However, we are deeply concerned by three things in particular:
• That the draft regulations sacrifice scheme-specific flexibility, over-stepping into areas that should sit in the Regulator’s Code of Practice.
• That what a business can afford to pay to its pension schemes would be prioritised over how a business needs to invest to grow.
• The narrowness of the envisaged target investment strategies leaves no room for economically efficient investing and will supercharge systemic risks.
“As drafted, the regulations go much further than what has been put forward in TPR’s 2020 consultation on DB funding. They also go far beyond the conclusions of the government’s Green and White papers. The narrow and prescriptive approach is simply not fit for purpose across an industry with such a wide spectrum of circumstances.
“The consequences of overly prescriptive regulation will be far reaching and detrimental to businesses, scheme members and economic growth. The amplification of systemic risks currently being witnessed in gilt markets has potentially dire consequences that will spill beyond pensions and into debt, mortgage and foreign exchange markets.
“A better outcome would be to redraft the regulations to remain broad and coherent with the current scheme-specific funding regime. TPR should be empowered to regulate through the ‘Fast Track and Bespoke’ model it has been warming the pensions industry to for the last two years. This would also make it easier for the industry and regulators to keep pace with the ever-changing financial and political climate.”
Hymans Robertson notes the following specific points in response to the consultation:
• The industry had been anticipating that the new funding regime would be flexible enough to take account of the circumstances of individual pension schemes. Some flexibility is essential, especially for schemes with greater long term covenant visibility and/or contingent support in place. However, this does not appear to be evident in the proposed legislation. Instead, there seems to be little scope for a scheme to be able to rely (to any extent) on ongoing employer support once it has reached significant maturity, even if the strength of the employer covenant and/or contingent assets would support it.
• The government’s 2018 findings showed that the current regime was working well for the majority of schemes. Therefore, while there is a balance between the Pensions Regulator being able to regulate the minority more firmly, the new requirements risk unduly constraining schemes that are acting reasonably. The consultation makes no attempt to assess the financial consequences of the proposed changes in terms of contribution calls to business. In many cases these will be substantial.
• It is concerning that within the proposals there are examples where the changes would not appear to achieve the intended risk reduction. For those with weaker covenants, the effect of being forced to de-risk too quickly could be to ‘lock-in’ a deficit with the sponsoring employer being asked for unaffordable pension contributions. Similarly, schemes that are already at or, close to significant maturity when the new regime is implemented could be forced to immediately de-risk and pay significant contributions to hit a much higher low-dependency funding target. It is not clear what will happen to schemes that cannot reach a low dependency funding level by significant maturity, nor whether there will be any transitional arrangements. This ‘heads we win, tails you lose’ attitude need reconsidering.
• On low dependency asset allocation, the Regulations go in to too much detail in dictating to pension trustees how their assets should be invested. Encouraging all schemes to have the same investment strategy and herding them into certain asset classes, will push up the cost of those assets and will exacerbate systemic risks. Recent weeks have highlighted the systemic consequences of pension schemes being regulated towards buying gilts. Legislating schemes to effectively buy gilts will make the situation worse still.
• The regulations fail to address the requirement for trustees to agree the funding and investment strategy with the employer, in combination with trustee’s general unfettered power over investment strategy, this too needs reconsidering.
• Sponsor affordability should remain one of the factors for trustees to consider when agreeing contributions, but should not sit above all other factors. Requiring deficits to always be recovered as quickly as possible will add costs to sponsors, lead to sub-optimal investment strategies and make UK businesses less competitive. It will also increase the risk of ‘trapped surpluses’. It is a glaring oversight that the impact assessment does not consider what the impact is on employer contributions.
• There must be more flexibility for open schemes, otherwise these regulations will kill off defined benefit accrual in the few places it remains. We are encouraged by the intention for open schemes to have more investment flexibility than closed schemes, but the new governance requirements are disproportionate. Mapping out a journey to a significant maturity destination that an open scheme has no intention of reaching makes little sense. It will be a self-fulfilling tragedy if open schemes are legislated as closed schemes in waiting.
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