IORP II / SI 2018/1103: The new architecture for pension scheme governance

The Pension Schemes Act (PSA) 2021 has introduced new criminal and civil penalties for conduct (an act or a failure to act) on something that is known, or ought to have been known, which could materially prejudice benefits, without reasonable excuse.

It must be arguable that not having an effective system of governance in place would potentially be conduct that is a failure to act. Whilst much of PSA21 will not come into force until regulations are passed, there has, under SI 2018/1103, been a requirement for an effective system of governance since January 2019. This statutory instrument implements ‘IORP’ II.

IORPS and internal controls

‘IORPs’ (Institutions for Occupational Retirement Provision) are what we know as occupational pension schemes, both defined benefit and defined contribution.

The EU IORP I (2003) legislation was transposed into UK law within the Pensions Act (PA) 2004, with the detail provided by The Pension Regulator’s (TPR) Code of Practice (CoP) 9, first published in 2006. CoP 9 states that internal controls are systems, arrangements and procedures to be followed in the administration and management of a pension scheme, together with the safe custody and security of the assets.

This meant that trustees and managers of occupational pension schemes had to have internal controls. However, IORP I, the original PA04 and CoP 9 omitted to specify that the internal controls needed to be effective or had to include a requirement to assess the effectiveness of the systems, arrangements and procedures.

The EU IORP II, published in 2016 (while we were still a Member State of the EU), requires an effective system of governance, which meant that existing requirements needed to be extended. Statutory Instrument (SI) 2018/1103 transposed the IORP II requirements into UK legislation in January 2019 (pre-Brexit), removing ‘internal controls’ from the key paragraphs of PA04 and replacing them with the requirement for trustees and managers of occupational pension schemes to have an effective system of governance, including internal controls.

The structure of the effective system of governance includes three key functions: an own-risk assessment, the actuarial function and an internal evaluation. IORP II actually requires an internal audit, although SI 2018/1103 transposed this into UK legislation as an internal evaluation. This will undoubtedly reduce the compliance costs for trustees, managers and sponsors, with due credit to the DWP for facilitating this outcome.

PA04 and CoP 9 are slightly disconnected at the moment; CoP 9 requiring internal controls, whereas PA04, as amended by SI 2018/1103, requires an effective system of governance. However, the SI requires an appropriate supporting CoP to fully apply. The initial expectation was that COP 9 would be updated, although it has taken a little longer (due to COVID-19 related delays). It is now understood to be included within TPR’s ‘Super Code’, which we believe isn’t too far away. A recent comment on TPR’s website stated that the regulations place new requirements on certain occupational pension schemes (a few exceptions include public sector schemes and authorised Master Trusts, as they have their own governance structure), the most far-reaching of which is the requirement to establish an effective system of governance, which builds on the previous requirement for trustees to maintain adequate internal controls.

Here, TPR is referring to internal controls as the previous requirement, although the timing for full compliance with an effective system of governance is a little grey. SI 2018/1103 states the CoP must include the matters relating to the effective system of governance, the three key functions, outsourcing activities, written policies and the documentation of the own-risk assessment. However, in terms of timing, the SI only states that the documentation of the occupational pension scheme’s first own-risk assessment must be prepared within around 12 – 24 months of TPR’s CoP being issued. By indication therefore, the timing for the requirement to have an effective system of governance was January 2019.

Action required

For your pension scheme’s governance framework, it is important to set an architecture for an effective system of governance and to plan for completing and documenting your own-risk assessment and internal evaluation. All occupational pension schemes (IORPs), excluding the few exceptions, will need to step up to meet the new documented, evidence based, governance culture. It just depends on how big your step is.