On 24 March, the Pensions Regulator (TPR) closed its consultation on the new draft Defined Benefit Funding Code of Practice (Draft Code). In our last blog on this topic, we discussed the key features of the Draft Code. In this blog, we explore some prominent themes in the industry reaction to the Draft Code and look ahead to what further changes (if any) TPR might make to the Draft Code before it is finalised.
TPR intends that the final DB funding code will come into force alongside the DWP’s finalised draft regulations on DB scheme funding (discussed in our blogs here and here), in October 2023.
To guide or to prescribe?
The Draft Code did not contain many surprises for those in the pensions industry. TPR has long signalled its regulatory direction of travel, but one area in which concerns were raised in the course of the consultation on the principles of the Code (back in 2020) was the extent to which TPR appeared to prescribe – rather than use principles to guide – the approach of different schemes to the new funding requirements. Throughout the Draft Code, TPR insists that it does not intend to move towards a mandatory objective funding standard, which is welcome. However, this does in places appear inconsistent with some parts of the guidance which are expressed as requirements. Some industry consultation responses suggest that focussing on a less rigid set of outcome-oriented funding principles, which could be sensitively applied to the specific situations of pension schemes across the DB ecosystem, would align more fully and effectively with TPR’s stated intentions.
Proportionality
Concerns around the role of proportionality in complying with the Draft Code also persist. TPR has said that trustees and employers of smaller schemes will be permitted to take a proportionate approach to compliance in many areas, but the administrative and governance demands of even a more stripped back journey plan could eat significantly into the assets of such schemes, increasing the cost and management time burden for scheme employers. Even if TPR’s enforcement approach is heavily informed by a proportionality assessment in practice, the Draft Code should provide clarity and stability for those involved in scheme funding who will need to rely on proportionality as to the expectations on them in complying with the guidance.
Encroaching on the employer?
Certain elements of the Draft Code emphasise the trustee’s role – as opposed to a scheme employer’s – more than might be expected. For example, the Draft Code engages with the issue of future DB accrual, suggesting that trustees could consider ending such accrual in certain circumstances where the security of accrued benefits may be in doubt. While trustees should engage with the employer on those concerns, continued accrual is an issue which would normally be for employers alone to determine in considering their employees.
Further, the Draft Code reflects the draft new funding regulations in stating that deficits should be recovered “as soon as the employer can reasonably afford”. In relation to this requirement, the Draft Code envisages employers determining whether any available cash could reasonably be used other than to make contributions to the scheme – known as “reasonable alternative uses”. The Draft Code includes a list of “reasonable alternative uses”, but there is scope for this list to be expanded. The list does not, for instance, refer to holding cash reserves. The list also has a fairly narrow understanding of “investment in sustainable growth” as using cash to finance investment in growth a business could maintain “without creating a heightened risk of running into difficulty”.
The Draft Code reflects the Pension Schemes Act 2021 requirement for a “statement of strategy”, recording the funding and investment strategy dealing with the planned funding “end game” over the long-term (and the journey plan to get there). That statement will require the agreement of the employer, if a scheme’s rules require funding matters to be agreed with the employer. Further clarity could be provided in the Draft Code in relation to how the investment aspects of the statement of strategy would interact with a trustee’s investment powers, which cannot be subject to employer agreement.
What’s next?
TPR will now consider the consultation responses and may make further changes to the Draft Code ahead of laying it before Parliament in Summer 2023. The content of the DWP’s draft regulations (mentioned above) has not yet been resolved, so the Code may need further revisions to address changes in the regulations.
If you would like to discuss any issues relating to the new scheme funding regime, the Pension Schemes Act 2021, or the defined benefit pensions “endgame” more generally, then please get in touch with your usual Freshfields contact or any of the authors.
