Regulating Defined Benefit pension schemes Buck Consultants response to consultation by the Pensions Regulator February 2014
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Overview We are pleased to have this opportunity to comment on the Regulator s draft new approach to regulating defined benefit schemes, learning from the experience of the past eight years, and adapting to incorporate consideration of the new statutory objective. The latter in particular will require a change of approach to accommodate a shift in balance in favour of employers future business interests. This requires a corresponding change to the requirements on trustees to ensure that members interests continue to be adequately protected. Similarly, to ensure that the Pension Protection Fund is not exposed to significant additional risk as a result of giving sponsoring employers potentially more leeway over the extent and pace of their funding commitments. We recognise that this is a difficult balance for the Regulator to maintain, and as advisers both to trustees and employers of a number of schemes, support its efforts to achieve an equitable result. Overall we consider that the draft policy reflected in the draft documents makes a good start (although the documents themselves are rather longer than they need to be and taken together are somewhat repetitive, which will make the task of trustees in particular more difficult than it needs to be in trying to establish a practical approach). However, there are a couple of areas where we consider that the policy s requirements do not provide a sufficiently practical framework for schemes to follow. These relate specifically to schemes of a UK employer within a global corporate entity, and to smaller schemes. Schemes of a UK employer within a global entity The new policy seeks to increase the understanding and involvement of the trustees in the current financial position and future business strategy of the sponsoring employer. In a number of places it requires trustees to enter into a dialogue with the sponsoring employer, based upon information which the trustees should request and the employer should freely provide. That approach is both reasonable and desirable in theory and will generally work in practice in the context of a single or small UK group business entity. However, in practice many sponsoring employers who are businesses within a global entity (and many of whom are relatively small and/or have little overall influence in respect of the global business) are in a very different relationship with those responsible for determining the direction of the overall business. The direction and resourcing of the global level entity expose the businesses in individual countries to changes according to a number of frequently-changing business and economic criteria. It is not always clear to the managers of a group business in a particular country what their business objectives beyond the very short term are at any time. They often do not have sufficient knowledge of the global position (including that of group businesses in other countries) to be able to satisfy their duties to their defined benefit workplace pension scheme in the UK and to the trustees. This presents a practical problem for the trustees of those UK schemes, who with the best will in the world are unlikely to be able to obtain sufficient information to satisfy their new duties as proposed under the new regulatory regime. There is the other possibility that the information required to make an assessment of the covenant of an overseas entity would be of such detail and complexity that it would require substantial interpretation Buck Consultants response to tpr consultation 2
of which the cost would be out of proportion to the size of the scheme, Consequently these requirements should be reviewed in the light of the practical difficulties faced by these trustees. Nevertheless, we recognise the need for funding plans to be robust and where they incorporate allowance to minimise any adverse impact on the sustainable growth of an employer, are based upon an accurate assessment of the true position of that employer. That of course in turn raises a more fundamental question in respect of the wording of the new statutory duty itself, of whether focusing upon the employer responsible for the scheme provides the expected level of protection for the scheme. In the situation of a large global group whose parent is located outside of the UK and where its UK subsidiary is a relatively minor part of the group, arguably the more important entity to be considering is the global level entity. It could also be argued that if the trustees and the Regulator cannot get sufficient information from the global entity to justify a more benign funding approach that the trustees will have to push for a stronger funding outcome to compensate. If the Guidance made some explicit reference to this approach it might facilitate the information gathering. As an aside, the Regulator uses information within the consultation and the supporting documents to demonstrate that the strength of the technical provisions (and investment risk) does not seem to vary with strength of covenant. There is a strong possibility that this result is due to the impact of employers with a global entity because of the difficulty of UK managers and the trustees having a common approach to the assessment of the covenant. Approach to smaller schemes The second issue is in respect of smaller schemes. We appreciate the Regulator s need to focus its limited resources on areas that will provide the greatest return in respect of effective regulatory coverage. We recognise the statistics that show the proportion of total DB workplace scheme membership that resides in larger schemes. We understand therefore the policy to focus regulatory attention on the larger schemes. However, there are difficulties caused by this approach. We believe that many of the larger schemes are already subject to what can be an onerous regulatory burden from the Regulator, as they are habitually the schemes targeted by the Regulator. The administration this requires and the attendant costs, are regarded by many as a disproportionate and unfair burden upon the larger schemes. There is also a potential flaw in the logic, expressed in the consultation documents, that the lessons learned from looking at the larger schemes give useful insight into what is likely to be happening in the smaller ones, and so regulatory policy for those can be tailored accordingly. In fact, the larger schemes are likely to have larger budgets and more effective systems and processes than many of the smaller ones. Consequently the challenges faced by the larger schemes, and their responses to those, are not necessarily a good guide to those in respect of the smaller schemes. Finally, we question whether making a public statement that the regulatory focus will be so heavily biased towards larger schemes provides encouragement to those smaller schemes - in particular, those that are so inclined not to be as conscientious in their adherence to the funding process as they would be if they thought they could be reviewed by the Regulator on a random basis. Whilst any severe issues should be 3 Buck Consultants response to tpr consultation
picked up under the whistleblowing regime, it would be preferable for the schemes to be run properly in the first place; in some cases it is also conceivable that a scheme could stay under the radar completely while still operating in an unacceptable manner. There is also a danger that the Regulator is seen to be favouring its mandate to protect the Pension Protection Fund at the expense of the individual member of a smaller scheme. It would not seem unreasonable to have a similar probability of loss of pension benefits across all pension schemes. We therefore suggest that the regulatory focus should be more evenly spread across the size range. A useful approach for the smaller schemes would be for the Regulator to produce some advice and guidance specifically focused on the situation of the smaller schemes. This would take into account the particular challenges they face, and aimed at helping them meet the regulatory requirements. Such an approach would help in steering the discussions between the trustees and the employer towards achieving a balanced funding outcome. Buck Consultants response to tpr consultation 4
Comments on specific draft documents Defined benefit regulatory strategy We recognise that the Regulator has limited resources, and it is desirable also for it to have a consistent approach across schemes with genuinely similar characteristics; these two factors support the high-level strategy of segmenting schemes for regulatory attention. However, we are concerned that such an approach, if not particularly sophisticated, could lead to schemes that fall into a particular segment by virtue of having particular characteristics, being forced into adopting particular strategies simply because of their membership of that segment, rather than because the strategy is appropriate to them. An example, would be two closed schemes being in the same segment and both being pushed towards buy-out as this was seen as the appropriate strategy for this segment, even though one scheme may be perfectly capable of continuing in place supported by the sponsoring employer. Defined benefit funding policy We welcome the new statutory objective and the resultant rebalancing of the interests of the scheme and of the sponsor(s). We have two points on this: We believe that part of a programme of sustainable growth for an employer can be the holding of an appropriate amount of cash within the business, and so that should be capable of being classified as an investment within the terms of the statutory objective; consequently it would be helpful to have the Regulator s confirmation in this document that trustees are not required to regard cash held in the sponsor s business as necessarily assets that should be transferred to the scheme. Where the employer directly sponsoring the scheme is part of a larger group, consideration under the statutory objective should include the position of the group, and not only that of the sponsor; it would be helpful to see that clearly acknowledged in the document. Paragraph 25 states that as part of its risk assessment approach the Regulator only considers the covenant of those employers with legal obligations to the scheme. However, the complexity of global corporations can mean that the covenant of other, especially overseas, companies within a group can also be relevant to the covenant assessment, and so the Regulator s approach should allow for that in appropriate cases. Covenant segmentation. We appreciate the value of segmentation by covenant strength, but we are not clear how the Regulator makes its assessment as to which box a scheme fits into. It would be helpful for schemes to be able to anticipate which box the Regulator is likely to put them into and to note that when the valuation is 5 Buck Consultants response to tpr consultation
submitted to the Regulator, which would then make the valuation process more efficient. In view of the importance of the balanced funding outcome to the process, we consider it would be particularly helpful to see the BFO indicator and to understand how it works to assess a particular scheme; please can an example be published. Similarly, we are unclear as to what a risk bar would look like and again an example would be helpful. Paragraph 87 in Appendix A refers to the use of a number of metrics relating to employers as part of the process of assessing covenant strength. It would be useful guidance for trustees and their advisers if those metrics used by the Regulator were published. We would question the ability of the Regulator in practice to obtain accurate and meaningful information under all the bulleted points set out in paragraph 89 in the case of overseas parent companies in particular; without that accurate information the UK schemes within the group cannot be accurately assessed under the present risk assessment process. In Appendix E on late valuations there appear to be conflicting messages arising from the attempt to strike a balance between getting the best deal for the scheme and completing the valuation within the specified 15 month timeframe. One of the main thrusts of the funding guidance is for trustees to get the best deal. The wording in Appendix A seems to be suggesting something more like achieve the best deal possible within the 15 month deadline which could lead to very different outcomes. Some clarification here would be welcome. Code of practice As a general observation this document, as a code addressed to trustees, concentrates on the trustees behaviours in a valuation process. Paragraphs 63 to 66 address how the trustees should engage with the employer in this process, but there is no corresponding advice to employers as to how they should engage with the trustees. We believe it would lead to better collaboration and so to better overall outcomes if there was guidance to help the employer to structure its approach to negotiations on the valuation in a way that is more in line with that required under the code from trustees. Paragraph 51 quite reasonably draws parallels between the position of trustees and that of other groups and organisations that find themselves in a position of being creditors and suggests that consideration of banks mitigation techniques against counterparty risk might be instructive. Given the fate of many banks during the recent economic downturn, this might be a useful place to reinforce the message that mitigation techniques should be assessed effectively and that risk can never be entirely eradicated so proportionality is always an appropriate consideration. Paragraph 76 makes a clear, albeit brief, statement about not accounting for the fallback position of PPF compensation. Whilst we fully understand the reason for this line being taken which is strongly expressed, this is a rather bald statement of the strict technical position. It does not necessarily recognise the practicalities involved in the funding process. In reality it has become common (and anecdotally supported by the Regulator) for trustees to consider PPF drift when appropriate in analysing recovery plans and funding solutions. It would be helpful therefore if this paragraph in the code were to be expanded to address PPF entry specifically and also to provide more guidance on how trustees should consider the results of a s179 valuation. Buck Consultants response to tpr consultation 6
The draft code makes sensible statements in paragraphs 101 to 105 around the important issue of trustees contingency planning, and for a large scheme with significant resources it is wholly appropriate that this is undertaken extensively and robustly, with an appropriate allocation of resource. However, as the draft code also sensibly acknowledges, this is an area where the approach should be proportionate, depending upon the size of the scheme and the resources available to it. For many small schemes resourcing restrictions mean that in practice their contingency plans will be little more than request more contributions from the employer, even though they may wish that they could do more. We recognise and support the principlesbased regulatory approach adopted by the Regulator, and would not want to see the Regulator prescribing standard approaches to be used. Nevertheless, given the importance of this issue it would be helpful to have more guidance on how to approach formulating a plan, perhaps with an indication of the relative weighting that the Regulator would assign to various options, to enable trustees and sponsors to formulate a proportionate plan in circumstances where available resources are severely restricted. Such guidance might usefully include an example plan by way of demonstrating what the Regulator might be looking for. The use of solvency information as described in paragraph 148 is indeed useful. In our experience solvency information is often held by consultants, garnered from other recent buy-out quotations that they have received, and this is often also used to assist consideration of the adequacy of the technical provisions. It might be useful to draw attention to this possible additional source of information in the code. The process referred to in paragraphs 170/171 will be a protracted one and as such is an ideal situation. Once again the extent to which this is achievable in practice will be dependent upon the size of the scheme and of the sponsor, and the availability of resources. Arguably in the case of a small employer/scheme combination the closeness of the parties will allow a more informal approach to be followed, but this does appear to be a section where the need for a proportionate approach should be emphasised. 7 Buck Consultants response to tpr consultation
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