Paul Myners was asked to carry out his review of institutional investment by the Chancellor in the 2...
Paul Myners was asked to carry out his review of institutional investment by the Chancellor in the 2000 Budget. Myners published a consultation document in May 2000 setting out the primary focus of the review, which was to investigate whether there are factors distorting institutional investors' decision-making, encouraging excessive dependence on industry-standard investment patterns, for example.
Myners subsequently wrote an open letter to ministers in November 2000, in which he set out two main proposals. First, to replace the Minimum Funding Requirement (MFR) for pension funds with tougher checks on fraud and a regime of transparency and disclosure. Second, to make a legal change to investment restrictions on pension funds, making it easier for them to invest in private equity limited partnerships.
Myners published the final report, Institutional Investment in the United Kingdom: A Review, on 6 March 2001.
Principles of institutional investment
The central proposal of the review, closely modelled on the approach taken on corporate governance by the Cadbury (and subsequent) Codes, is a short set of clear principles of investment decision-making. These would apply to pension funds and, in due course, other institutional investors.
As with the Cadbury Code, they would not be mandatory. But where a pension fund chose not to comply with them, it would have to explain to its members why not. Under the code, trustees would be paid but given additional responsibilities to set investment objectives specific to the fund and to consider all asset classes including private equity partnerships, instead of simply judging fund managers in accordance with industry averages.
The review believes that it would be preferable for the industry to adopt the principles voluntarily, but is clear that if necessary, the Government should legislate to require disclosure. It is recommended that, after two years, the Government should examine the extent to which the review's proposals have been successful in changing behaviour.
The main elements of the principles include:
l Trustees should set out an overall investment objective for the fund, in terms that relate directly to the circumstances of the fund, and not to some other objective, such as the performance of other funds.
l Trustees should seek separate advisers on investment and actuarial matters.
l Fund managers should be given a written brief that sets out the timescale over which they are expected to perform
l Fund managers should be forced by law to intervene actively to improve the management of companies in which they have invested if this could improve investment returns
l It should be made easier for funds to invest in private equity partnerships and high-risk ventures
l The attention devoted to asset allocation decisions should fully reflect the contribution they can make to achieving the fund's investment objective.
l Decision-makers should consider a full range of investment opportunities across all major asset classes, including private equity.
l The fund should be prepared to pay sufficient fees for actuarial and investment advice to attract a broad range of kinds of potential providers.
l Trustees should give fund managers an explicit written mandate setting out the agreement between them on issues such as the investment objective, and a clear timescale for measurement and evaluation. Fees paid to managers should include the costs of information, research or transactional services used by the manager. Fund managers' contracts should include payments to cover research fees and broking commissions, rather than these being charged to the fund, in order to cut the cost.
l In consultation with their investment manager, funds should explicitly consider whether the index benchmarks they have selected are appropriate. Where they believe active management has the potential to achieve higher returns, they should set targets and risk controls that reflect this, allowing sufficient freedom for genuinely active management to occur.
l Trustees should arrange to measure the performance of the fund and the effectiveness of their own decision-making and formally assess the performance and decision-making delegated to advisers and managers.
l In defined contribution schemes, when selecting funds to offer as options to scheme members, trustees should consider the investment objectives, expected returns, risks and other relevant characteristics of each such fund. Where a fund is offering a default option to members through a customised combination of funds, trustees should ensure an objective is set for the option, including expected risks and returns.
The review makes a series of other proposals. The main ones are:
l A legal requirement for trustees to be familiar with and have knowledge on the issues on which they make decisions, as in the US.
l The replacement of the Minimum Funding Requirement with a regime based on transparency and disclosure, as already put forward by the review in November 2000.
l Incorporation of the US ERISA principle on shareholder activism into UK law, making intervention in companies, where it is in shareholders' interest, a duty for fund managers.
l Surpluses returned to the employer should be taxed at a lower rate than 40%. This has already been acted on with the rate proposed at 35%.
l The Law Commission to be asked whether it can suggest greater legal clarity around the ownership of surplus pension fund assets.
l A follow-on review of capital and information flows relating to personal investment products.
The review also looked specifically at private equity. Investment in private equity should benefit from the framework set out by the principles and from the replacement of the Minimum Funding Requirement. Myners also made a number of proposals that take account of the special nature of private equity as an asset class for institutional investors, including changes to the maximum number of partners in a limited partnership and changes to the taxation of investments in limited partnerships. He also calls for the British Venture Capital Association to take action to improve transparency and disclosure about issues such as investment returns and compensation.
The review also looked at life insurance. It found that competition in the industry, though intense, tends not to focus directly on investment performance. This raises issues beyond the review's remit, but which need to be tackled if stronger incentives to efficient investment decision-making in the industry are to be created.
The Chancellor's response
In his last Budget, the Chancellor said the Government intends to take forward all the recommendations made by Paul Myners, including the abolition of the Minimum Funding Requirement.
Among the other consequences of this decision is the fact that once the principles for institutional decision making are agreed (following further short consultation), pension funds and other institutions in due course will be required to set out publicly whether they comply with the principles. The Government will also undertake a review in two years time to see whether the principles bring about any behavioural change
The Government will legislate to replace the MFR with a long-term scheme, with additional protective measures for scheme members, including a statutory duty of care for the scheme actuary, stricter rules on voluntary wind up and an extension to the fraud compensation scheme.
There are a number of extremely important changes as a result of the Myners recommendations. It was almost universally agreed that the MFR did not properly fulfil its function to provide protection for scheme members' benefits, while at the same time unnecessarily imposing additional liabilities on employers offering final salary schemes. It remains to be seen whether the Government's proposals will be more effective
Being a trustee of an occupational scheme is already an onerous task following the implementation of the Pensions Act 1995 provisions. This will be even more so following the Myners recommendations and there may well be a shortage of applicants for the trustees' jobs. Moreover, the costs of implementing the Myners recommendations may significantly increase the administration costs for smaller schemes and may be a further catalyst in the move towards stakeholder pensions.
The David Aaron Partnership is a Milton Keynes-based IFA firm
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