The Occupational Pension Scheme (Investment) Regulations, 2005 (SI No. 593 of 2005) (the Regulations) came into force on 23rd September. This Statutory Instrument (SI) implements the investment rules that pension vehicles covered by Directive 2003/41/EC of the European Parliament and the Council on the activities and supervision of institutions for occupational retirement provision must comply with. This is known as the IORPs Directive.

The assets of the pension schemes must be invested in accordance with the prudent person rule and certain investment rules. The Regulations prohibit a scheme from borrowing unless for short term liquidity purposes. The IORPs directive permits Member States to opt out of certain provisions in the case of schemes with less than 100 members, unless the scheme is operating on a cross border basis.

Under domestic rules a pension scheme could borrow if it was permitted by its governing documents, unless it was a small scheme known as small self administered scheme (SSAS). SSASs are generally arrangements set up by shareholder directors of companies for their own benefit. Revenue Rules had prohibited such schemes from borrowing.

The Finance Act 2004 unexpectedly permitted all pension schemes to borrow.

When the Finance Act 2004 was enacted the IORPs directive had been published and the deadline for compliance, 23rd September, 2005, was already set. It seemed a little inconsistent for pension schemes to be enabled to borrow in light of the forthcoming implementation of the IORPs Directive, which generally would prohibit borrowings except in the case of schemes with less than 100 members. In practice, the only schemes that engaged in borrowing following the enactment of Finance Act 2004 were SSAS.

When the Social Welfare and Pensions Bill 2005 was published there was a protest lobby on the part of SSASs at the proposed prohibition on borrowing for all pension schemes in light of the IORPs Directive's exemption for schemes with less than 100 members. The Bill was amended to enable an opt out, via regulations, pending the report of a group that the Minister for Social and Family Affairs had established to deliberate and report on the matter. As far as an opt out from the IORPs Directive's borrowing regime is concerned, the Regulations reflect the outcome of those deliberations.

The investment rules, described below, apply to any scheme other than a "one member arrangement". Schemes with more than 100 members (being active and deferred members but not pensioners) must issue a statement of investment policy principles.

Article 7 of the Regulations sets out the investment rules applying to schemes other than one member arrangements.

Assets must be invested in a manner designed to ensure that the security, quality, liquidity and profitability of the portfolio as a whole having regard to the nature and duration of the expected liabilities of the scheme. At least 50% of assets must be invested in regulated markets; non regulated investments must be kept at a prudent level. There must be proper diversification and no excess reliance on any particular asset, insurer or group of undertakings; there must be avoidance of accumulations of risk in the portfolio as a whole; excessive risk of concentration must be avoided; investment in derivatives is generally discouraged.

Special rules apply where investment is made via insurance products. Schemes, other than one member arrangements, are permitted to borrow for liquidity purposes and only on a temporary basis.

One member arrangements are permitted to borrow and do not need to comply with the investment rules in Article 7 of the Regulations.

A one member arrangement is defined as a "scheme which is established for one person only and that one person will always be the only member and that member has discretion as to how the resources of the scheme are invested, unless the scheme is made the subject of a Pension Adjustment Order, in which case it may also include the person or persons referred to in the Pension Adjustment Order".

Several difficulties are presented by this definition.

Rarely, if ever, is a pension scheme established for one person only; it is invariably the case that a scheme is established for the benefit of employees of the sponsoring employer and their respective spouses and dependants. When a scheme is being drafted it is usual to set a wide class of potential beneficiaries even though the scheme is, in the case of an SSAS, intended to benefit one or two people (i.e. the controlling shareholder(s)) and their respective family members and other dependants).

Even if the scheme is established for a single active member, the class of beneficiaries will cover his/her spouse and dependants. Indeed, applicable Revenue limits by which any gearing will have been calculated are likely to have taken into account the cost of the funding of a spouse's/dependant's contingent benefits on death-in-service or in retirement. The definition implies that such benefits ought to be ignored. Thus the definition has a knock on effects for Revenue limits.

Failure to admit a spouse and dependants as beneficiaries of a one member arrangement means that on the death of the member the pension assets fall into their estate and thus any pay out may be delayed until a grant of probate issues. Also, the pension assets would be at risk from the creditors of the deceased member.

It is submitted that this outcome was not intended by the Regulations.

Where a scheme was been established for more than one person even if its class of beneficiaries is restricted in the future it will always have been established with a wider beneficial class; this may pose difficulties for existing SSASs that borrow. Thus, it appears that the Regulations create insurmountable hurdles for such schemes. How can they ever be legally adapted to be a one person arrangement? One solution might be to make a transfer to a newly set up arrangement, but this will involve cost. Also, if the existing plan invests in geared property this route will require a transfer of the property to a new plan, with the uncertainty that stamp duty might arise, and if borrowings arise banking documents will need to be re executed.

The Finance Act 2004 enabled borrowings by all SSASs, not merely those with one principal beneficiary. Under the IORPs directive Ireland has the freedom to permit borrowings by an SSAS with more than one principal beneficiary and their respective spouses and dependants, provided the total membership does not exceed 100. It appears that the legislature presented borrowing opportunities in 2004 and is now is doing an about turn leaving some schemes in a quandary as to how they can comply. Is this fair?

It seems that what would be fair is if transitional arrangements apply. These could permit all existing arrangements in place with less than 100 members as at 23rd September to continue as is. Such a step is permitted by the IORPs directive.

The definition of "one member arrangement" also requires that the sole member has discretion as to how the resources of the scheme are to be invested:

"the [sole] member has discretion as to how the resources of the scheme are invested.."

Revenue rules overlap with any investment decisions that can be taken by a member of an SSAS. They provide that a professional trustee, known as a pensioneer trustee, must be a party to all financial decisions affecting the scheme. Consequently, it is unclear how this Revenue obligation sits with that of the Regulations. Mainly, but not always, a principal beneficiary of an SSAS will also be a trustee of the scheme along with a professional pensioneer trustee. It's unclear from this part of the definition if this test will be met if the principal beneficiary is a co trustee, notwithstanding that in practice any investment decisions that he wishes to make require, under Revenue Rules, to be capable of being overridden by his co pensioneer trustee. Alternatively, is it intended that the member must be given a formal discretion, as a beneficiary, under the rules of the SSAS as to how the scheme's resources must be invested? In that event even if the member were conferred with such a discretion Revenue rules still require that the pensioneer trustee could effectively veto the decision as it is required to be a cosignatory on all financial transactions and it may decide in a given case that what is proposed is inappropriate, perhaps due to breach of the self dealing rules.

In such a scenario it is clear that to comply with Revenue practice it is not possible for a sole member to have any discretion as to how the scheme's resources are invested.

The Pensions Board has published very useful FAQs on the Regulations. They indicate that the borrowing restriction only applies from 23rd September 2005. The Regulations are silent on this point, although they are only effective from 23rd September 2005

For the reasons mentioned above many existing SSASs will not come within the definition of "one member arrangement". What is less clear is whether or not they are required to comply with the provisions of Article 7. It seems that it was not intended that they would. But the Regulations are inconsistent. How can they comply with Article 7 when being invested in a single geared asset class?

Many existing SSASs are incapable of coming within the definition of "one member arrangement" despite only having only ever had one active member.

Clearly the Regulations need to be changed to produce a more sensible outcome. Also, it is appropriate that transitional arrangements are permitted. One easy way to do this would be to enable schemes with less than 100 members that were established before 23rd September 2005 to remain unaffected.

It seems that the definition of one person arrangement needs to be changed to make it clear that an SSAS established after 23rd September 2005 will be exempt from the Regulations provided it is established for and in respect of one member who, subject to compliance with Revenue rules, is entitled to direct how the scheme's assets are invested. The inclusion of the words "and in respect of" should be enough to include a member's spouse and other dependants.

Until the Regulations are changed it is difficult to see how an SSAS could now be set up which complies with the current regime.

October 2005.

For further information please contact Fiona Thornton.