1. Introduction
  2. Funding and Investment modules: overview
  3. What's new and what's not included?
  4. Next steps
  5. Complying with the Code

Introduction

The Pensions Regulator's General Code of Practice (theCode) took effect on 28 March 2024 and sets out its expectations for good governance in occupational, personal and public service pension schemes. This includes expectations around funding and investment matters.

This article provides an overview of:

  • What the funding and investment modules of the Code cover
  • What's changed from the Regulator's previous guidance and what's still to come
  • Five next steps that trustees could take to develop their effective system of governance (ESOG) on investment matters:
  1. Write it down
  2. Get training
  3. Take advice
  4. Check your public statements
  5. Demonstrate engagement with climate change and stewardship

The Code consolidates and replaces 10 former Codes of Practice, and this briefing forms part of a series which will also cover the other sections of the Code (Governing Bodies and the Effective System of Governance, Administration, Communications and Disclosure, and Reporting to the Regulator).

Funding and Investment modules: overview

The digital version of the Code, available on the Pensions Regulator's website, includes the Regulator's current Defined Benefit Funding Code, which will be replaced with a heavily revised new version later in 2024. The revised Funding Code will cover the new funding and investment regime envisaged by the Pension Schemes Act 2021. Trustees responsible for defined benefit (DB) liabilities should continue to monitor developments in these areas.

The investment modules of the Code will be familiar from the Regulator's earlier Code of Practice1, particularly those sections concerning investment governance, default arrangements and charge restrictions.

Separately, the Code also sets out the Regulator's expectations for carrying out an Own Risk Assessment (ORA) which will include investment aspects (further general information on carrying out an ORA is available here). In relation to investment aspects of their ORA, trustees are required to consider the effectiveness of, and risks arising from, matters such as:

  • the scheme's investment governance processes;
  • how investment performance is reviewed and monitored;
  • how the trustee assesses the protection mechanisms available to the scheme, including how these might apply and the risks of them not functioning as intended;
  • how the trustee ensures the security of assets and their liquidity when they are required; and
  • how the trustee assesses the protection of member benefits in the event of the insolvency of a sponsoring or participating employer, or a decision to discontinue the scheme.

The Code also sets out specific requirements for the ORA concerning climate change and stewardship (see Step 5: Demonstrate engagement with climate change and stewardship, below).

What's new and what's not included?

The sections on investment decision making, investment monitoring and the scheme's statement of investment principles largely draw on the earlier Code of Practice, but have been broadened to address the Regulator's expectations concerning DB(as well as defined contribution (DC)) schemes.

Key changes from previous Code of Practices include brand new sections on stewardship (including implementation statements) and climate change. The new sections make clear that the Regulator expects all schemes to which the Code applies to consider these areas – not just schemes falling within the scope of the pensions climate governance and reporting regulations based on Taskforce for Climate-related Financial Disclosures (TCFD) principles. The Code states that: "An effective system of governance should include consideration of ESG matters relating to scheme investments".

Some funding and investment matters are not covered in the Code. The Regulator has intentionally excluded detail on the requirements to set and monitor strategic investment objectives in this phase of the Code (these were previously set by the Competition and Markets Authority, following its investigation into the supply and acquisition of investment consultancy and fiduciary management services), but their guidance on these requirements is available here. The Regulator has also issued separate new guidance concerning investment in private markets (available here) and TCFD-aligned governance and reporting (available here).

It is possible that some of these areas might be integrated into the Code in future.

Next steps

Trustees may already have established ways of addressing investment matters and working with their investment advisers which comply, in substance, with most or all of the Regulator's expectations in this part of the Code. However, it can still be valuable to reflect on any particular areas that need further attention; and on how their existing policies and processes will sit within the scheme's wider ESOG. How would the scheme demonstrate that there is an ESOG in place around investment matters if asked? Are there any areas where they could improve ahead of carrying out their first ORA? Trustees could seek to answer these questions by taking five key steps.

Step 1: Write it down

A sensible first step is to look at whether existing policies ought to be more systematically organised or more fully documented.

The scheme's statement of investment principles (SIP) will be the cornerstone of the relevant documents and the Code includes a detailed checklist of statutory requirements and the Regulator's expectations here. Trustees who haven't reviewed their SIP recently may find it helpful to consider whether there are any gaps in their current version – or if there's scope to simplify it and make it more accessible for members (see Step 4: Check your public statements, below). This may also help trustees to assess the extent to which the investment guidelines provided to managers in their investment and fiduciary management agreements remain consistent with their SIP, and other scheme policies, and their ability to hold managers accountable for delivering against the scheme's targets and objectives.

The Regulator expects trustees to document the objectives, roles, responsibilities and reporting relationships of all parties involved in making investment decisions. This includes having:

  • clear terms of reference and appropriate oversight for any bodies with delegated responsibilities;
  • written policies covering the use of advisers (taking into account the trustees' investment knowledge and experience); and
  • a clear explanation of the trustees' strategy and objectives and how specific requirements will be met where they use bespoke investment arrangements to meet specific requirements.

Trustees are also expected to identify clearly any investments not traded on a regulated market, and document why such investments are being used and how they fit in with the agreed investment objectives. In response to industry concerns concerning its earlier draft of the Code, the Regulator has removed the expectation that no more than a fifth of scheme investments should be held in assets outside regulated markets, unless there are exceptional circumstances (often referred to as the 80% or 20% rule).

Action: Review where investment practices have been documented and consider whether these need to be reorganised, updated or expanded to meet the expectations set out in the Code.

Step 2: Get training

The Code provides a helpful framework for understanding the Regulator's expectations for trustee knowledge and understanding (TKU) on investment matters.

Broadly, the Regulator expects that trustees should:

  • ensure that investment decisions are taken by those with the necessary skills, knowledge, information and resources; and
  • have sufficient expertise to evaluate and challenge the advice they receive from advisers and service providers.

This is very largely consistent with trustees' existing legal duties on proper investment decision-making, so for many schemes it should not be a cause for concern. However, trustees may wish to consider the Government's recent response to its call for evidence on pension trustee skills, capability and culture2, which noted that the Government considers there is space for additional support to ensure that trustees have a good understanding of all potential types of assets, enabling them to consider the fullest range of investment opportunities so as to deliver good outcomes for savers. It also recommended that trustee training should include sufficient coverage of alternative asset classes.

The Regulator also identifies particular areas in the Code where trustees may need training tailored to the specific characteristics of, and terms negotiated for, their own investment portfolio. For example, the Regulator expects trustees to understand the types of protection available, such as indemnity insurance or the Financial Services Compensation Scheme, for their different investments in the event of fraud, wrongdoing or other adverse events. These protections will be most directly influenced by the type of legal structure or "wrapper" used to effect a particular investment, which can be more significant than the specific asset class when considering the protections available. (One notable exception to this is real property, which is subject to asset-specific risks (i.e. physical destruction caused by adverse events) and for which asset specific protection (insurance) is available.)

Action: Consider the scheme's future training agenda and ensure that future investment training is sufficiently bespoke to trustee needs and the characteristics of their scheme's portfolio.

Step 3: Take advice

The Regulator highlights several situations where it expects trustees to take advice concerning scheme investments. It reminds trustees that they are legally required to obtain and consider proper advice about investments from a suitably qualified person (commonly known as "section 36 advice" after the relevant provision in the Pensions Act 1995).

The Regulator expects trustees to take investment and, where appropriate, legal advice, when reviewing an investment manager's fund documentation. In doing so, it is important to understand the structure of each investment and any inherent features and risks. Unpacking this requirement, depending on the type of investment, we would suggest that the types of issues trustees (and their advisers) may need to consider, include:

  • whether there are any ongoing funding commitments, including staggered drawdowns, ongoing indemnification obligations or potential obligations to return investment distributions;
  • their ability to exit an investment, noting that even purportedly liquid investments may be subject to minimum holding periods or redemption gates;
  • the investment policy and strategy of the investment product, taking into account the trustees' own approach to climate change, prohibited investments and stewardship (see Step 5: Demonstrate engagement with climate change and stewardship, below) and considering whether any investment product could comprise employer-related investments;
  • the interaction of any contractual confidentiality obligations with the trustees' reporting and disclosure obligations;
  • whether the structure of any product could attract additional unanticipated taxation (including overseas taxation) that could negatively affect returns;
  • whether derivatives, repurchase arrangements and/or stock lending are permitted; and
  • the types of protection available (see Step 2: Get training, above).

Having taken appropriate advice, trustees should then put in place the right level of protection for members. This may involve negotiating bespoke terms and side letters with the provider.

Trustees have ongoing duties to review and monitor investments. In connection with this, trustees may need to obtain investment or legal advice periodically during the life of an investment, including in connection with exercising voting or other contractual rights, if performance issues arise or where a provider may be proposing to amend investment terms.

The Regulator also expects trustees to ensure that costs and charges for any advice sought, and/or investment transactions that may result, represent reasonable value.

Action: Ensure that trustees are obtaining, and acting on, sufficient advice on investment matters to protect members appropriately.

Step 4: Check your public statements

The Code reflects the ever-increasing emphasis on trustees communicating and reporting publicly on investment matters. Relevant obligations include (as applicable) duties to produce and publish the following documents online: SIPs, Implementation Statements (ISs) (essentially, a report tracking progress against the SIP policies and explaining how far these have been applied during the year), certain parts of the Chair's Statements and TCFD-aligned climate reports. The Regulator has announced previously that failure to comply with requirements for schemes to publish SIPs and ISs may result in enforcement action. The Regulator also has a very clear and increasing focus on the scope and quality of schemes' TCFD disclosures.

These duties contribute to the growing pressure trustees face (from both internal and external stakeholders) to publicise their position on investment matters – particularly on environmental, social and governance (ESG) issues. This means that allegations of greenwashing (broadly, making misleading or overstated claims about environmental or sustainability credentials) are a live risk for pension trustees. Trustees can manage these risks by ensuring that their public statements concerning ESG matters i) are clear and unambiguous; ii) are not misleading or overstated; and iii) can be independently verified and corroborated by underlying evidence. Further information on ensuring sound governance on ESG matters is available here.

Action: Manage risks arising from public statements by careful verification, effective due diligence and implementing processes which ensure that any asserted intentions do materialise.

Step 5: Demonstrate engagement with climate change and stewardship

The Code reaffirms the Regulator's message that managing climate change risk and effective stewardship are not just matters for large schemes. The Regulator expects trustees to maintain and document processes for identifying and assessing climate-related risks and opportunities for their scheme and integrate these processes into their risk management and governance arrangements. It's important to note that this expectation applies even where trustees are not required to prepare TCFD-aligned reporting. This is a key development within the Code and, in our view, a notable extension of climate change regulatory requirements within the occupational pensions industry.

The Code also underscores that stewardship is a valuable part of the trustee investment toolkit and an important component of trustee legal duties. The Regulator expects trustees to incorporate stewardship into their ESOG by:

  • identifying the stewardship rights attached to their investments and considering their approach to voting and engagement;
  • ensuring they are familiar with their investment manager's stewardship policies, seeking to influence them, as appropriate, and monitoring and regularly reviewing their managers' stewardship practices; and
  • seeking to establish engagement approaches with investee companies and collaborative industry initiatives, either directly or via their investment managers, and considering co-operating with other institutional investors in engaging with investee companies.

The Code also sets out how trustees should consider risks arising from climate change and the effectiveness of stewardship as part of their ORA, including by how they assess and consider:

  • investment risks relating to climate change, the use of resources and the environment;
  • social risks to the scheme's investments; and
  • the potential for depreciation of assets arising from regulatory or societal change.

Specialist pensions investment expertise can be particularly important here. While more issuers and investment managers are required to publish, or voluntarily do publish, information about their stewardship, climate and wider ESG practices, the information is often complex and may not immediately translate to the needs of trustees. It is often necessary to negotiate with investment managers to ensure the right asset allocation aligned with the trustee's stewardship goals and to secure contractually appropriate stewardship rights and reporting.

The Code does not address proposals for a labelling regime for pensions and insurance-based investment products seeking to achieve positive sustainability outcomes – although trustees should note that the Financial Conduct Authority (FCA) has confirmed that it will, together with the Regulator and the Department for Work and Pensions, consider extending the regime to these products (based on the FCA's Sustainability Disclosure Requirements (SDR) regime). Further information on the SDR and investment labels is available here.

The Regulator also expects trustees to consider following (where appropriate) the principles set out in the Financial Reporting Council's (FRC's) UK Stewardship Code and has aligned its definition of stewardship with the definition set out in that code.

Further detail on the challenges and opportunities for pension scheme stewardship (including for fixed income assets) is set out in our article the PMI's ESG Report 2023, "Putting stewardship into practice".

Action: Consider how the scheme is managing and documenting climate change risks and opportunities in investment decisions and governance, and refresh the scheme's stance on stewardship, including reviewing how the trustees are exercising their investment rights and engaging with issuers and managers. Discuss and consider the FRC UK Stewardship Code principles.

Complying with the Code

Although the Code is not legally binding, it can be used in legal proceedings as evidence in support of a claim of non-compliance with a legal requirement. The Regulator may also cite its expectations, as set out in the Code, when taking enforcement action. Our early experience is that many schemes are therefore actively allocating time and resources to making sure they are complying with Code. Schemes may want to consider the extent to which their existing policies, processes and governance structures already meet the expectations of the Code, and whether there are other areas that may need updating or documenting more fully.

The Code states that trustees should "use their judgement as to what is a reasonable and suitable method for ensuring compliance for their scheme". Legislation also states that ESOGs must be "proportionate" to the scheme's "size, nature, scale and complexity of [its] activities". Consequently, there is a degree of flexibility for schemes to set their approach to the Code by thinking about what is reasonable and proportionate in their relevant circumstances. We have not included in this briefing the aspects of the Code applicable to public service pension schemes.

The Pensions Regulator's General Code of Practice

  • Governing Body
  • Investment
  • Administration
  • Communications and Disclosure
  • Reporting to the Regulator

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.