The weakest link

Back in 2006 The Pensions Regulator wasn't mincing its words. Having cast a critical eye over the workings of Britain's occupational schemes, the watchdog cited evidence of poor standards of governance and low levels of knowledge and understanding on the part of trustees. It wasn't an across the board criticism - the regulator's first medium-term strategy document made clear that schemes with 1000 members or less were the most likely to have governance shortcomings - but it was a situation that required action.

A year later the regulator's annual report was a shade more upbeat. According to the review there had been a marked increase in trustee training, a trend that had in turn improved the competency of boards and improved the overall standard of scheme oversight. "We take comfort from the evidence of improvement in the three areas of governance on which we have focused most heavily during the last year," The Pensions Regulator chief executive Tony Hobman commented.

All of which illustrates the change that has taken place in pension scheme governance in recent times. While the 2004 Pensions Act bestowed additional powers on trustees, it also demanded more in terms of time and commitment. And one of the key stipulations of the legislation was that trustees should be able to demonstrate 'œknowledge and understanding' across a range of legal and financial issues, a requirement that was underpinned by a comprehensive code of practice. The upshot was that anyone taking on the role of trustee faced an ongoing process of self education.

You might say it was ever thus. Long before the conception of the 2004 act, trusteeship required a degree of specialist knowledge. You could argue that the legislation (and the associated guidance issued by the regulator) did nothing more than remind board members that they owed it to themselves and scheme members to stay abreast of their legal obligations and the ever-changing actuarial and investment landscapes. Or as CMS Cameron McKenna partner Neil Smith points out: "The TKU requirements have simply helped to focus trustees on issues that they should have known about already."

But that's not to say the new rules haven't had a major impact. When the regulator expressed concern about poor governance, it was also pointing to a divide between the standards achieved in larger, well-resourced schemes and their smaller counterparts. By laying down the law on trustee knowledge and understanding, government and watchdogs were intent on levelling that particular playing field.

"In the past there was much variation between the trustee board of small and large schemes in terms of the training on offer" says Sacker & Partners partner Claire Altman. "What we're seeing today is smaller schemes making a real push towards higher governance standards. They are introducing into their training some of the processes that bigger schemes have had for some time."

But what has all this meant in practice? Each member of a trustee board brings his or her own skills to the table, and it is perhaps too much to ask that each individual should be equally expert in arcane matters of law or the intricacies of today's investment planning environment. So what level of knowledge should trustees be aspiring to and what needs to be done to ensure that they have that knowledge?

How wide and how deep?
The first thing that has to be said is that in terms of the breadth of knowledge required, the code of practice drops trustees into a largely familiar landscape. As set out in the regulator's Scope Guidance. The trustee must get to grips with pension and trust law, the rules governing his or her own particular scheme and the principals of investment and scheme funding.

But the devil is in the detail. For instance, when trustees set about getting to grips with investment and scheme funding issues they are looking at a moving target - or to be more precise, an investment environment where the options are becoming ever more complex. "Trustees have a much harder job these days," says Barclays Global Investors head of UK business development, and coordinator of a series of finance-driven training sessions tailored for trustees, Jo Willis. "Over the last few years we've seen trustees having to come to terms with issues such as liability-driven investment, diversification and new asset classes such as hedge funds."

In the case of pension and trust law and scheme rules, ground may not be shifting quite so rapidly but trustees still have a huge amount to assimilate, particularly if they are new to the job. For instance, as Smith points out, the starting point for many board members will be the rules governing their own schemes and (perhaps more crucially) how those regulations affect their own duties and responsibilities.

"You have to understand the balance of power within the scheme and the duties, power and discretion that you have as a trustee," Smith says. In addition, the trustee must be conversant with the membership of the scheme and the benefits offered. And even old hands who know their way around the scheme rule book have had some catching up to do. β€œThere are some new things in the legislation," adds Smith. "For instance, the requirement to understand the employer covenant is new."

Finally, of course, there is the wider legal framework as defined by pension and trust laws. Trustees are expected to be aware of their own duties under the law, their potential liabilities and the rules surrounding conflicts of interest. It's also important that board members should be familiar with the role that advisers play, the importance of risk control, contingency planning and investment law as it applies to pension funds and trusts.

All in all it's a crowded smorgasbord. The question that really hangs over the head of trustees is just how deep to drill down into the subjects. According to Altman the answer to that question is defined by the ability of board members to engage effectively with advisers. "Trustees have to learn enough to understand the advice they are being given and to challenge that advice if necessary," she says.

Lane Clark & Peacock head of trustee training Chris Green agrees, but adds it is equally important that trustees should be aware of the limits of their own understanding and, thus, know when to seek outside help. "Board members have to be able to recognise when they can handle a problem themselves and when it is necessary to seek input from an adviser," he says.

As set out in the code of practice, every trustee should have an understanding of the issues he or she will face, but that doesn't mean each trustee should have (or be expected to have) the same level of knowledge. As Smith observes, the majority of boards will have members with a specialist interest in, say, governance issues or finance and this may be formalised in terms of structure. "In the case of bigger schemes, trustee boards are often divided into sub-committees specialising in areas such as investment and report back to the whole board," he says.

Morgan Stanley Investment Management head of UK business Richard Lockwood notes the same trend and he sees real advantages in a committee system, particularly in the complex areas such as his own specialist subject of investment strategy. "It's very often the case that an investment committee can move more quickly in terms of addressing issues than would be the case if all members of the trustee board were involved," he says.

But there is, he admits, something of a balancing act to perform. Ultimately, all board members have fiduciary responsibilities and if something goes wrong accountability does not stop at the sub-committee. In other words, the presence of experts on a board will not diminish the requirement for all members to be sufficiently on top of a subject to make informed decisions. Lay members should feel comfortable about challenging the opinions and submissions of their more expert colleagues. And while a committee might do the groundwork, any decisions that affect policy or strategy must be understood and approved by the board as a whole.

Lockwood cites the choice of an investment manager as an example. "Very often the investment sub-committee will review the possible candidates and make a recommendation. Once that recommendation has been made, all trustees will take a decision on whether to go ahead with the investment manager that has been recommended," he says.
The learning curve

If nothing else, the introduction of the knowledge and understanding code of practice has resulted in a marked increase in the number of trustees attending courses. For instance, in response to demand, Lane Clark & Peacock is running a growing number of training sessions every year, with more people turning up for each event. "We used to hold four courses a year and we had perhaps six to eight people attending each one," says Green. "At the moment we're running eight courses a year and they are always fully booked."

And in addition to formal training, trustees can, of course, seek guidance from their own advisers before they address a particular issue. "What often happens is that advisers will provide bespoke training sessions ahead of meetings," says Baker Tilly head of pensions Ian Bell. "Before a valuation an actuary will run through the issues. Or accountants will talk to the trustees before an audit takes place."

But the challenge facing boards - and, in particular, board chairmen - is to match the training to the need. As Bell points out, training would be relatively simple if all board members were starting from the same place. In practice, however, there is likely to be a huge variation in skills and knowledge across a single board. Bell believes it is essential to tailor training to the requirements of individual trustees. "We have seen a real drive towards better trustee knowledge and understanding," he says. "But some trustees know more than others and some learn quicker than others. Boards have to work on ways to capture the skills required."

What is needed, says Bell, is some kind of gap analysis to identify weak spots in the board as a whole and in the knowledge of individuals. Once this has been done, you can begin to address the training needs of each member.

There are various ways to do this. The regulator's own Trustee Toolkit (available at the website) provides an easily accessible means for board members to assess whether their own levels of knowledge match the standards set down in the code of practice. Many trainers also offer online resources. Lane Clark & Peacock is a case in point. The firm's website provides a test covering pension and trust law and investment topics. "It can be used either for training needs analysis or as a test for trustees after they have attended training," says Green.

In many cases, though, any gap analysis that takes place often relies on the intuition and people skills of the chairman rather than formal testing. "What you often see is a chairman questioning individual trustees about there areas where they feel they need support," says Altman.

New faces
To complicate matters chairmen must also think about the skills levels of incoming as well as existing trustees. Recently introduced rules on member nomination have meant an influx of new faces. The Pensions Act allows board members six months to acquire the necessary knowledge levels but in practice the expectation is that new arrivals will hit the ground running. "A trustee is a trustee as soon as they join the board and they have to be up to speed," says Bell. "That presents a real challenge in terms of succession planning. Boards should be thinking about how new trustees are prepared and trained."

In some cases, incoming trustees will be well primed. For instance, as Bell points out, member nominations in many large schemes are in the gift of trade unions, and these organisations take the grooming process very seriously. However, in smaller schemes member nominees may have very little relevant experience before taking on the new role and as Trustee and Pensions Management Association (TPMA) chief executive of training organisation Wayne Phelan observes, the learning curve can be steep and daunting. "Most of our courses are for new trustees and we are also training people who have yet to take up their appointments. One thing that we have seen is quite a high drop out rate. There are people who come to our courses and decide that this is not a role that they want to take on," says Phelan. In response to that trend, the TPMA has developed courses tailored specifically for prospective trustees.

What all this means is that well run boards are probably looking at a number of training options - courses for new and prospective candidates, adviser briefings and refresher sessions for the board as a whole or specialist sub-committees. However, with no recognised training standard in place it is up to the chairman to ensure that the instruction provided complies with the expectations of the regulator. And according to Altman, training must not only be done, but seen to be done. "Training should be documented," she says. "Most boards have some sort of training log, but are also important to minute any discussions about training issues and provision."

From the anecdotal evidence of advisers through to the findings of the regulator, standards of trustee training have improved in response to the demands of the 2004 act. But keeping trustees up to speed is an ongoing process, requiring regular reviews, gap analysis and action to plug any holes in the knowledge and understanding of individuals and the board as a whole. It remains to be seen whether less well resourced boards can continue to recruit suitable trustees and keep pace with the governance standards set by the larger schemes.