The Pensions Regulator (TPR) has published interim guidance on the regulatory framework it will apply to superfunds (also known as 'DB consolidators').
The guidance is intended to govern the operation of superfunds pending the introduction by the UK government of a comprehensive legislative framework for authorisation and supervision later this year, which will build on the results of the Department for Work and Pension’s (DWP's) consultation on the use of consolidators in 2018-19. This guidance is expected to give superfunds the green light to seek 'clearance' from TPR to implement their first transactions.
As other market commentary has noted, one of the more unexpected pensions outcomes of the COVID-19 crisis has been TPR’s ability to overcome the political hurdles that have held up this framework for the last year.
By way of introduction (or a recap), superfunds essentially involve removing the employer covenant and replacing it with the security of third-party capital (typically provided by institutional investors such specialist private equity funds). In most cases this will be alongside a material improvement in funding provided by the departing employer sponsor as a lump sum contribution.
Superfunds are not for every scheme - they are about trying to fill a gap within the defined-benefit pensions market where an insurance solution is not affordable for the scheme today or in the foreseeable future.
By way of illustration, we understand that the current providers in the market, The Pension SuperFund and ClaraPensions, aim to undercut insurance pricing by up to 10 to 15 per cent, depending on the profile of the scheme in question.
The guidance sets out TPR’s minimum standards that it expects superfunds to meet before writing business.
Very broadly, the key points for trustees and employers to note are as follows:
- TPR appears to be demonstrating a cautious but positive approach, with the focus on protecting members’ benefits and monitoring the risk of superfunds failing in this interim period. Crucially, TPR has been clear that nothing in its guidance will affect the ability of TPR to use its moral hazard powers.
- In regulating superfunds, TPR’s focus will be on protecting members’ benefits. Where the employer is supported by a capital buffer that meets TPR expectations, this buffer will be considered to be a proxy for the employer covenant and is key for securing member outcomes. TPR reserves the ability to use all its existing legislative powers to ensure that the governance of superfunds meet their expectations, including powers over trustee appointment and scheme funding.
- Before the launch of a new superfund, TPR will need to be satisfied that the superfund is capable of being supervised by the trustees, is run by fit and proper persons with effective governance in place, is financially stable and has adequate contingency plans in place, and has sufficient administrative systems in place for effective operation.
- Superfunds are expected to have robust risk-management practices in place, and a key area of governance will be the oversight of investments. All investments should comply with the eight principles set out by TPR in the guidance, including limits on illiquid assets and requirements for scheme asset management.
- TPR may ask superfunds for further details in relation to investment governance and the way decisions are made, including any incentive structures or performance-related fees. In particular, TPR has taken a cautious approach concerning any possible ‘management for profit’ motivation, which it sees as a unique risk for superfund structures; as a result, no surplus value should be extracted from the capital buffer or the scheme unless scheme benefits have been bought out in full. This is intended to align the incentives of those running the superfund with those of the members, and limit excessive risk-taking behaviours. This position will be reviewed within three years.
- TPR will pay particular attention to transfers both in and out of the pensions scheme. Employers are expected to apply for clearance for any transfer from their scheme to a superfund. This will be considered a new category of Type A event for the purpose of TPR’s clearance guidance, and clearance applications must be able to demonstrate trustee due diligence on the suitability of the superfund as method of securing the benefits.
- Superfunds will be expected to provide full and transparent details of their offering, funding and investment objectives to prospective ceding employers and trustees, and to engage with the TPR as soon as possible. They must also have robust business plans and strategies for dealing with intervention or winding up, and sufficient financial reserves to pay any costs incurred as a result of these events. Superfunds should not accept transfers from schemes that have the ability to buy-out (or are on a course to do so within the foreseeable future, such as the next five years), meaning they are not an alternative option for schemes already close to buy-out funding.
- Superfunds are also expected to have a baseline level of legal protection, in that triggers should be included in their legal arrangements for reports to be made to TPR when:
- The scheme assets fall below 100 per cent of minimum technical provisions (in which case the trustees will gain complete control over the scheme unless additional capital is injected).
- The superfund funding level dips below 105 per cent funding on the PPF funding level under s.179 of the Pensions Act 2004 (in which case it must wind-up, apart from in exceptional circumstances).
No doubt superfunds will continue to face some challenges going forward. They are untested and the regulatory environment for them will inevitably evolve, initially with the authorisation and supervision framework expected from the DWP and also with greater scrutiny from TPR over time as experience in the pensions industry shows. For trustees, deciding to enter a superfund is a balance between giving up an often long-standing employer relationship and the unproven superfund route.
These developments open up some exciting prospects for many pension scheme trustees and sponsors to secure member benefits within a foreseeable timeframe.
While it remains to be seen what type of take up rate there is among schemes we expect to know the direction of travel pretty soon now that the light has turned green.