?
Industry participants are generally loath to advocate replacing the trustee model on which their income depends. Despite his concerns, Heenk thinks the trustee model is right, arguing that “balanced decision making” in the interest of all members is needed.
Professional trustees are often seen as a way to improve governance. However, for Heenk, they are only an addition if their expertise “outweighs the agency cost” from additional services being offered. He says regulating professional trustees – something the Pensions Regulator said it would consider – can be helpful but not sufficient to create good governance.
“It comes down to members having the right representation. In the end it is all about having the right people, capable, honest, communicative individuals who are able to give enough of their time and able to operate effectively in a trustee board,” he says, adding however that this is “easier said than done".
TPR is making attempts at tackling the issue by seeking to improve governance through regulation, driving more schemes with lower resources to consolidate. The regulator’s stated goal is consolidation of pension funds so it can require that each trustee board hires a professional trustee. Having a smaller number of schemes would also make oversight easier for TPR.
However, things are moving slowly; there are still more than 5,000 defined benefit schemes and thousands of trust-based defined contribution schemes in existence today.
Individual governance and systemic risk
After the latest investment debacle, it can be easy and tempting to point the finger, observe Julia Land, senior adviser, and Barry Mack, director at governance specialists Muse Advisory, who describe what happened in September as a systemic issue.
“We have to be realistic about what an individual board... could have done to ‘avoid’ the potential impact of extreme market turmoil, whilst keeping funding risk within trustee and employer appetite, in line with the funding regime,” they say.
Nonetheless, trustees are now asking the challenging questions needed of their own process, and of their advisers and LDI managers, to learn any lessons for their own arrangements, and expect regulatory action that could involve data collection and a cap on leverage.
However, time demands and complexity continue to increase for trustee roles, while few of them constitute a day job. This makes the degree of executive support available to them paramount. “Regulators could recognise this more,” say Land and Mack.
The incoming single code of practice will set clearer expectations of trustees, with the Final Code coming into force in Q1 next year, but Land and Mack say government and TPR should be careful what they wish for, “not creating further unintended consequences via changes to pensions regulation and legislation”.
What do you think – does the trustee model work in its current form?
