On 29 April, the Pensions Regulator (TPR) published its 2022 Annual Funding Statement, which confirmed that 2022 is likely to be a year of significant developments for the scheme funding requirements for defined benefit (DB) pension schemes. In particular:
- late this Spring, the Department of Work and Pensions (DWP) is expected to release a consultation on new draft funding and investment regulations (the Draft Regulations); and
- late this Summer, TPR is scheduled to launch a consultation on a new draft DB Funding Code (the New Code).
These consultations will provide many in the industry with a first opportunity to assess the real scale and scope of the major changes coming to scheme funding. Ahead of these consultations, we’re taking a look at what we know so far, and what we can expect in the coming year.
The story so far
The Pension Schemes Act 2021 (PSA 2021) will introduce a new obligation for trustees to develop a legally binding funding and investment strategy (FIS). The FIS must specify: (i) a funding level that the trustee intends the scheme to have by a certain date (the long-term funding target or LTFT); and (ii) the investments that the trustee intends the scheme to hold as at a certain date. The Draft Regulations will provide much of the detail on how these FIS obligations are to be interpreted and satisfied in practice.
In March 2020 TPR consulted on the principles that should underpin the New Code. TPR’s proposals sought to align its own regulatory approach with the current legislative focus on securing long-term scheme sustainability. TPR proposed a new ‘twin track’ supervisory structure, made up of: (i) an off-the-shelf ‘Fast Track’ approach with reduced regulatory scrutiny for (better-funded) schemes which meet certain qualifying criteria; and (ii) a more flexible ‘Bespoke’ approach with greater regulatory involvement, for schemes which do not meet the above criteria, or want to employ more risky investment strategies.
TPR also proposed that all schemes should have a ‘long-term objective’ (LTO) to guide progress towards the LTFT. The LTO is likely to be defined under the New Code (and defined more tightly for ‘Fast Track’ schemes than ‘Bespoke’ schemes), unlike the LTFT which will be set more flexibly by reference to a specific scheme. TPR suggested that the LTO might be broadly defined as: by the time a scheme becomes significantly mature, its investments should be highly resilient to risk and it should have a low level of reliance on the employer.
What can we expect from the Draft Regulations?
For many schemes, the new FIS requirement may not carry a huge practical burden. It has been increasingly common practice in recent years for trustees to set out a non-binding ‘journey plan’ for how they intend to secure the long-term health of the scheme. On a practical level, the FIS appears to simply make this type of long-term planning mandatory.
The Draft Regulations, however, will need to structure how the FIS will operate, and that provokes all sorts of complications. For example, the current regime restricts the scheme employer from taking an active role in designing a scheme’s investment strategy, whereas the PSA 2021 appears to require that the trustee agree the FIS with the employer. This may tilt the balance of powers towards the employer and it potentially opens up a whole range of knotty questions which the DWP will have to grapple with:
- If employers need to consent to the FIS, would they push for a riskier investment strategies?
- Would employers be subject to shareholder pressure in the development of a FIS?
- Could employers be subject to an ESG duty which would affect how they negotiate the FIS?
We are intrigued to see whether (and if so, how) the DWP approaches such delicate issues in the Draft Regulations.
Beyond the immediate practical implications, the broader shift in approach that the Draft Regulations will map out is very significant. In the 2022 Annual Funding Statement, TPR indicated that schemes that are in deficit should focus on reaching a full funding position on a technical provisions basis, but added that where schemes have already reached that level they should “remain focused” on their LTFT “and their journey towards it”.
What can we expect from the New Code?
The industry response to TPR’s March 2020 proposals was cool, and particular concerns were raised over the bifurcated approach to TPR’s supervisory role. The wider environment has also changed significantly since then, not least because of the COVID-19 pandemic and the war in Ukraine.
Late this summer should see the release of the draft text of the New Code. To a large extent, the content of the New Code is likely to depend on the detail of, and consultation response to, the Draft Regulations; TPR has stated that it intends to “learn from” the DWP’s consultation.
Additionally, TPR’s executive director of regulatory policy, analysis and advice, recently indicated that TPR’s thinking around the New Code has “evolved a lot” since its March 2020 consultation. Key issues are still likely to include whether (and if so how) the twin-track regulatory approach is retained and refined, and how the LTO is defined in the New Code.
We will issue a further update once the Draft Regulations have been published. If you would like to discuss any of the issues discussed in this blog post, please get in touch with your usual Freshfields contact or any of the authors.