SPC has responded to the Treasury's proposed principles on investment decision making flowing from the Myners Report. This is our response.

We welcome the fact that the Myners review does not recommend further regulation now. Regulation is, however, clearly a threat, should trustees and, where appropriate, consultants and investment managers not adopt the principles proposed by Myners and endorsed by the Treasury. Some trustees might therefore feel obliged to adopt the principles when they would otherwise have seen no justification for doing so. This implies greater burdens on trustees and increased costs for sponsoring employers. This might hasten the demise of occupational schemes.

In particular, the principles appear to have been drawn up very much with large schemes invested in segregated funds in mind, with a range of specialist advisers and managers at their disposal and the support of in-house expertise. Many schemes do not correspond to this model. They might be, for instance, invested in one or more managed funds and/or sponsored by small employers without the resources which the principles envisage should be made available. In his interim recommendations last year Paul Myners drew a distinction between larger schemes and others. This is absent in his final report.

The principles imply a requirement for more trustee training and more in house investment staff to support trustees. This in turn implies significantly greater costs for smaller schemes. The principles possibly confuse financial expertise (which smaller employers will generally have in house) with investment expertise (which smaller employers and indeed many larger ones (for example in the manufacturing sector) often will not). It is investment expertise which is relevant in the context of the principles. It should be recognised that, for the great majority of schemes by number, some or all of the detail of the principles is inappropriate. These schemes, in reporting on their adherence to the principles, should be able to do so on the basis that that their size makes adoption of the detail of the principles inappropriate, but that they have operated in a manner consistent with them.

It is striking that the principles make no reference to the sponsoring employer, who is one of the key parties to a scheme, particularly a defined benefit scheme. In contrast, the need to retain the support of the employer, and to reward the employer for backing its defined benefit scheme, emerged strongly from the Myners review.

We suggest that it should be left beyond doubt that, in any situation where the trustees consider that the principles clash with their duty to act in the members' best interests, the principles should be over-ridden.

The practical application of the proposal that trustees should in general be paid needs to be clarified. We support debate between trustees and their professional advisers, and we would not wish payment of trustees to jeopardise the system in which committed, but non-expert, trustees enter into a thoroughgoing discussion with their advisers. Non-expert trustees generally have a good understanding of the position of the sponsoring employer, which is a key factor in the running of the scheme. A professional trustee is unlikely to have this knowledge. We understand that employee trustees or senior employees nominated as trustees by the sponsoring employer, receiving paid time off for trustee duties, would be regarded as being paid. If so, the great majority of schemes already comply with the principle. Non-experts, such as pensioners, would probably be less willing to come forward as trustees if they were paid directly, because this would imply a level of responsibility under trust law closer to that of a professional trustee.

In some situations direct payment could reduce members' benefits. If a scheme was winding-up, and the sponsoring employer no longer existed, there would be no alternative to payment coming from the pension fund.

It needs to be kept in mind that there is a tension between the investment provisions of the Pensions Act 1995, FSA's views on activities requiring authorisation and the role of trustees in investment decision making. The combined effect of these factors will be to distance trustees from the decision-making process.

We agree that it is often good practice for trustee boards to have an investment sub-committee. However, in some cases it will be inappropriate. For instance, if the trustees as a whole are actively involved in investment, a sub-committee is superfluous.

We suggest the deletion of the statement that trustees "should draw up a forward-looking business plan." In our view it adds nothing to the principle and is so vague as to be unhelpful.

We agree that trustees should set an overall investment objective which represents their best judgment of what is necessary to meet the fund's liabilities. However, care is needed that the objectives of the fund are not expressed in such a way as to prevent proper measurement of the fund manager's performance. While scheme specific investment benchmarks should play a key role in the expression of objectives, performance relative to other pension funds or to a market index can be essential supplementary information required to monitor the performance of the fund manager. For example, in a falling market there might be a general failure among managers to meet their scheme specific benchmarks, so more, non-scheme specific, information would be needed to assess their performance.

In the final paragraph we suggest a reference to "The overall objective for the fund" instead of "Objectives for the overall fund". This would accommodate, for example, a composite index performance objective, underneath, for example, an RPI+ objective.

The implication of the first bullet point is that trustees should have regard to the quality of the employer's covenant. Assessing the quality of the covenant over the length of time likely to be relevant to a pension scheme is not practicable. In any case, doing so could cause trustees who are directors of the sponsoring company to have such conflict that they might feel unable to act as trustees. This runs counter to the spirit of the Myners review, which encourages the involvement of employers with the pension schemes they sponsor.

We agree that strategic asset allocation decisions should receive a high level of attention. There is already a significant move in this direction.

The Myners report implies that, where trustees are not investment experts, decisions on asset allocation should be taken by an investment consultant. In our view, unless the financial services legislation rules it out, decisions must be taken by trustees, taking expert advice where necessary.

We suggest that the final sentence should be reworded to read "In setting their asset allocation, trustees should take into account the fund's own characteristics, not the average allocation of other funds"

We support the principle, provided that it would not preclude trustees from deciding that obtaining actuarial services and investment advice from the same source is the best course to follow. The key factor, in our view, is that actuarial services and investment advice are explicitly recognised as separate items. This then highlights the possibility of trustees obtaining them from separate sources.

As a general comment, it is inappropriate for the principles to cover what mandates should or should not provide for. If there are to be principles governing exclusions of financial instruments these should be set at the level of the statement of investment principles not at the level of mandates. Lack of experience or understanding of a financial instrument, among trustees or investment managers, should be able to constitute a clear justification for excluding it from a mandate. Consider the problems which have arisen from the use of derivatives when the necessary risk management measures have not been in place.

More specifically, it is already common practice to give investment managers three or five year targets, with set margins for under and over performance. We regard as unworkable, the proposal that the mandate should be incapable of termination before the expiry of the evaluation period (other than for clear breach of the conditions of the mandate or because of the significant change in the ownership or personnel of the investment manager). It should certainly not be a principle of investment decision making. For example, a scheme merger or large scale redundancies, changing the liability profile of a scheme, might give rise to a need to terminate a mandate before the expiry of the evaluation period. Such a principle could also hamper schemes' ability to adjust to changing market circumstances. For example, if it became appropriate to move fixed interest investment from gilts into corporate bonds, a fixed term mandate in gilts could delay the move.

The principle appears to be based on the assumption that trustees take too short term a view. We do not believe this to be the case. (We note that the principles appear to encourage a longer-term view among trustees, but also provide elsewhere for them to report annually to members on the performance of the investment managers. This could encourage greater short termism).

We do not believe that transaction services should be included within management fees. Fund managers have a duty of best execution. If it is not being met, this should to be taken up with the Financial Services Authority who should be monitoring this. If the principle remains as drafted, it could in fact lead to poorer execution, as more dealing would be done on a net basis, with wider spreads than on a commission basis.

Taking the wording as it stands, the principle is unworkable where trustees employ pooled fund managers. Managers of pooled funds cannot agree different mandates for different trustees using the same pooled fund. It would therefore be incumbent on such managers to spell out clearly the objectives, benchmarks and risk parameters for each of their funds, and for trustees to select them taking these into account.

We suggest that any principle on activism should be drawn up with UK circumstances in mind. The US Department of Labour Interpretative Bulletin could be a starting point but, because it reflects the role in the USA of the investment manager as a fiduciary, a role the manager does not play in the UK, it could not be adopted without modification.

Any principle should reflect that private intervention may be preferable to public intervention.

We would generally support guidelines on voting, which encourage trustees to instruct the investment manager to vote on any matter which affects the value of an investment.

We endorse the first bullet point and agree that trustees should consider with their investment managers the index benchmarks which they have selected and their likely effect on investment strategies. The other bullet points are matters of detail, rather than principle, and should be deleted. If retained they could apply to trustees, acting in conjunction with their investment managers or consultants and it would be helpful to make clear which points are intended to apply to each party.

It would also be appropriate to include any investment consultant in the consultation between the investment managers and the trustees.

We broadly agree that the performance of trustees and their advisers should be evaluated, and trustees should consider independent evaluation where objective assessment is readily available. But for some advisers and types of advice it could be difficult to devise objective indicators capable of accurate measurement. We do have reservations about the principle that trustees should formally assess their own procedures and decisions because of the new layer of costs involved and the potential it has for opening up a new area of litigation.

Given the principle that trustees should set an overall investment objective for the fund, which takes account of attitude to risk, it is perhaps inconsistent that the principle on performance measurement should make no reference to measurement taking risk into account.

A provision that projected investment returns be included in statements of investment principles is far too detailed. Such projections can change quarterly, or even monthly, and should not therefore be required to be included in a statement of underlying principles.

It should not be a principle that the statement should be sent annually to all members.

If the statement of investment principles contains all the recommended information, it will be a weighty document and if the full version is sent to members there will inevitably be costs in answering questions arising from lack of understanding and some needless anxiety among members. This needless anxiety might cause trustees, nevertheless, to be more cautious in their approach to following higher return and risk strategies. Where the employer (as is usual), rather than the members, carries the investment risk, this would not benefit the members. It would be more appropriate to make the full version of the statement available on request, as at present, while sending a simplified version to members.

Our general comments on the proposed principles for defined benefit pension schemes also apply here.

Additionally, whereas defined benefit schemes might regard the removal of the minimum funding requirement as some compensation for the increased burden arising from the principles, defined contribution schemes do not have this compensation, since the minimum funding requirement does not apply to them.

Since group personal pension schemes and stakeholder schemes are alternative forms of defined contribution employee provision, evenhandedness dictates that any principles should also apply to them.

The requirement that trustees satisfy themselves that they have taken their members' preferences into account is unworkable because preferences are difficult to define and frequently change. Equally importantly, the preferences might be inappropriate. A member in his or her early 30's might prefer to be invested 100% in cash, but that is unlikely to be to their advantage. A better principle would be to take the members' circumstances into account, e.g what is their level of financial understanding, what is the cost/benefit balance to members of offering a given range of options, including the cost of communicating the range?

This principle should include recognition that in defined contribution schemes members bear the investment risk.

It needs to be recognised that defined contribution schemes which are fully insured are not required to prepare a statement of investment principles. The principle could be read as assuming that all schemes will have a statement. This would be unduly costly and bureaucratic.

JM/HMW 4.33