The industry has responded to the draft funding code of practice for defined benefit (DB) pension schemes released today by The Pensions Regulator (TPR) along with a consultation paper.
The consultation will last for 14 weeks and outlines expectations for programmes to establish a long-term goal and a route to get there.
The code will replace the current code, established in 2014, and provide trustees, sponsoring businesses, and their advisors with guidance in managing their pension plans.
The current schedule for the final regulation and code to go into effect is October 2023.
TPR executive director of regulatory policy, advice and analysis David Fairs says: “In line with DWP’s draft regulations, our draft code is clear that all DB schemes should have the necessary long-term funding approach to ensure savers have the best chance of receiving the benefits they expect.
“We want to provide schemes with the continued flexibility around funding to suit their circumstances while requiring trustees to think carefully about risk management to improve security for their members.
“We have worked hard to ensure the draft code’s principles reflect the 127 responses we received to our first consultation on the code, the clarity we now have on the draft regulations, and our modelling and analysis. The code sets out our expectations in relation to how trustees should comply with legislative requirements. I urge trustees and their advisers to read our consultation and respond.”
PLSA head of DB, LGPS and investment Tiffany Tsang says: “We are pleased that the draft allows for the flexibility the PLSA called for in determining technical provisions for schemes open to new entrants. Overall, we support TPR’s move away from using Fast Track as a benchmark and that TPR has signalled clearly that many Bespoke valuation submissions will not result in detailed scrutiny or engagement. We note that recovery plans based on affordability will be a core focus for the regulator if schemes fall within Fast Track in all other ways.
“While we support ongoing dialogue between trustees and employers in developing funding and investment strategy, we remain concerned that the draft code shifts the fundamental ways in which strategy negotiations currently operate. The proposals may give disproportionate weight to employers’ preferences, which may not be aligned with trustees’ objectives, particularly in the current economic climate. We agree that the use of LDI should be wrapped into considerations of supportable risks that would naturally be laid out in journey plans; the drafted expectations around when and how to use LDI are reasonable.
“However, further assessment of the proposals is needed before drawing firm conclusions so we will work closely with our membership and TPR in the coming months to determine the on-the-ground impact of the detail that is now provided – on open schemes, for Bespoke approaches, and for multi-employer schemes in particular. The Code will also need to completely fill in the gaps that the draft scheme funding regulations left open for interpretation.”
Isio head of research and development Iain McLellan says: “TPR’s draft DB funding code will introduce more detailed requirements for trustees and sponsors of DB pensions schemes to address, signalling a move from a more principle-based approach to a more mechanistic one. As such, it feels more like a Haynes manual than a Highway code.
“The flexibility in the Code will be welcomed, but it begs the question of why we need so much detailed regulation if it will have such little impact. This seems to run counter to the general thrust of the Government’s de-regulation agenda and Hunt’s commitment to delivering ‘agile and proportionate’ regulation as part of the Edinburgh Reforms. It is unclear why the noose is tightening on DB schemes whilst insurers for example get more flexibility. It also ignores the changing landscape from when the Green papers that kicked off these reforms were published in 2017.
“Most pension schemes have never been better funded, the PPF is running a huge surplus and most schemes are within 10 years of being able to buyout. Looking at the complex draft funding code in this light doesn’t feel proportionate and it now reads like a solution looking for a problem.
“The rules should be more targeted and directed at poorly-run schemes, so that well-run schemes can get on with securing members’ benefits without distraction by more well-meaning but inconsequential regulation.”
PMI director of policy and external affairs Tim Middleton says: “We are greatly encouraged that the new Funding Code addresses the key issues affecting the UK’s remaining Defined Benefit Schemes. Trustees now have clear guidance concerning the development of a route to full funding which fully recognises the importance of the employer covenant in achieving independence. The clarity of guidance will greatly encourage trustees as they manage a complicated task in a time of particularly volatile economic conditions.”
WTW head of trustee consulting Adam Boyes says: “This is a welcome improvement on the Regulator’s original proposals from March 2020. Although some formulaic elements remain, the level of prescription has been pared back. The Fast Track route to compliance has been relegated from being part of the Code itself to a filter for regulatory attention. Hopefully, for most well-managed schemes, the finished product will be more ‘evolution’ than ‘regime change’.
“In many cases, a principal departure from existing practice will be the requirement to set out how a scheme’s investment strategy will change as it moves along its journey plan, which will in turn constrain the funding agreements that employers and trustees can reach.
“In the consultation document, the Regulator suggests that the ‘outer edge of compliance’ could involve a scheme having up to 30 per cent of its investments in growth assets at the point when it is supposed to have reached ‘low dependency’ on the sponsoring employer – though the draft Code itself gives 15 per cent as an example of a satisfactory approach. If the regulations can indeed be read this broadly, it would imply quite a lot of flexibility around how schemes are ultimately run off.
“After originally indicating that a draft Code of Practice would have to wait until regulations are finalised, the Regulator has issued this at a time when one of the key components of the regulations – the way in which a scheme’s maturity is measured – is still being debated; it believes that going any slower would prevent the Code being in force in time to catch valuations with effective dates at the end of 2023. As the Regulator’s analysis makes clear, recent market movements have made an enormous difference to schemes’ durations, and therefore to how close they would have to be to their low dependency target under the regulatory approach proposed. This is not consistent with schemes making steady progress towards a target they have agreed to reach by a fixed date. The Regulator’s hands are tied by the need to make the Code consistent with the regulations, but the final Code could be meaningfully different from this draft if the Department for Work and Pensions has a change of heart.”
Barnett Waddingham partner Paul Houghton says: “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.”
