Master trust consolidation looms but are we ready?

16 June 2016

Master Trust Consolidation will follow tightening of rules once the new Pensions Bill passes into law next year argues Adrian Boulding, Retirement Strategy Director, Dunstan Thomas

Last month’s Queens Speech outlined the Pensions Bill 2016 which will now be launched in the House of Lords in September and become law early next year. In this bill, the issue of tightening regulation of master trusts makes it onto the legislative agenda following a period of voluntary regulation called the Master Trust Assurance Framework which many providers have elected not to sign up to. When this new bill goes live, master trusts will have to demonstrate that schemes meet “strict new criteria before entering the market and taking money from employers or members”. Existing schemes will be given a timeframe by which they must also comply.

There are two issues here: unlike contract-based schemes, master trusts are not regulated by the FCA. Instead they are overseen by The Pensions Regulator (TPR), which has provided a much softer supervision regime to date. In addition, master trusts have been the victims of Auto-Enrolment’s success, hoovering up millions of new pension savers. Auto-enrolment (AE) is set to yield up to £16bn in additional pension savings by 2020, according to the Government, and TPR estimates that 94% of all employers are now choosing master trust schemes as a way of ensuring they are compliant with auto-enrolment.

The BBC ran a rather worrying story of alleged misleading information from a master trust operator called MyWorkplacePension concerning millions of pounds of AE pensions savings , back in February. That report, including a reference to “Wide Boys R Us”, makes disturbing reading as small and micro business reach staging dates over the next 12 months or so.

Fortunately, the new bill will confer greater powers on TPR to authorise and supervise master trust-based schemes and take action when necessary. So what will these new criteria demand of master trusts which now govern more than six million AE pensions? Listening to the mood music I expect to see a combination of the following:
1. Tighter ‘Fit & Proper person’ requirements, with more stringent checks on trustees and executives to ensure they have the right experience and expertise to look after millions of pounds of AE pension assets on behalf of pensions savers
2. Capital Adequacy requirements on master trust providers to further improve protection of pension holders’ savings. In the event of a scheme discontinuing the capital should cover the cost of wind-up without any need to dip into members’ pension pots.

Linked to #1 is the clear need for demonstration of independence of trustee boards. It is important to ensure that master trust board members are independent from their operators and have the skills necessary to truthfully assess the business – for example a critical analysis of how the business plan intends to reach sustainability and deciding if its operation remains viable.

When looking at capital adequacy requirements, it is instructive to look at what recent tighter capital adequacy requirements on the SIPP operator space led to. Yes, we have already seen quite significant consolidation from well over 30 SIPP operators down to just over 20 with significant assets under administration.
And there is more to come: a recent SIPP market Financial Stability Report by analyst house FinalytiQ, working with Mr SIPP himself John Moret, found that five of the largest 18 SIPP providers (which together represent 90% of SIPP-held assets) are unprofitable and most have reported falling net profitability as they prop up balance sheets in readiness for capital adequacy rules being enforced for the first time from this coming September.

So is market consolidation in the SIPP space an early indication of what is coming down the pipe for master trust providers when the new Pensions Bill comes into law? Certainly, many people believe that there are too many small-scale master trust providers out there. And of the larger players many are already taking action to build their balance sheets, conscious that they must put their operations on a sounding footing or be vulnerable when tighter regulation becomes enforceable. The key point of capital adequacy is to ensure that the business of a master trust risks the sponsors capital and not the members’ savings.
Ensuring the sustainability of master trusts is not simple, as the example of the National Employment Savings Trust (NEST) shows. Established by government as a fund of last resort, it has over two million members and assets of £420m (€558m). While this is a significant increase since April 2014 when assets were £104m, a recent report by the National Audit Office (NAO) said this master trust is far from being able to pay its own way.

NEST is partly financed through a 0.3% per annum charge on members’ assets and a 1.8% charge on contributions. The remaining running costs are met through a loan from the Department for Work and Pensions, to be repaid at an undetermined future date. To date, NEST has drawn down £387m, but the NAO found that to have been self-sustaining in 2014-15, NEST would have required assets under management of £20bn so it’s still a long way adrift.

Not many master trusts have sponsors with pockets that deep, which means that they may struggle with the new capital adequacy requirements. Indeed, some may wave the white flag as soon as the legislation comes into force. There will be both existing assets and future contributions to find homes for, so consolidation will be the order of the day.

In our view the TPR may need to work with providers to pull together best practice in consolidating and winding up master trusts should this be required following new regulatory pressures that will flow from new legislation. A focus on tightening back office administration systems to ensure bulk data migrations can be handled smoothly, efficiently and cost-effectively, should be one operational requirement that the TPR checks for. If it looks like there is too much reliance on manual re-keying of data to move books of business this should be flagged up in due diligence checks and/or financial health checks that will need to be set up by TPR to help police master trusts better in the light of vulnerabilities already evident.

This pre-planning is important as speed will be of the essence in consolidation. What will be needed is a rapid rescue by a stronger partner, with members moved smartly across to their new home so there is no time for doubts and worries to creep in. As such it should be a trustee duty to ensure that their records are in a shape ready for merger. No less important is stress testing their capability of taking in ‘survivors’. Trustees are in place to look after members’ interests and that includes planning for an orderly wind-up as much as planning for business success.

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