In this edition of our Insight, we provide you with a round-up of the latest Pensions Regulator developments, summarise recent financial market events surrounding the Bank of England's temporary gilts purchase intervention, and cover other key pensions developments including the cessation of the CMA Order and the PPF levy consultation.
The Pensions Regulator round-up
Publication of diversity and inclusion action plan
On 27 September 2022, the Pensions Regulator published the equality, diversity and inclusion action plan that it has produced in partnership with the Diversity and Inclusion Industry Working Group. This aims to improve diversity and inclusion on trustee boards and sets out how the Regulator will:
- collect and use diversity data to quantify success;
- set expectations in this area in the new single code of practice;
- publish guidance – the first edition of which is expected by the end of 2022 or early in 2023;
- continue its work with industry stakeholders on diversity and inclusion; and
- engage directly with trustees via supervision.
Trustees should be keeping up to date with developments in this area and considering relevant diversity and inclusion matters, in particular in relation to their composition, governance, and decision-making.
Expectations on mergers and acquisitions
The Regulator has also published a blog setting out its expectations on mergers and acquisitions that involve UK companies involved with a defined benefit pension scheme. Key points to note:
- Trustees should remain alert and follow the Regulator's protecting schemes from sponsoring employer distress guidance. They should also be 'robust in defending' members' interests and engage early on in the process.
- Employers and bidders must ensure fair and equitable treatment of the scheme and management must support trustees in having a strong funding plan. Communication is key – schemes must be treated as a primary creditor not an 'afterthought'. Scheme engagement must be early – employers should 'immediately alert' trustees about a proposed corporate transaction. Equitable treatment involves trustees having direct and early access to the bidder and advisers.
- Bidders should have a proper business plan that looks at the scheme and which does not move from being acceptable on 'day one' to less robust on 'day two'. There should be a legally binding agreement with the trustees put in place before completion with sufficient trustee board independence governance protections.
As an aside, we note that the Regulator has had more engagement in the previous year on M&A work than companies in distress, although distress may feature more heavily in the future given the current economic position.
The key message from the blog is that all three parties (employers, bidders and trustees) are responsible for protecting the scheme and that early effective engagement and sufficient protections are essential.
Updated guidance on climate reporting
The Regulator has updated its climate-related governance and reporting guidance to reflect the changes made by regulations which, as from 1 October 2022, will require schemes in scope of TCFD climate governance and reporting obligations to report on an additional 'Paris Agreement' portfolio alignment metric.
Updated guidance on value for members (DC)
The Regulator has also updated its value for DC scheme members guidance to add a section on the £100 flat fee threshold on active and deferred pots. This came into force on 6 April 2022 (see our Insight).
Prosecution of former trustees and professional adviser for alleged ERI breaches
The Regulator has confirmed that it will be prosecuting two former pension trustees of the Worthington Employee Pension Top Up Scheme and a professional adviser for alleged breaches of the employer-related investment provisions in respect of illegal loans made to the sponsoring employer group and investments connected with the employer amounting to £700,000.
Legislation prohibits both loans being made from a pension scheme to the employer and investments being made that exceed 5% of the value of scheme resources in land occupied or used by, or subject to a lease favouring, the employer. Breach is a criminal offence subject to an unlimited fine and/or imprisonment.
Financial markets update
Bank of England purchase of gilts: Following the recent financial markets turbulence that arose after the Chancellor's 23 September Growth Plan, the Bank of England (the Bank) announced on 28 September 2022 that it would commence a 'temporary and targeted' operation of buying long-dated UK Government bonds until 14 October 2022 in the secondary market to 'restore orderly market conditions' (see (1), (2), (3) and (4) for the relevant Bank announcements available as at the time of writing).
The Bank is prepared to purchase up to £5bn (extended to £10bn on 10 October) of gilts in each daily auction until 14 October and will continue to study patterns of demand. As of 10 October 2022, the Bank had bought £5bn out of the £40bn offered.
LDI: The Bank's potential £65bn intervention came following marked movements in gilt yields which had a significant impact on certain market sectors, in particular the Liability Driven Investment (LDI) funds of certain pension scheme portfolios.
LDI strategies are popular amongst defined benefit pension schemes as they are used to help make sure that asset values move in line with liability values (the closest match being long-term gilts) and to ease a transition to full funding. They utilise borrowing to increase long-term gilt exposure whilst at the same time having exposure to higher yielding but riskier assets to increase returns. There is a margin between asset and liability value that aims to soak up any gilt shortfalls. However, if losses exceed this margin the scheme may need to provide funds to 'rebalance' the margin. The recent gilt yields movements led to some LDI funds needing to rebalance meaning increased collateral calls (which if not met may necessitate gilt sales in an increasingly turbulent and illiquid market).
Bank's 5 October letter: The Bank wrote to the Treasury Committee on 5 October 2022, noting that without the Bank's intervention "a large number of pooled LDI funds would have been left with negative net asset value and would have faced shortfalls in collateral posted to banking counterparties. DB pension fund investments in those pooled LDI funds would be worth zero" and may have led to sales of large quantities of gilts with potentially "excessive and sudden tightening of financing conditions for the real economy". The Bank's intervention was designed to allow LDI funds to stabilise.
Further Bank measures: On 10 October 2022, the Bank announced further measures to assist the 14 October purchase end date. These include: (1) the possibility of increasing the daily auction size to make sure there is enough allowance for gilt purchases; (2) having a Temporary Expanded Collateral Repo Facility to allow banks to assist in resolving liquidity issues experienced by LDI funds including allowing acceptance of additional collateral; and (3) the ability to use Indexed Long Term Repo operations to assist further alleviation of LDI liquidity stress.
Just a day later, the Bank announced that it would be expanding its daily gilt purchase to include index-linked gilts between 11-14 October 2022. This additional measure is intended to "act as a further backstop to restore orderly market conditions" following "further significant repricing of UK Government debt" which could pose "a material risk to UK financial stability".
Beyond these measures, the Bank, the Pensions Regulator and the Financial Conduct Authority will continue to review LDI funds to consider how they can become better equipped to deal with future pressures.
WPC 4 October letter: Separately, in a 4 October 2022 letter, Stephen Timms MP, the chair of the Work and Pensions Committee, has asked the Regulator about the action it is taking to assess the risk to pension schemes and whether it thought that steps should have been taken earlier in respect of the recent LDI issues.
Action: Trustees, especially those of schemes with LDI strategies, should liaise with their advisers about the impact of recent market events on their schemes if they have not already done so.
Competition and Markets Authority announces end to obligations of pension scheme trustees under the CMA Order
The CMA has announced that the provisions of the Investment Consultancy and Fiduciary Market Investigation Order 2019 (the CMA Order) which required trustees to carry out a qualifying tender process for fiduciary management (FM) services and to set objectives for investment consultants (IC) have ceased to be in force. Its cessation follows the integration of the CMA Order requirements into pensions legislation with effect from 1 October 2022 (see our Insight).
The CMA introduced the Order in 2019 following its market investigation in 2017 which found features of both the IC and FM market impeded competition.
The CMA's announcement also confirms that compliance statements from trustees should be submitted to the Pensions Regulator (via the Scheme Return) whilst compliance statements from IC and FM providers should continue to be sent to the CMA.
PPF proposes reduction to PPF levy and consults on 2023/24 levy rules
On 29 September 2022, the Pension Protection Fund published both a Long-Term Funding Strategy review and a consultation for the calculation of the 2023/24 levy. The press release explains that:
The Long-Term Strategy review
- the PPF will have a revised funding objective and new priorities – because of investment performance, levy collection and reduced risk, the PPF is in a strong financial position (reserves of £11.7bn as at 31 March 2022) and can begin a 'maturing' phase of funding under which the PPF will move from building to maintaining financial resilience whereby reserves must give a high level of confidence as to meeting PPF compensation without reliance on investment returns and levy;
- current funding is close to meeting this financial resilience test;
- the PPF will have funding priorities that align with this new approach, it can reduce the levy as a result and in so doing change the way it is calculated;
- the consultation on the 2023/24 levy rules starts the process – the levy will be reduced and there will be some simplifications to the methodology (reduction of the sensitivity of the levy to insolvency risk changes and reducing the Levy Scaling Factor by 23% and Scheme-based Levy Multiplier by 10%);
- the PPF expects to collect £200m in the 2023/24 levy year – this compares to the 2022/23 levy year amount of £390m and, as a result, 'almost all schemes' will see a levy reduction.
See here for details of the documents that have also been published with adjustments to take account of the changes. The consultation closes at 5pm on 10 November 2022.
DWP consultation on DC investment regulation changes and statutory guidance
On 6 October 2022, the DWP published its consultation on broadening investment opportunities for DC schemes, draft regulations and draft statutory guidance. The consultation responds to the DWP's March 2022 consultation on performance fees and its proposals for increasing investment diversity and follows the announcement in the Chancellor's 23 September 2022 Growth Plan that 'well-designed' performance fees would be removed from the 0.75% DC default arrangement charge cap (see our Insight).
The draft regulations amend existing regulations to:
- require relevant DC schemes (default arrangements of occupational DC schemes) to disclose and explain their policy on illiquid investment through the statement of investment principles. The disclosure requirements will apply the first time that the SIP is revised after 1 October 2023 or by 1 October 2024 at the latest;
- require relevant DC schemes to disclose and explain their default asset allocation in the annual chair's statement, starting with the statement for the first scheme year ending after 1 October 2023. The statutory guidance relates to these asset allocation disclosure requirements;
- allow trustees to invest in arrangements that include 'well designed' performance fees, where they believe that this would be in members' interests. The regulations exempt those fees falling within a statutory definition from counting as 'charges' for the purposes of the charge cap. This change is expected to be introduced on 6 April 2023. The current regulatory provisions allowing smoothing of performance fees will be repealed with suitable transitionary measures as a result.
The consultation closes on 10 November 2022.