Game-changer on boardroom pay in the UK?

The Executive Remuneration Working Group (ERWG), set up last year under the auspices of the Investment Association, has published its much-anticipated final report on simplifying and re-aligning executive pay in the UK.  The ERWG hopes that this report will have a major influence on how executive remuneration in FTSE companies is structured.

The remit of the ERWG was to conduct an independent review of executive remuneration in order to find workable solutions to the problems inherent in the current system of executive remuneration, which is frequently said to be broken.  It reported on an interim basis in April of this year and has followed that up with round-table discussions prior to publishing its final report.

The ERWG’s core recommendation remains the same.  It concludes that the current “one size fits all” approach to executive remuneration (i.e. salary/benefits/annual bonus/LTIP) simply cannot, almost by definition, be suitable for all companies.   Remuneration committees should have the freedom to move away from it.  In fact, the ERWG describes greater flexibility as “the” solution to “the” problem with executive pay!

The difficulties that stand in the way of that change are acknowledged and the ERWG has made nine further recommendations designed to re-establish trust and strengthen relationships with shareholders.  None of these additional recommendations are particularly novel and it remains to be seen whether they and the other guidance offered will be sufficient to coax remuneration committees out of the perceived safe harbour of the existing model.  The clear acknowledgement that change needs to come from both sides is an encouraging output from the working group.  Having said that, and it comes as no surprise, there is a renewed emphasis on disinfecting the relationship between companies and investors through increased transparency.  The ERWG pulls no punches in asserting that without greater transparency (amongst other things), there may not be sufficient trust to enable companies to explore more bespoke solutions for the compensation structure of executives.

The ERWG has recommended two possible models as alternatives to reliance on traditional LTIPs (although this is not intended to be an exhaustive list).  These are:

  • the deferral of bonuses into shares; and
  • restricted share awards vesting in stages over 3-5 years (with no performance conditions).

At the interim stage there was a third model (performance on grant) but that has been deemed to be unworkable due to the long time frames involved.  The ERWG declined to add market value options to this list.  Where LTIPs are used, the model of a three-year performance period followed by a further two-year retention period is endorsed.  Guidance is offered on a number of inter-related issues including shareholding guidelines, prevention of rewards for failure and the discount factor when moving from LTIP awards to restricted share awards.  A discount factor of 50% is endorsed as a basic starting point (i.e. other factors aside, the value of restricted shares awarded would normally be half the value of shares that would otherwise have been included in an LTIP grant under an existing plan).

Interestingly, shareholders involved in the ERWG’s discussion groups did not request greater consultation on pay matters.  In fact, they would like to reduce the time spent on this area through more effective and timely consultation – which loosely translates into a request to focus on the key issues and not to bother consulting on everything.  For good measure, the ERWG makes the point that just because there has been consultation there won’t necessarily be support for the conclusion.

The ERWG noted that its remit was to find ways of simplifying executive pay rather than reducing it.  However, the two are not unrelated and the detailed recommendations touch on process and disclosure in this area.  In the past, significant changes in the structure of executive pay have often resulted in overall increases in remuneration and it will be interesting to see if the recent pressure exerted by shareholders during the 2016 FTSE100 AGM season prevents that from happening again.  In particular, if there is a move away from LTIPs how will the compensating increases in other remuneration elements be portrayed in the media?

Theresa May has promised to have another go at tackling excessive remuneration through more legislation.  The ERWG has not had enough time to consider these proposals in detail, albeit its members do not appear to be convinced.  They note in particular that the change from advisory to binding votes is likely to encounter similar problems to those that resulted in the watering down of the original proposals from the Coalition Government in 2010.  Mrs May’s ideas are about increasing stakeholder influence in the governance system in the hope that it will bring boardroom pay under tighter control.  That rather indirect approach contrasts with the ERWG proposals, which are intended to have a much more direct effect on executive remuneration by promoting changes to the remuneration policies that most FTSE companies will put to their shareholders for renewal in 2017.

The Investment Association will now be considering what changes are needed to its guidelines on executive remuneration as a result of the ERWG report but most companies that are due to put a new remuneration policy to shareholders for approval in 2017 will, no doubt, already be working out whether they should be considering significant changes to their policies.  The ERWG has stressed that remuneration committees should be placing less reliance on remuneration consultants, but it is hard to see this type of decision being made without heavy input from external advisers.

As the saying goes, the proof of the pudding will be in the eating, but we will need to wait until 2017 to see how many remuneration committees have the stomach for such radical change.

Data Protection: There is no escape pre or post Brexit

On 24 May 2016 a new General Data Protection Regulation (GDPR) was adopted by the European Union – this is a radical reform which will have a material impact on the operation of pension plans.  The GDPR will be directly applicable in all EEA countries (so no implementing legislation is required from the UK Government) and will replace the Data Protection Act 1998 (DPA) from 25 May 2018.

Given that the GDPR comes into force on 25 May 2018, and it is anticipated that Brexit will not occur until two years after the date the Government serves a notice on the EU of its intention to leave, the GDPR will come into force in the UK and will govern for an interim period. This means that pension plans must, for now, continue to comply with the DPA, and should also prepare for the stricter data privacy regime to be introduced by the GDPR. The question of enforcement by the UK Information Commissioner (ICO) remains an open question once the GDPR is in force and before Brexit occurs, but the ICO has stated that it has always worked closely with regulators in other countries, and that would continue to be the case during this period of flux, and beyond.

The position after Brexit will depend on the terms of Britain’s access to the EU market. If the UK adopts the Norwegian model, it will have to agree to comply with the GDPR in full, but even if the UK opts for a less rigid relationship with the EU, in order to protect the flow of personal data between the UK and Europe, it is more than likely that the UK will need to align its data protection laws with the GDPR. The ICO has already stated that it will be making this case to the Government. 

In the unlikely event that the UK does not adopt provisions broadly equivalent to the GDPR, it is inconceivable that the UK Government would repeal the DPA as, without that, the UK would have no chance of being treated as a country approved by the European Commission for data transfer purposes (and even with that, it may not be enough). Many pensions trustees do not comply fully with current data protection law, particularly as regards the appointment of service providers, the giving of privacy notices, and transfers by their service providers or them allowing access to personal data from outside the EEA. The ICO, which is already becoming more willing to exercise its powers to fine, is likely to become more assertive, so as to seek to demonstrate to its European counterparts that data protection is still treated seriously in the UK. Also, a number of the changes that will be mandatory under the GDPR, like the additional clauses that must be included in processor agreements, are ones that are highly beneficial for trustees, so there are significant benefits in trustees starting to address them now. See our newsletter for more details.

Culture Club: FRC strengthens link between company values and executive remuneration

The UK Financial Reporting Council (the FRC) has just published a report entitled “Corporate Culture and the Role of Boards“. This is the result of a mammoth project kicked off in early 2015 by a round-table with FTSE100 chairmen.  Content for the report was produced by a survey of 44 chairmen and 33 company secretaries and interviews with 22 chief executives and 58 chairmen, all from FTSE350 companies.

The report covers many aspects of the actions and behaviours of a company in establishing, communicating and maintaining its culture and values.  Unsurprisingly, one of the topics covered is executive remuneration and incentives.

It is emphasised that, despite the mounting regulation governing transparency and disclosure, there has been an increasing lack of public confidence in the link between executive pay and company performance.  This “is something that should be of the utmost concern to boards and remuneration committees, which could do more to apply a cultural and values lens to the design of remuneration policies and individual remuneration decisions”.  The report refers to the paper published in February 2016 by ICSA, the governance institute, which identified flawed executive remuneration practices and misaligned incentives as one of the indicators of bad business culture and behaviour.  It makes it clear that a company is expected to ensure that its recruitment, performance appraisal and reward structures reflect and support not only its strategy and business model, but also its culture and values.  The setting of executive pay should be considered in the light of reputational risk to the company and the balance of financial and non-financial performance targets attached to remuneration should encourage corporate culture and values.

Investors are encouraged to consider their role in influencing a company’s behaviour and the way in which their requirements affect company incentives.  Shareholders should ask questions of the board to ensure that incentives are structured in a way that does not encourage undesirable behaviour and to establish how the culture and values of the company are supported by the remuneration structure.

Next year, the FRC is to review its Guidance on Board Effectiveness published in 2011 and it welcomes feedback on the report to culturecoalition@frc.org.uk.

UK Data Protection Packs a Painful Punch For Processors

Football may not be coming home, but data protection certainly is!

There are many issues stemming from the General Data Protection Regulation (“GDPR”) which will impact on pension plans. We would like to share a few thoughts on just one of these.

For the first time, data processors will be directly liable for breaches of the GDPR, and the figures, quite frankly, are scary. Breaches can carry a maximum fine of €20m (or 4% of global turnover), whichever is the higher. Ouch!

For pension trustees, as data controllers, this must surely be good news as some of the responsibilities for compliance are shared. However, housekeeping issues must first be addressed, and this could be a little painful. More extensive obligations will have to be included in data processing agreements.

How are data processors likely to react to increased risks that they face?

One distinct possibility is that data processors will seek indemnities from trustees. The increased work associated with compliance may also push up data processing costs. For example, data processors will be required to keep full records of exactly what personal data is processed, for what purposes, how and by whom, and with whom it is shared, as well as, where feasible, the security measures applied to it and how long it is to be kept. Data processors also risk being sued by individuals or by consumer organisations bringing a “class action”. In addition, the requirement to notify compliance breaches within 72 hours means that data controllers will need a robust data breach response plan – one that builds in the fact that breaches can happen at 11pm on Friday evening or whilst the person normally responsible for compliance is ‘finding himself’ in Outer Mongolia.

If trustees are negotiating new contracts with service providers that will (or might) continue after May 2018, it is important that:

  • the new mandatory provisions under the GDPR are built into the contract,
  • any limitation of liability provisions still offer the maximum protections available to trustees,
  • the contract sets out which party will comply with the new mandatory record keeping requirements about the personal data that is processed.

If these issues are not built into contracts now service providers may resist providing some services or may seek to make additional charges for doing so when this becomes a legal requirement. Trustees should also consider revisions to existing contracts for the same reasons set out above.

As a general principle, trustees should avoid accepting “standard terms” from service providers without seeking legal advice. Don’t throw in the towel too easily – the risks are too high.

Our pensions specific data protection newsletter gives a fuller picture of the actions that trustees, as data controllers, should consider.

Welcome tinkering in U.S. Code section 409A proposed regulations

U.S. Internal Revenue Code §409A provides a wide range of very restrictive rules pertaining to “nonqualified” deferred compensation plans and many other types of compensation arrangements that may defer compensation.

On June 22, 2016, the Internal Revenue Service issued proposed changes to the regulations under IRC §409A. This post reviews a few highlights of the proposal that may be of interest to employers and employees.

Coordinated proposed regulations were issued under IRC §457, a deferred compensation provision for state and local governments and tax-exempt organizations – see our recent post.

The proposed changes to the §409A regulations contain nearly 20 substantive points. The overall tone is tinkering that will address minor issues that have arisen over time.  Most changes are helpful to taxpayers, with a couple of changes designed to close potential loopholes.  The following are some highlights of the proposed regulations.

Separations From Service

The current regulations provide that a “separation from service” may or may not occur when an employee terminates employment and has an ongoing consulting agreement. The determination of whether there is a separation from service (thus triggering payment of deferred compensation) is to be made based on what the facts and circumstances show is a reasonable expectation of how many hours will be required under the consulting agreement.

The proposed regulations and preamble seem to provide that if a separation from service does not occur at the time of the transition to the consulting agreement, a separation from service cannot be deemed to occur until the consulting agreement has entirely ceased. This may be an important planning consideration in relation to terminations of executive employment agreements.

Stock Options

A non-statutory stock option can avoid the application of §409A if certain requirements are met in relation to the option and the type of stock being issued. One requirement is that the stock cannot be subject to a mandatory repurchase obligation (other than a right of first refusal) that has a price less than fair market value.  Nor can the stock have a permanent put or call right that has a price less than fair market value.

The proposed regulations will modify this rule to allow for a purchase price that is less than fair market value in limited circumstances. Those circumstances would include an employee’s involuntary separation for cause, or the occurrence of a “condition” that is within the control of the employee, such as violation of a non-compete or non-disclosure requirement.

In another vein, the current regulations require that the employee actually be employed by the corporation granting the option (or an affiliate) at the time the option is granted. The proposed regulations will allow an option to be issued to an individual if it is reasonably anticipated that he or she will become an employee or service provider within 12 months.

Business Transactions

In an asset deal, the employees who go to work for the buyer will have a separation from service. That may trigger required payouts under nonqualified deferred compensation plans.  However, the current regulations allow the buyer and seller to agree not to treat the transaction as a separation from service for employees who go to work for the buyer.

The proposed regulations will clarify that no such election is available when a stock sale occurs, even if the buyer makes an election under IRC Section 338 to have the transaction treated as an asset sale. In a stock sale, a separation from service may or may not occur, depending on the underlying facts and circumstances.

In addition, the current regulations provide a special exception for certain change in control payouts for employees who are holders of company stock or stock rights. If the payments are spread out after the closing, no violation of the Section 409A rules will exist as long as (i) the payments are made under the same terms and conditions as apply to other shareholders, and (ii) are made within five years.  The proposed regulations will extend this treatment to statutory stock options and otherwise clarify its availability.

Plan Terminations

Under current rules, the §409A regulations define nine different types of §409A plans (e.g., elective deferrals, nonelective deferrals and stock rights plans). In order for an employer to terminate a §409A plan, the employer must terminate all deferred compensation plans of the same type, and not adopt any plans of the same type for three years.

The proposed regulations will clarify that this rule extends to all employees of the employer, not just the ones who were participating in the terminated plan.

The Short-Term Deferral Exemption

A compensation arrangement is not subject to §409A if the compensation earned under the arrangement is paid within 2½ months following the later of (i) the end of the calendar year in which it is earned, or (ii) the employer’s tax year in which it is earned. Quite often, this date becomes March 15 following the end of the calendar year

In the past, delayed payments have been permitted on account of three specific reasons. The proposed regulations will expand the reasons for delay to include potential violations of U.S. securities laws or other applicable law.

Enforcement of Legal Claims

Under current regulations, the §409A rules do not apply to amounts paid to reimburse an employee for settlement of a bona fide claim against an employer based on violation of applicable law, including reimbursement of attorney fees and costs.

The proposed regulations will expand this exception to also apply to reimbursements of attorney fees and costs that are provided for under an employment agreement or other deferred compensation plan, if an employee or service provider has to enforce his or her rights under the agreement or plan.

Payments Upon and After Death

The proposed regulations will modify the rules regarding the timing of payments after the death of an employee to prevent inadvertent violations of §409A. Essentially, no violation will be deemed to occur if payment is made by December 31 of the following calendar year.

The proposed regulations will clarify that after the death of an employee, it is permissible to accelerate payments on account of the disability or death of the beneficiary, or an unforseeable emergency of the beneficiary.

Recurring Part-Year Compensation

The current regulations have an exception from the §409A rules for “recurring part-year compensation”. For example, this applies to teachers who have 9 or 10 month service periods that may begin in August or September and end in May or June.  Often, they are paid over a 12 month period, the effective of which is to push some compensation into a later year.

The current exception states that it applies only if the compensation being deferred into the following year is not more than a limit tied to IRC §402(g) (currently $18,000). The proposed regulations will tie the limit to IRC §401(a)(17) (currently $265,000).  This will  expand the availability of this common sense exception.

Highlights of the proposed regulations under section 457(f)

U.S. Internal Revenue Code §457(f) addresses federal income taxation of certain types of “nonqualified” deferred compensation plans and arrangements of entities that are either state and local governments or tax-exempt organizations (under IRC §501(c)). Most of those deferred compensation arrangements also must comply with IRC §409A to avoid tax penalties.

For state and local governments and tax-exempt organizations, the IRC §457(f) rules principally apply to employment agreements and other compensation arrangements for executive level employees and certain highly compensated employees (e.g. physicians). Essentially, under IRC §457(f), deferred compensation is subject to tax when it is no longer subject to a substantial risk of forfeiture.  Opportunities for extended deferral of taxation have been very limited.

On June 22, 2016, the IRS issued long promised proposed regulations under IRC §457(f). Coordinating changes were also proposed to the regulations under IRC §409A.

In general, the changes in the proposed regulations will clarify a number of longstanding ambiguities in this area of the tax law, in ways that will be helpful to employers. The following are a few highlights from the proposed regulations:

Substantial Risk of Forfeiture

IRC §457(f) states that a substantial risk of forfeiture will exist if receipt of the deferred compensation is conditioned upon “the future performance of substantial services”. The proposed regulations will clarify the following points:

  • In order to be substantial services, the required performance period must be at least two years in length.
  • A substantial risk of forfeiture can exist if payment is conditioned upon the employee meeting certain performance goals or it is conditioned upon certain organizational goals being met.
  • A bona fide, legally enforceable non-compete can constitute a substantial risk of forfeiture.
  • A substantial risk of forfeiture can still exist, even if the deferred compensation is payable upon death, disability or an involuntary termination of employment (including a termination for good reason).

Rolling Risks of Forfeiture

A typical Section 457(f) deferred compensation plan will provide for payment to the employee at the time the risk of forfeiture will lapse (e.g., the end of an employment agreement’s term). That is because it is at that time that the deferred compensation becomes taxable.

The proposed regulations allow for taxation to be deferred to a future date by an agreement that extends a substantial risk of forfeiture into the future (e.g., a contract extension). Conditions for doing so are:

  • The agreement must be made in writing and entered into at least 90 days before the original substantial risk of forfeiture lapses.
  • For at least two more years, the employee must be required to render substantial services or be subject to a bona fide, legally enforceable non-compete. However, payment can be made upon death, disability or involuntary termination.
  • The amount payable at the end of the agreement must be materially greater than the current amount that would be payable to the employee. Specifically, the present value of the amount that will be payable to the employee at the end of the agreement has to at least be at least 25% more than the amount currently payable to the employee.

Deferrals of Current Compensation

The proposed regulations also will allow an employee to make deferrals out of current compensation (e.g. salary deferrals or deferral of a bonus). Conditions for doing so are:

  • An agreement in writing to defer the compensation must be entered into before the calendar year in which any services are rendered that give rise to the payment of the compensation.
  • For at least two more years from the date of the deferral, the employee must be required to render substantial services or be subject to a bona fide, legally enforceable non-compete. However, payment can be made upon death, disability or involuntary termination.
  • The amount payable when the substantial risk of forfeiture lapses must be materially greater than it was at the time the deferral. Specifically, the present value of the amount payable when the substantial risk of forfeiture will lapse has to at least be 25% more than the amount deferred.

Effective Date Concerns

The proposed regulations will be applicable to calendar years beginning after the date that final regulations are published. That could be as early as January 1, 2017.

Importantly, the new regulations will apply to any pre-exiting plans and arrangements that did not have the amounts deferred thereunder previously reported as taxable income. This could cause employees under pre-existing plans or arrangements to be subject to tax as of the effective date of the new regulations.

Accordingly, employers should examine any pre-existing plans and arrangements that are subject to IRC §457(f) to determine if they will be in compliance once the proposed regulations are made final.

First mandatory fine for failure to issue pension trustee chair’s statement

The UK Pensions Regulator (TPR) has issued its first fine to the trustees of a pension plan who failed to comply with the new legal requirement to prepare an annual governance statement, signed by the chair of trustees. The trustees received the minimum mandatory fine of £500 in this case.

Since last year, a new statutory requirement means that trustees of defined contribution (DC) pension plans must prepare an annual governance statement, which sets out how governance requirements have been met, or a mandatory fine will be imposed of up to £2,000. This statement must be prepared within seven months of the end of each scheme year.

In this first case of a fine being issued, it is interesting to note that the trustees complied with their duty to notify TPR of the breach and also quickly rectified the breach by producing the required statement 23 days after the breach had occurred. The actions of the trustees were taken into account by TPR in the calculation of the amount of the fine.

TPR reminds trustees in its regulatory intervention report on the case that “Trustees should be aware that we are required by law to impose a penalty where this type of breach occurs. This is still the case even when… the trustee notifies us of the breach and takes immediate remedial action”.

The Executive Director for Regulatory Policy at TPR, Andrew Warwick-Thompson, added “We hope that our report will act as a reminder and a deterrent for other schemes”.

On that note, we would urge trustees of DC pension plans to issue the required statement in time. However, if this deadline has been missed, you should take immediate remedial action and notify TPR of the breach.

Fines imposed on the trustees of a pension plan by TPR cannot be paid out of the plan’s assets. Payment will therefore need to be made from an alternative source, for example, by the sponsoring employer or out of trustees’ own pockets. Trustees who are fined by TPR will also need to notify their insurer.

If you think this may affect you in any way, or would like any further information, please speak to your usual Squire Patton Boggs contact.

May or May not? Further proposals to get tough on UK executive pay

With the news today that Theresa May will become prime minister this Wednesday, we note with interest reports that she intends to make large companies more accountable by having consumers and employee representatives on boards.  This resurrects an idea put to consultation by BIS during Vince Cable’s watch in the run-up to the introduction of the current regulations on directors’ pay, which was not carried through in the end.

In addition, we are told that in the wake of high-profile shareholder revolts on executive pay this AGM season, Mrs May plans to make the shareholder vote on the implementation of a company’s directors’ remuneration policy binding, rather than advisory as it currently is.  It will be interesting to see how it is proposed that this will work.  Companies will be reporting the outcome, in terms of value paid out during the relevant financial year and included in the “single figure” remuneration disclosure, of share awards to directors granted three (or even five) years previously by means of contractual agreements.  Will a binding vote against mean that the company is expected somehow to renege on these contracts?  Perhaps another situation in which companies will be expected to invoke claw-back?

We’ll keep you posted ….

No exit post-Brexit from property funds: what pension funds need to know about ‘gates’

In the wake of the Brexit vote, several asset managers have closed their UK property funds to redemptions – commonly known as imposing a ‘gate’. This highlights why pension funds and other investors should pay careful attention to the gating provisions in fund documents, both before entering into an investment and as part of the ongoing monitoring and review process.

What is a gate?

Open-ended investment funds normally contain provisions allowing the fund manager to suspend dealing in units of the fund during exceptional circumstances. These circumstances may include a period during which markets are closed or a period when it is otherwise impossible to determine the true price of assets held by the fund, and the fund documents usually contain a ‘catch-all’ provision allowing the manager to suspend dealing whenever it determines it is necessary to protect the interests of investors.

The effect of suspending dealing is that new investors cannot purchase units in the fund and existing investors are unable to redeem their investment, i.e. withdraw their money from the fund and invest elsewhere. The power to activate a gate came to many investors’ attention during the 2007-08 financial crisis, when many hedge funds and other funds sought to use gates to stem the tide of investors seeking to exit the funds.

Are gates necessary?

The recent spate of closures of UK property funds illustrate why ‘gates’ are needed in investment funds. The future for UK property could not be more uncertain: prices have fallen since the Brexit referendum and there is, as yet, no indication of whether the UK will join the EEA or EFTA, pull out of Europe altogether or even decide not to invoke Article 50 after all.  In this economic environment, not even the boldest economic forecasters are professing certainty over the future prospects for the UK property market.

Should investors in UK property funds start to withdraw their monies at the present time, the property funds are likely to be forced to sell assets at a significantly reduced value in order to pay redemption proceeds. This will affect the value of the fund and can therefore reduce the value of all other investors’ investments.  It is therefore reasonable for the investment funds, to protect the interests of remaining investors, to postpone dealing in the fund.

However, the downside of this, for investors who wish to cut their losses by selling their UK property holdings now, is that they are unable to do so. An investor who expects the market to fall further in the future may wish to sell their UK property portfolio but, if they are invested in one of the closed funds, this option is not available to them.  They must retain their exposure to the sector until the fund manager decides that the time is right to re-open the fund.

In addition, almost all funds now contain gating provisions regardless of how liquid their assets are. Whilst a ‘fire sale’ of assets may be undesirable in property funds, the need for gates in liquidity funds is less obvious.

Investors may not always be aware of the existence of gates, particularly in funds such as UCITS funds which are marketed as being highly liquid, with daily dealing provisions in normal circumstances. The point that in a crisis situation, there is no liquidity at all, is often missed.  The Financial Conduct Authority has therefore announced that it intends to review the role of gates in illiquid funds ‘both from the point of view of conduct and from the point of view of systemic stability.’

What lessons can investors learn from this?

Firstly, investors should always understand the gating provisions in fund documents and consider the possibility of gates being activated before deciding to invest in a comingled fund. If the investor wants to be able to sell assets during a crisis at the investor’s own pace, rather than the fund manager’s, it should consider investing directly rather than through a fund.  This was the reason many investors moved to managed accounts for hedge funds after the 2007-08 financial crisis.

Secondly, it is important that the fund documents contain protections against the misuse of the investment manager’s power to close a fund to redemptions. Since management fees are almost always calculated as a percentage of assets under management, the fund manager has an obvious conflict of interest when deciding whether to allow investors to withdraw monies.  Academic research carried out after the 2007-08 financial crisis found that the main beneficiaries of the activation of gates were the fund managers.  Review – and, if necessary, negotiation – of the fund documents at the point of investment is therefore crucial in order to protect investors’ interests.

Finally, investors should be taking the time now to understand the gate provisions in fund documents – and in particular assessing if the gates do come into operation, whether there would still be sufficient liquidity within the investment portfolio. There is a possibility that further gates will be imposed in the short- to medium-term, both on property and other investment funds.

Brexit – what action should trustees and investment committees be taking?

Whilst it is too early to tell what the full implications of the Brexit vote will be, we have had a number of enquiries from clients asking what their duties are in relation to their investment strategy.  We have therefore set out some general guidelines for action now and in the short to medium term.

What duties do trustees have in these circumstances?

Under trust law, trustees are required to monitor and periodically review the investment strategy for the pension plan.  In particular, trustees are expected to carry out a review of their Statement of Investment Principles where there is a material change in circumstances, either in the scheme or in the broader economy. 

Our view is that with increased levels of volatility in markets already obvious, it would be sensible for trustees to classify the Brexit vote as a material change in circumstances, in order to protect themselves from future challenge. Don’t forget that defined contribution members are as likely (if not more likely) to raise queries with trustees about the actions they have taken in response to the Brexit vote, especially if they are nearing retirement and have to take short term decisions.

The implications of Brexit are impossible to judge at this stage.  What can trustees do at present?

Short term volatility control measures aside, trustees should consider putting in place a plan for dealing with the longer term consequences of the Brexit vote.  For example, if trustees conclude that no changes should be made to the investment strategy at present, they could schedule a further review meeting for September (when the new Government is expected to be in place), or for some other date that they consider appropriate.

We also recommend that trustees consider contacting their investment managers now to ask them what their plans are for dealing with Brexit. How, for instance, are overseas portfolios managing sterling currency risk? What plans do managers have to address any further reduction in gilt yields or cuts in interest rates? Similar questions should be put to investment consultants given their role in advising the trustees on overall asset allocation strategy.

Where the managers have Brexit procedures and policies in place, trustees should ask for copies of these documents (to the extent that the managers are willing to disclose them).  Trustees may then wish to discuss with their investment consultant whether they consider their managers’ plans to be adequate.

Trustees’ risk registers should be appropriately updated to record any measures taken and manager/investment adviser responses.  

What if one of the scheme’s UK investment managers announces plans to relocate operations in the wake of the Brexit vote?

In these circumstances, trustees should ask their manager how, if at all, this will affect the delivery of services to the trustees.  If there will be a change in key personnel and/or critical back office personnel, or the change will involve a major upheaval to the manager’s operations, trustees may want to discuss with their investment consultant whether further due diligence on the manager is required.  

Trustees may also want to consider whether the move will in itself trigger a review of the manager.  Whilst it would be improper for trustees to act on the basis of their political views or a desire to protect the UK economy, legitimate questions to ask the manager would include whether there will be a reduction in regulatory protection for investors and whether the trustees will enjoy the same access to key individuals who are no longer based locally.

Changes may be also be required to investment documentation.  Trustees should carefully consider the implications of such changes, taking advice where appropriate, before signing any variations to existing documents.

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