DB regulation – changes at the wrong time?

A lot has happened since the Pensions Regulator released its consultation on a new Funding Code on 3 March.

And it feels like unfortunate timing on the Regulator’s part - a step change is being proposed in the DB funding world at the same time as the political pendulum may well be swinging in the opposite direction. There is now likely to be much greater emphasis on supporting employers in an unprecedented time of global impacts being felt from Covid-19, a point recognised by the Regulator in its recent guidance for DB scheme trustees whose sponsoring employers are in corporate distress.

The Regulator’s proposed changes to the funding code have been well trailed over an extended period of time, though it’s worth remembering how radically different the proposed scheme funding regime would be. Fundamental to this shift is the change in the balance of powers between the Regulator on the one hand and pension scheme trustees and sponsors on the other. In our current DB funding world, the Regulator has to show that a scheme’s approach to funding does not meet the necessary requirements. This is difficult in practice to achieve and can take years to prove. However, under the new system, the Regulator will set out clear boundaries of what meets the requirements, as set out in the Fast Track approach. And notably, it shifts the onus of proof on to schemes – that is, it will be for schemes to demonstrate that, where they have not followed the Fast Track approach, this is justified by scheme-specific factors.

A triple blow for schemes

But looking at this through a Covid-19 lens, many scheme sponsors will be hard hit by the current crisis, with knock-on effects on affordability. Combining this with the impact of financial markets on scheme funding, especially for those who aren’t well hedged or who hold material return-seeking assets, this could be a triple blow of larger deficits, lower affordability and a higher regulatory hurdle.

Even before Covid-19 took hold, it seemed the Regulator would need to manage a delicate balancing act of where to draw the lines in the sand in relation to the Fast Track option (with the consultation document still leaving a wide scope on this). The higher the bar, the more security the Regulator creates in the world of DB funding. But too high a bar results in more schemes needing to take the “Bespoke approach” (for example, because the Fast Track deficit recovery period is considered unaffordable), requiring greater Regulator resources in order to get them approved.

Will Covid-19 affect where the Regulator sets the bar?

The economic effects of Covid-19 are likely to be at the front of people’s minds when the consultation responses are being submitted (which it has been hinted may now be later than originally planned). However, it seems difficult to imagine the Regulator reducing its overall focus on long-term funding and security of DB benefits, even if shorter-term affordability is adversely affected.

Many trustees already have long-term objectives in place, and for these schemes a key question will be around exactly where the Fast Track bar is set.  For some schemes, Covid-19 might mean that long-term goals seem even further away, but having an appropriate long-term plan in place will help add clarity on how to achieve those goals.

In the meantime, trustees have more pressing matters to deal with, like ensuring their pension scheme can continue its business-as-usual activities, such as paying benefits – we shouldn’t take anything for granted right now.

Sally Minchella, Director, LawDeb Pension Trustees 

www.lawdebenture.com/our-people-and-locations/member/sally-minchella