Scottish voters will be given the chance on 18 September 2014 to have their say on Scottish
independence from the United Kingdom. The ballot papers will ask voters, ‘should Scotland
be an independent country?’
A ‘yes’ vote is likely to have wide-reaching ramifications. This briefing focuses on a number
of potential consequences in respect of UK pensions that can currently be foreseen if
Scotland is to become an independent state.
In this briefing we consider some of the key issues that independence raises in respect of
UK pension schemes.
• How will Scottish private pensions be regulated?
• How might the development of different tax regimes affect UK pension schemes?
• In what circumstances will the rules on cross-border pension schemes be engaged?
• How might existing asset-backed funding arrangements be affected?
1) Regulation of Scottish private pensions
Independence raises many questions related to the regulation of private pensions in Scotland.
We consider below two key aspects of the pensions regulatory framework: (i) regulatory
institutions, and (ii) the body of law applicable to Scottish pensions. These two issues are
specifically discussed in two papers published by the Scottish government which set out its
current proposals in respect of pensions in an independent Scotland (‘Scotland’s Future: Your
Guide to an Independent Scotland’ (26 November 2013) and ‘Pensions in an Independent Scotland’
There are also separate practical questions of how to determine which set of laws will apply
to an existing pension scheme that operates in both Scotland and the rest of the UK, and
(depending on whether a monetary union could be agreed post-independence) the currency
in which payments would be made in respect of members based in Scotland.
a) Regulatory institutions
At present, there are a number of regulatory bodies with different supervisory/regulatory
responsibilities and roles in relation to UK pension schemes: the Pensions Regulator (TPR),
the Pension Protection Fund (PPF), the Prudential Regulatory Authority (PRA) of the Bank of
England, the Financial Conduct Authority (FCA) and the Financial Services Compensation
Scheme (FSCS). These bodies have different roles, but together (very broadly) seek to ensure
adequate supervision of defined benefit and defined contribution pension schemes in the UK,
both in occupational and personal contexts, to regulate the life insurance industry, and also
to provide a capped level of protection/compensation where employers or insurers become
Regulation of Scottish
for UK pension schemes
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With the introduction of automatic enrolment in the UK, a further body, the National
Employment Savings Trust (NEST), has become relevant. NEST is a national pension scheme
whose rules satisfy the requirements set out in auto-enrolment legislation. Rather than set
up their own schemes, NEST is a defined contribution pension scheme into which employers
can enrol their employees in order to comply with auto-enrolment requirements. It is
generally focused on those with low-to-moderate earnings.
In respect of the roles played by these regulatory organisations, the Scottish government
has proposed the following:
• the establishment of a Scottish Pensions Regulator which would work closely with TPR
and the FCA ‘to maintain a pan-UK approach to the regulation of private pensions’;
• Scotland continuing to participate in the PPF, with the possibility that the Scottish
government may in the future establish a Scottish equivalent of the PPF; and
• the establishment of a Scottish equivalent of the FSCS.
With regard to auto-enrolment, the Scottish government has explained that it would
continue with current UK arrangements if Scotland was to become independent. However,
while it would seek to ensure that Scottish individuals and employers could continue to
access NEST and that accrued benefits in NEST would be protected, the Scottish government
has stated that it proposes to set up a Scottish Employment Savings Trust (SEST). The
intention would be that SEST would be aligned with the Scottish government’s policy
on automatic enrolment in an independent Scotland.
The Scottish government has also indicated that it is considering two possible methods
of providing access to a pensions ombudsman in an independent Scotland: either a single
Scottish Ombudsman Service (which would deal with general consumer complaints,
including in relation to pensions), or a specific Scottish Financial Services Ombudsman
with jurisdiction over complaints concerning pensions and financial services.
The Scottish government’s aim that ‘the structure and activities of the regulatory
framework in Scotland for private pensions should be closely aligned with the regulatory
framework in the UK, post-independence’,
can clearly be seen through its regulatory
proposals as set out above.
These proposed changes raise the general debate of whether it is best to continue with the
existing system in order to minimise disruption to the existing regime or to establish new,
more tailored institutions. Considerations in favour of retaining the status quo include: being
able to benefit from current economies of scale, spreading risk, and avoiding the difficulty of
carving up liability/spheres of influence. However, continued use of the existing framework
would require co-operation and agreement between the two independent states. On the other
hand, setting up new institutions would, insofar as relevant to the particular institution,
provide a clean break between the two states, prevent cross-subsidies and allow each state
to make its own political decisions without necessarily needing to consult the other. These
advantages would need to be considered against the significant costs of establishing new
In the particular context of Scottish independence, and in relation to the proposals for
the PPF and NEST, there is a further issue of the currency that will be used in a newly
independent Scottish state. It is unclear whether Scotland will choose and/or be able to
continue to use sterling. If Scotland was to adopt a different currency to the rest of the UK,
and continue participating in the PPF and/or NEST, this would raise issues of a currency
mismatch in these two funds/institutions.
The Institute of Chartered Accountants of Scotland (ICAS) has also raised the issue of whether
the regulatory package proposed by the Scottish government would work consistently as
a whole, ie how would it work in practice to have two pension regulators in two countries,
sharing a protection fund in common. How would issues be resolved if there was to be
a divergence of policy between the governments (and parliaments) of both countries?
1 Pages 147–148, Scotland’s Future: Your Guide to an Independent Scotland (26 November 2013)
2 Page 62, Pensions in an Independent Scotland (September 2013)
3 Page 436, Scotland’s Future: Your Guide to an Independent Scotland (26 November 2013)
4 Page 69, Pensions in an Independent Scotland (September 2013)
5 Page 7, ICAS: Scotland’s pensions future: have our questions been answered? (3 February 2014)
How would issues be
resolved if there was
to be a divergence
of policy between
of both countries?Freshfields Bruckhaus Deringer LLP
b) Body of law applicable to Scottish pensions
In terms of the legislative framework that would be applicable to occupational and personal
pension schemes in an independent Scotland, the Scottish government has said that ‘the
body of law governing pensions would continue to apply in Scotland, until amended, replaced
or repealed by the Scottish parliament’.
By way of comments on specific aspects of legislation
relevant to pensions, the Scottish government has said expressly that it will continue with
the roll-out of automatic enrolment already commenced in the UK.
The Scottish government has also set out (to a limited extent) its position on taxation in an
independent Scotland. It has commented that it is not planning any immediate changes to
the tax treatment of private pensions at the point of independence, although future Scottish
governments ‘will wish to consider whether adjusting tax relief arrangements would improve
incentives to save’.
In a later paper, the Scottish government also published a Q&A which said
that while Scotland will inherit the existing tax system and the prevailing UK tax rates and
thresholds, future Scottish governments in an independent Scotland would take decisions on
specific taxes, including rates, allowances and credits.
In addition, the Scotland Act 2012
(which is due to take effect in April 2016) gives the Scottish parliament the power to decide
on a rate of Scottish income tax for Scottish taxpayers, and also the ability to create new
taxes in Scotland – this would apply regardless of the outcome of the referendum.
From the point of view of administration, it is clear that if two separate tax regimes develop,
this will increase costs for companies that employ both UK and Scottish taxpayers; this is
because separate payroll/tax systems would be needed whereas currently one system can be
used for all UK (including Scotland) taxpayers. As the NAPF has commented, if different tax
thresholds are set, this will impact automatic enrolment triggers and pensions tax relief.
Companies would also need to identify UK and Scottish taxpayers in order to apply the
correct regime. It does not seem unfeasible that costs might be passed onto members/
There is also an issue in relation to the potential for tax discrimination if an independent
Scotland does not become a member of the European Union. It is an established principle
in European case law that member states are unable to offer tax relief in respect of pension
contributions to national schemes while not offering it to schemes in other member states, as
to do so would be contrary to the freedom to provide services, freedom of establishment and
the free movement of workers. To the extent, therefore, that an independent Scotland
becomes a member of the European Union, these rules on tax discrimination would apply
to prevent Scotland from adopting pension tax practices that discriminate against UK
pension schemes (and vice versa). However, if Scotland were not to become an independent
member of the Union, the position may be different.
6 Page x, Pensions in an Independent Scotland (September 2013)
7 Page x, Pensions in an Independent Scotland (September 2013)
8 Page 66, Pensions in an Independent Scotland (September 2013)
9 Page 435, Scotland’s Future: Your Guide to an Independent Scotland (26 November 2013)
If different tax
thresholds are set,
this will impact
triggers and pensions
tax relief.Freshfields Bruckhaus Deringer LLP
c) Practical issues of jurisdiction and currency
In addition to the point above about the likely shape of Scottish pensions law, for schemes
currently operating across both Scotland and the rest of the UK, if Scotland was to become
an independent nation it would be necessary to understand the governing law that would
be applicable to the scheme.
The governing law of a pension plan is usually expressly stated in the scheme documentation.
This will usually deal with the issue in relation to trust law and contract issues.
However, there is also the question of which set of statutory provisions will apply to the plan
going forward, eg pensions regulations and taxation requirements. It seems likely that issues
such as where the scheme is ‘established’ or administered, where trustee meetings are held,
and the residence or place of incorporation of the trustee would be taken into account in
determining the legal regime applicable to the scheme. Potentially, the legislation applicable
can differ from the governing law.
There is also much comment in the press around the likelihood or possibility of a monetary
union between an independent Scotland and the rest of the UK. It is at present unclear
whether an independent Scotland would be able to retain sterling as the main currency.
If this was not possible, there would be a further practical problem for pension schemes that
have both English and Scottish participants. For example, would such a scheme continue to
pay sterling to all members (including Scottish pensioners), or would the scheme switch to
paying in the new Scottish currency for Scottish participants? Similarly, if the scheme was
Scottish but contained participants in England, the same issue would arise but in reverse.
A further question would be the rate of inflation that would be used to index pension
entitlements – should Scottish/UK measures of inflation be applied depending on the
country of residence of the member?
2) Cross-border pension schemes
The EU Pension (IORP) Directive
was implemented in the UK through the Pensions Act
2004 and the underlying Occupational Pension Schemes (Cross-border Activities) Regulations
2005 (Cross-Border Regulations). Broadly, the Cross-Border Regulations require a UK-based
occupational pension scheme that accepts contributions from a ‘European employer’ to
(i) obtain authorisation and approval from the Pensions Regulator to operate as a cross-border
pension scheme and (ii) in the case of a defined benefit scheme, to be funded at the level of
the statutory funding objective more quickly than would otherwise be necessary (essentially,
the scheme needs to be fully funded on a technical provisions basis either immediately
without the use of a recovery plan, or within two years of the application to the Pensions
Regulator, depending on whether the scheme is an existing or a new scheme at the time
of the application).
The requirement to fully fund a pension scheme more quickly on it becoming cross-border
is by far the greatest obstacle to the establishment of cross-border pension schemes. There
had been some discussion in early 2014 that the full funding requirement would be dropped
from the draft of the recast IORP Directive; however, for now, the requirement has
The Cross-Border Regulations are engaged where a European employer makes contributions
into a UK occupational pension scheme. ‘European employer’ is, broadly speaking, defined to
include an employer that employs at least one person whose place of work under his contract
is in a non-UK member state.
It seems clear, therefore, that where a pension scheme accepts contributions from both
Scottish and UK employers in a post-independence context, the pension scheme would
be a cross-border scheme and subject to the full funding requirement post-independence
(whereas it is not so subject currently). This brings with it serious costs implications for
10 Directive 2003/41/EC
Where a pension
both Scottish and UK
employers in a postindependence context,
the pension scheme
would be a crossborder scheme and
subject to the full
post-independence.Freshfields Bruckhaus Deringer LLP
businesses both sides of the border, whether employers seek to fund schemes to technical
provisions in line with the cross-border requirements, or to split them into separate UK and
This issue has been recognised by the Scottish government, and its proposed method of
resolution is for discussions to commence immediately with a view to undertaking impact
assessments and to agree transitional arrangements with the European Union. The Scottish
government refers to the following arguments in favour of transitional arrangements.
• The cross-border requirements were not designed to apply in relation to an integrated
financial services market – ie, the protections were designed to protect members against
significant variances in pension provisions across different member states.
• The operation of transitional arrangements would be a common sense solution which
would be of mutual benefit to Scotland, the UK and the European Commission. This is
on the basis that the Commission’s aim is to promote greater cross-border occupational
• The cross-border requirements (including the full-funding requirement) are already
interpreted in different ways across the European community.
The Scottish government envisages transitional arrangements for independence that allow a
scheme with an existing recovery plan to implement that plan in accordance with its original
timescales. The Scottish government also notes that transitional arrangements have
previously been implemented on the introduction of the IORP Directive.
However, it is not clear that such transitional arrangements could be negotiated, and it is
also not currently clear what the solvency requirements for Scottish pension schemes would
be, if Scotland was not able to join the European Union as an independent state. Indeed,
even if transitional arrangements in this form could be negotiated, this would (on the terms
of the current proposals) result in a much more inflexible funding regime for relevant
schemes. At present, such schemes undergo triennial valuations, following which (where
applicable) recovery plans would be negotiated between the employer(s) and the scheme
trustee depending on the level of deficit revealed in the latest valuation. Under the current
system, therefore, there is scope to agree an amended recovery plan where there has been
a change in the scheme deficit between valuations. The proposal put forward by the Scottish
government to permit existing recovery plans to be implemented according to their
original timescales does not appear to permit this sort of flexibility.
Given the retention of the full funding requirement in the latest draft of the IORP II
Directive, this is very much a live issue that employers and schemes operating in the UK and
in Scotland will need to keep in view.
3) Asset-backed funding arrangements
As we have previously commented, employers and trustees are finding increasingly
innovative ways of funding/supporting defined benefit pension schemes (see Briefing no. 260
‘Asset-backed funding: challenges and opportunities for employers and trustees’). One such method is
the asset-backed funding arrangement, where the sponsoring employer of a pension scheme
transfers group assets into a special purpose vehicle, which in turn uses those assets to
generate an income stream for the pension scheme.
The most common method of structuring this special purpose vehicle is to set it up as a
Scottish Limited Partnership (SLP), with the employer and the trustee each being partners
of the SLP. The reason that an SLP is used is that the employer-related investment (ERI)
restrictions in the Pensions Act 1995 are not breached by the asset-backed arrangement.
11 Pages 80–83, Pensions in an Independent Scotland (September 2013)
12 Pages 148–149, Scotland’s Future: Your Guide to an Independent Scotland (26 November 2013)Freshfields Bruckhaus Deringer LLP
ERI legislation broadly prevents a pension scheme’s assets from being invested in employer
assets (depending on the asset class, up to 5 per cent of the scheme’s assets may be permitted
to be so invested). On its face, therefore, a trustee taking an interest in a vehicle that contains
employer assets would breach ERI rules.
However, use of the SLP structure does not involve a breach of the legislation. The usual
analysis runs as follows:
• employer-related investments include ‘shares or other securities’ issued by the employer
or a person connected or associated with the employer;
• ‘shares’ is defined as shares or stock in the share capital of:
— any body corporate (wherever incorporated); and
— any unincorporated body constituted under the laws of a country or territory outside
• an SLP is an unincorporated body, but (currently at least) constituted under the laws
of the UK; and
• therefore, an interest in an SLP is not a ‘share’ for the purposes of ERI legislation,
and does not breach the terms of the rules.
If Scotland were to become independent from the UK, this logic would no longer hold as the
SLP would no longer be constituted under the laws of the UK. This would not necessarily be
fatal to the permissibility of SLPs, as it could also be argued that the definition of ‘shares’ is
simply not relevant to partnership interests, and so the existing analysis, as set out above,
is strictly not necessary.
In addition, conscious of the risks of putting in place long-term arrangements, many scheme
sponsors and trustees have agreed asset-backed funding documentation containing ‘change
of law’ provisions which provide for the arrangements to be unwound where the effect of
a change of legislation is that the arrangements can no longer be pursued as envisaged or
become illegal. Indeed, TPR has stated that trustees should seek an ‘underpin’ when agreeing
to asset-backed arrangements to protect the scheme in circumstances where the structure
becomes ‘void for illegality or where there is a change in law’.
If Scotland was to become an independent nation, this would clearly result in significant
uncertainty for asset-backed funding arrangements of the type described above.
Consideration would need to be given to the significance of the impact that independence
would have on the legal analysis around ERI rules, and we would expect much debate in the
pensions industry on this issue. A further consideration would be whether or not the UK
government might (subject to any limitations imposed by the IORP Directive) assist by
introducing transitional provisions for affected asset-backed funding arrangements, or even
by amending the ERI rules such as to 'cure' the issue and expressly permit arrangements
using an SLP structure.
13 TPR Guidance: Asset-Backed Contributions (November 2013)
If Scotland was
to become an
this would clearly
result in significant
uncertainty for assetbacked funding
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