Brexit and Pension Schemes A guide for employers and trustees
Action now and watching brief for future A guide to how we can help you The effect of the EU referendum vote has already made itself felt on pension scheme investments, the valuation of scheme liabilities and on the ability of some employers to continue to support their scheme. This guide looks at what has already changed, and what may happen in the future. We focus on what steps employers and trustees should be taking now, and what they should be looking out for going forward. Our credentials We are a market-leading team specialising in advising employers, trustees and providers on pensions law. We have a wealth of experience and know-how in relation to a large variety of pension schemes. We are assisted by our specialists working in other fields, such as public law, EU law and financial services regulation. We offer a dedicated service to clients affected by the Brexit vote. Summary of action points There are already a number of action points for trustees and employers: Scheme employers and trustees should consider telling members that they are monitoring the impact of Brexit on the pension scheme Trustees should review, in consultation with the employer, their integrated risk management strategy, which may result in a revised statement of investment principles, an employer covenant review and a review of any contingent asset arrangements Trustees should review DC default fund strategies, and remind DC members periodically to review their investment options Trustees should consider counterparty default risk and collateral arrangements on derivative and swap contracts Trustees should consider reviewing discount rates, transfer assumptions and commutation factors (especially if a trivial commutation or pension increase exchange is envisaged) 02
Pinsent Masons Brexit and Pension Schemes Immediate impact of Brexit on investments Pension scheme investments have already been affected by the Brexit vote. This has not necessarily been negative. The fall in the pound has resulted in an immediate increase in the sterling value of overseas assets. The impact on funding levels has varied widely across DB schemes, depending on the investment portfolio and the level of hedging. Reduced gilt yields inflate liabilities, increasing deficits for DB schemes that had not hedged against the yield reduction. Trustees need to check whether any legal triggers might come into play. For example, the downgrading of UK gilts by ratings agencies could bring them outside pre-agreed investment guidelines. If the credit rating of a counterparty to a derivative agreement deteriorates, termination of the agreement could be triggered. Credit downgrades could make it more difficult to post collateral and require more cash to be held. An investment strategy may include automatic switching to gilts if investments fall below a certain level. Awareness of all these potential triggers is key. Trustees need to be prepared to take action or, following due consideration, refrain from action once a trigger has kicked in. DB schemes employer covenant Trustees and employers should discuss together the potential impact of Brexit on the employer s ability to fund the scheme. Trustees will be particularly keen on this discussion if the employer exports goods or services to the EU, or may be considering relocating some of its business to the EU. Trustees should also look at any contingent assets in place and consider whether they can be relied on to the same extent as originally anticipated. Check for legal triggers We can help trustees to review their collateral arrangements and to understand the impact of further credit downgrades We can help trustees put in place information sharing protocols with employers 03
For sector specific updates and further insights see www.out-law.com/brexit We can support trustees and employers with benefit restructuring exercises and can help those wanting to take advantage of future buy-out opportunities DB valuations and de-risking Trustees should consider reviewing discount rates, transfer assumptions and commutation factors (especially if a trivial commutation or pension increase exchange is envisaged). In some cases, trustees may wish to bring forward valuations. Increased deficits may lead some employers to explore benefit restructuring exercises again. If the parent company is based outside the UK, the UK scheme s deficit may well have dropped in terms of the parent s non-sterling currency. Parents may be attracted to funding deficits more quickly to benefit from this, especially if combined with a benefit restructuring exercise. Securing benefits with an annuity Market volatility has already had an impact on the pricing of annuities. For schemes that have hedged against volatility, buy-out may now be more affordable. For foreign parent companies, the weak pound will have increased the attractiveness of buy-out by reducing the price in terms of the parent s non-sterling currency. Future volatility may present opportunities for well prepared trustees and employers. DC investments Trustees should consider reviewing their DC default fund strategy. Market volatility may undermine DC savers confidence (especially those who have just or are just about to enter drawdown, or who may make rash investment changes). The reduction in bond yields has led to steep increases in annuity prices. Trustees should consider writing to members to confirm that they are keeping the DC default fund strategy under review in light of Brexit. They may also wish to review whether their at retirement offering remains appropriate. 04
Pinsent Masons Brexit and Pension Schemes Future impact We don t yet know how Brexit will pan out. The formal trigger for the start of the Brexit process is expected in early 2017. It will then be at least two years before the UK formally leaves the EU. The possibility of a second vote cannot be ruled out. We do not yet know how much EU law the UK government may wish, or will be forced, to retain. We consider below what may be in the offing in a number of different areas. Discrimination The UK could decide to legislate for the removal of the requirements for GMP equalisation and for gender-neutral annuities. It may wish to simplify our current complex age discrimination legislation. Some schemes may consider postponing winding-up in the hope that GMP equalisation will no longer be required. Keep a watching brief on developments GMP equalisation could go away We urge the government to treat the problem of GMP equalisation as a priority. The cost of GMP equalisation has been estimated at between 13bn and 20bn. Often, it is rearranging deckchairs on a sinking ship. Funding regime The UK may need to implement the new directive on the activities and supervision of institutions for occupational retirement provision (IORP II) before it can implement Brexit. That directive would not be particularly onerous for the UK it deals with governance and not funding. If the UK stays in the European Economic Area, then the risk remains that a future IORP directive could bring a stringent new solvency requirement for DB schemes. IORP II Directive may need to be implemented The Pensions Regulator s integrated risk management (IRM) model was inspired by proposals by the European Insurance and Occupational Pensions Authority (EIOPA). Whilst this model could be dropped, some form of risk management model is inevitable. 05
For sector specific updates and further insights see www.out-law.com/brexit Business transfers The UK government might relax the requirements for a buyer to replicate the employment terms a seller had in place before a business is sold. Currently, certain early retirement benefits provided under an occupational pension scheme transfer to the buyer s employees. Removing these requirements could form part of a cutting red tape/encouraging business agenda. Data protection Much will depend on what relationship the UK retains with the EU. Even if the UK leaves the European Economic Area, it may still choose to implement the EU General Data Protection Regulation (currently in draft). This would ensure that personal data could continue to be sent from the UK to the EU. Whatever happens, the basic principles of data protection and security will remain. Investments The UK might relax the restrictions that currently apply to the investment by an occupational pension scheme in assets that relate to the employer. However, to protect scheme members, and the Pension Protection Fund, we expect self investment will continue to be restricted in most cases. Overseas contracts and judgments Depending on the result of the Brexit negotiations, it may become more difficult to enforce UK contracts and judgments in the EU. This could affect guarantees given by overseas parents, and contracts with overseas third-party administrators and managers and would also have implications for the enforceability of the Regulator s moral hazard powers within the EU. Guarantees given by overseas parents and contracts with overseas administrators may be affected 06
Pinsent Masons Brexit and Pension Schemes VAT HM Treasury may be able to write its own rules for VAT, which is an EU tax. It may well legislate to clarify the extent to which employers can recover VAT on pension costs - an area currently rife with uncertainty. Reducing accrued rights Reducing accrued pension rights is fraught with difficulty. The government has recently held back from reducing inflation protection for the Tata Steel pension scheme. One of the objections sometimes raised is that such reductions would be unlawful under EU law. Brexit may mean that the government is more willing to introduce greater flexibility into the system. Pension Protection Fund The PPF is partly designed to meet the government s obligations under EU law. Brexit would give the government a free hand over how the level of PPF compensation is determined. Whilst we expect the PPF would carry on as it is, at least in the short term, Brexit would reduce the risk of the PPF having to increase compensation levels in the future. Scoxit Scottish independence would add another raft of complexities. Many (in what would remain of the) UK schemes may then operate on a cross-border basis. What would this mean for funding, the PPF etc? The legality of some asset-backed funding arrangements, which rely on Scotland being part of the UK, would also be called into question. If Brexit leads to Scoxit, we ll be writing another paper... Next steps If you wish to find out more about how we can help you prepare for the challenges and opportunities triggered by Brexit, please contact your usual Pinsent Masons adviser or: Carolyn Saunders Head of Pensions and Lifetime Savings T: +44 20 7418 7141 E: carolyn.saunders@pinsentmasons.com 07
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