Paul Houghton, Partner at Barnett Waddingham, said; “Many DB schemes are already well-positioned to comply with the draft Code, having taken steps to incorporate the Regulator’s key messages in recent years. However, a lingering lack of flexibility in the overall regime is concerning and may lead to increased costs for sponsors and hinder innovation in the market.
“The core principle underpinning the new funding requirements is that maturing schemes should have long-term funding and investment strategies that are suitably low risk. This is a sound approach to risk management and is already adopted by most DB pension schemes. However, the DWP’s draft funding regulations – on which the draft Code is based – are too prescriptive in setting out how schemes must comply with this requirement. TPR’s draft Code provides welcome clarity on their interpretation of these regulations, and alleviates these concerns to some extent, but it remains to be seen whether the final regulations, and therefore TPR’s code, will ultimately be adapted to give DB schemes and sponsors appropriate flexibility whilst still ensuring the security of members’ benefits.
“This lack of flexibility could lead to significant additional cost for some sponsors if schemes are forced to adopt a ‘low dependency’ investment strategy in all circumstances once they are ‘significantly mature’. Recent market volatility has exacerbated the issue, with the timescales for schemes to reach a low-dependency position being materially reduced. TPR has recognised this and is consulting on potential ways to address the issue, but the rigidity of the new regime – and in particular if the final form of the legislation continues to specify duration as the measure of a scheme’s maturity - means that even well-funded schemes could see their investment approach and ability to adapt to changing economic circumstances hampered.
“Therefore, further consideration of the impact of the proposed changes is required. Today’s published analysis by the Regulator is (as TPR acknowledges) already out of date, being based on market conditions on 31 March 2021 that are very different from today. Perhaps, given all of the changes in financial markets, and wider, since the original consultation in March 2020, the consistency in the approach long signalled by TPR is remarkable. Hopefully this is a sign of a robust framework, rather than intransigence. Our own analysis suggests that recent changes in economic conditions mean that 1 in 6 schemes could find they have to unexpectedly and swiftly reduce investment risk to comply with the new requirements. Such issues could be addressed by introducing more flexibility and by incorporating a transitional period into regulations to allow schemes more time to adjust to recent events.
“Nevertheless, there are a number of welcome changes in the draft Code compared with the Regulator’s initial approach as set out in its March 2020 consultation. For example, keeping the Fast-Track regulatory approach outside of the Code itself is a sensible move that will give the regulator the ability to swiftly react to changing market conditions. And the proposal to make Fast Track covenant-independent is a helpful simplification. Trustees will still however need to continue being mindful of the importance of sponsor covenant in all decision-making.
“The additional leeway for open schemes is another positive development, although there remains a danger that open schemes are being shoehorned into a funding regime designed for closed schemes.”
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