In this insight we provide an overview of another busy week in pensions which saw the laying of the final draft DB funding code in Parliament. We summarise the changes made in the code and also provide our usual round-up of recent key pensions developments.
The Pensions Regulator (TPR) round-up
Final draft DB funding code laid before Parliament
On 29 July 2024, TPR confirmed that the final draft DB funding code of practice had been laid before Parliament. It will come into effect 40 days after being laid which, given Parliament’s summer recess, is expected to be in early autumn. The new funding and investment regime applies to actuarial valuations with effective dates on or after 22 September 2024. TPR has also published its response to the code consultation and its response to the fast track and regulatory approach consultation.
The code has been updated to take into account changes that were made to the final funding and investment regulations (see here), consultation feedback and changes in market conditions since the December 2022 draft code was published.
Key changes include the following:
- Significant maturity has been moved from being when duration reaches 12 years to 10 years.
- Confirmation that the notional investment allocation is just that, a notional one and may differ to the scheme’s actual investment allocation. The notional investment allocation is used to derive actuarial assumptions.
- Confirmation that neither the funding and investment strategy nor the journey plan “‘interfere’ with the trustees’ duty to invest in the best interests of members and their powers over the scheme’s actual investments as detailed in the scheme’s governing documents”.
- The low dependency investment allocation (LDIA) module in the code reflects the removal in the regulations to a LDIA requiring cash flow broadly matching benefit payments – LDIA now requires that invested assets are “highly resilient to short-term adverse changes in market conditions”. The code also replaces the prescriptive approach to testing of high resilience with a principles-based approach.
- A principles-based approach has also been adopted to the assessment of maximum supportable risk levels that can be taken during the journey plan.
- An explanation that, although the funding and investment strategy only contains the funding part of the journey plan, the journey plan covers both funding and investments.
- The code now reflects the regulations in allowing open schemes to take account of new members and future accrual when calculating maturity. There is also a new section for open schemes which pulls together the relevant parts for these schemes together with signposting.
- Further detail is provided on employer covenant and the code clarifies how reliability and covenant longevity periods, key concepts under the code, should be assessed. Employer forecast visibility references have been removed from the core assessment but are still a ‘starting block’ in considering cash flow and the reliability period.
- Other references to proportionality, where applicable, have been added into the code to provide more flexibility as regards scheme circumstances.
It is estimated that, as at March 2023, 62% of schemes satisfied all the fast track tests and another 19% could alter their funding approach with no additional cost to do so.
We have produced insight on the final draft code which can be accessed here for those who want to read about the code in more detail.
TPR’s ESG review shows too many smaller schemes are only doing minimum required
TPR’s review of schemes’ compliance with ESG reporting and disclosure requirements in the statement of investment principles (SIP) and implementation statements (IS) has revealed that, although most trustees are complying with their ESG obligations, many are only complying at minimum levels.
Of the 3,500 schemes checked, only approximately 1% had failed to provide working weblinks to their SIP and IS. More concerning for TPR were the results of the 375 machine read scheme reviews and 50 more in-depth reviews of SIPs and IS.
- Minimum compliance: “Too many smaller schemes opted for minimum compliance with ESG aspects of SIPs and IS”. Such schemes are ‘urged’ to think about whether a minimum compliance approach is appropriate – TPR wants to see a higher level of compliance. TPR notes trustees’ duties to consider financially material factors in investment decision-making bearing in mind that generally trustees had identified certain ESG factors as financially material investment risks.
- Consolidation: Trustees should consider consolidating their scheme if they do not have the experience or ‘scheme governance scale’ to properly manage financially material ESG risks.
- Improved trustee oversight needed: There needs to be better trustee oversight of investment managers which manage financially material risks, engagement and voting. Trustees must “take ownership of the scheme’s policies in relation to ESG.”
- Pooled funds: Most reviewed schemes were in pooled funds – the majority did not provide enough information on how managers are reviewed and monitored and many ISs did not contain good examples of ESG voting and engagement activities. More should be done to show effective ESG management in pooled funds.
- Other recommendations from TPR include: providing more policy detail to demonstrate consideration of ESG-related risks relating to the scheme; providing more scheme-specific voting activity detail; providing more information on asset management arrangements; consider extending reporting and developing policies on environmental factors in addition to climate change (e.g. social factors).
Trustees should, together with their investment advisers, consider if there are areas on ESG and the SIP/ IS which need to be or can be improved. Even schemes that do not have ESG SIP and IS obligations, must still consider ESG matters in relation to investments – TPR’s general code makes clear that part of having an effective system of governance is considering ESG and stewardship matters in relation to scheme investments.