Against the backdrop of a grey February morning, the long, hot, dry summer of 2022 with the added joys of digesting the first draft of the new funding and investment strategy regulations by the pool, seems like an eternity ago.
That draft prompted a flurry of activity across the pensions industry. We and many others expressed concerns that the proposals were not sufficiently clear and risked pushing schemes towards excessive levels of de-risking and a herding of strategies that would not necessarily be in the interests of members or the wider economy. Eighteen months of industry speculation followed, fueled in part by the Mansion House proposals last summer and DWP’s November announcement that the revised regulations “will make clearer what prudent funding plans look like, make explicit that there is headroom for more productive investment”.
With that packaging, excitement understandably built as I read the Government’s consultation response at the end of January, taking in the heady aroma of pronouncements that, in contrast to the draft, the final regulations provided more clarity and explicit recognition that schemes could take risk where appropriate. But as I peeled back the wrapping and delved into the regulations themselves, I couldn’t help feeling a bit deflated. That nagging feeling that a relative has just re-wrapped last year’s Christmas present and sent it back to you. Yes, there are a few changes, but fundamentally the structure is much the same as the first draft back in 2022, with many of the issues that we and others raised in our consultation responses not having been addressed fully or clearly.
“There are a few changes, but fundamentally the structure is much the same as the first draft back in 2022.”
At a high level, the requirements largely relate to the principles that need to be followed, or the factors that need to be taken into account, when determining a scheme’s funding and investment strategy along with what the strategy documentation needs to include. It is important to bear in mind that the new legislation does not prescribe how a scheme actually has to be invested or funded. Few, if any, in the industry that I have spoken with believe that this structure provides a huge amount of clarity, but some might argue that we’re a demanding bunch! The structure of the new legislation is, to say the least, pretty opaque and requires a fair amount of careful reading to pick apart. That creates the risk of trustees and sponsors reaching rather different interpretations, or reaching sub-optimal agreements if they haven’t appreciated some of the nuances in the drafting, and in particular the interaction between how a scheme’s strategy needs to be set and what needs to happen in practice.
Perhaps the biggest surprise in the revised draft is that the Government opted not to amend the ‘low dependency’ definition to provide greater flexibility, particularly given the importance they appear to attach to schemes being able to invest in productive finance assets. Indeed, the ‘flexibility’ trumpeted by the Government appears to stem simply from trustees not actually having to invest in line with their stated funding and investment strategy.
So, what are the main changes to the regulations since the first draft?
01
The calculation of a scheme’s maturity will now be based on economic conditions at 31 March 2023, rather than at the effective date of each actuarial valuation. This will give greater stability in the results of the liability duration calculation each time, but the implications of the change will depend critically on the figure that TPR deems to represent a scheme being ‘significantly mature’, which will be set out in the new funding Code (due to be released this summer).
02
It has been made clearer that the objective to invest in a ‘low dependency’ allocation applies only to assets up to the value of the liabilities on ‘low dependency funding basis’, and not to any surplus assets.
03
The requirement for a low dependency investment allocation to be ‘broadly cashflow matched’ has been dropped (although for us this was never a major concern; the bigger issue was the ‘highly resilient’ wording, which has been retained and is likely to remain in conflict with the levels of risk that the Pensions Regulator will be supportive of in the new funding Code).
04
The new requirement for any funding deficit to be paid off as quickly as the sponsor can reasonably afford has (arguably) been tempered by the introduction of a requirement for trustees to take into account the impact that the recovery plan will have on the sustainable growth of the sponsor. While this latter objective echoes a familiar provision elsewhere in the funding regime, it previously applied only to the Pensions Regulator in the context of it exercising its funding powers – this requirement has now been imposed at a trustee level for the first time.
05
There is now explicit recognition that future accrual can be taken into account for open schemes when determining the timeframe for expecting to reach significant maturity (although the previous draft didn’t preclude this, the explicit recognition is welcomed).
06
The list of factors to be taken into account when assessing the sponsor’s covenant is now less restrictive, but there is a new requirement for trustees to consider how long they can be ‘reasonably certain’ that the sponsor will be able to support the scheme.
So, despite my disappointment that we didn’t see more movement in the drafting, do I have any significant concerns about the regulations as they have landed? I think we are going to have to wait for the new Code of Practice on funding to be more definitive, but I’m currently hopeful that the new regime will provide sufficient flexibility for sponsors and trustees of the vast majority of schemes to continue to settle on funding and investment strategies that take account of each scheme’s unique circumstances. There will however be a new process to follow that will have to comply with the various requirements, which are going to need to be interpreted carefully to reduce the risk of any pitfalls. Clearer drafting would have made that a less tortuous task but we are where we are!
Leaving aside the technicalities and any concerns over how the requirements might be interpreted, the changes will hopefully reinforce the importance of trustees and sponsors pausing to think again about where they are trying to get to, and implementing a holistic strategy through their actuarial valuations to support these ambitions that leads to the best chance of delivering on all stakeholders’ goals.
