So after the UK’s historic decision to end its 43-year relationship with the EU, attention has moved to what happens next. It is clear that no one really knows all the details, but what is clear is that it is going to take a minimum of two years for the UK to leave the EU. During that time, the UK will continue to abide by EU treaties and laws.
However, although the initial legal and day-to-day operational implications of the UK leaving the EU will be relatively minimal for UK pension schemes, the immediate focus for pensions will inevitably be on investment, as discussed below.
Impact on defined benefit (DB) pension schemes
Trustees of DB pensions schemes are required to monitor the strength of the employer covenant. The term ‘employer covenant’ refers to the legal obligation, ability and willingness of a pension scheme's sponsoring employer (or employers) to provide the requisite funds in order to meet the scheme's liabilities both at present and in the future. The strength of the scheme employer's covenant is an important part of the scheme funding process.
Therefore, trustees need to be alive to market volatility and the impact that this may have on the trading conditions and the financial stability of the pension scheme’s sponsor(s). Trustees should liaise with scheme sponsor(s) for information on corporate risk analysis and seek updated covenant advice where appropriate. Trustees who consider their sponsor(s) to be at particular risk as a result of the UK’s withdrawal from EU membership may look for additional security to provide comfort in respect of the scheme’s position.
Impact on defined contribution (DC) pension schemes
For DC schemes it is the members who are directly impacted by the Brexit result. Changes in investment values affect the millions of DC savers and dramatic falls in asset values are not helpful to market confidence.
Trustees will need to monitor the on-going appropriateness of investment options available to members and may need to take advice on the performance of current investment options as a result of the Brexit vote.
Solvency II Directive (2009/138/EC) (Solvency II)
Solvency II provides the framework for a new EU solvency and supervisory regime for the insurance sector. It fundamentally reforms capital requirements for insurers and reinsurers, taking into account developments in insurance, corporate governance, risk management, reporting and prudential standards.
Solvency II had caused concern within the UK pension arena since it became apparent that the new requirements could apply to DB pension schemes. The idea of bringing pension schemes into line with insurance companies on solvency requirements alarmed many in the pensions industry, with warnings that stricter funding requirements could have severe consequences resulting in scheme sponsor(s) suddenly having to inject large amounts of capital into their DB pension schemes.
Whilst the EU Commission confirmed that Solvency II would not apply to DB pension schemes (for now), it seemed almost inevitable that some kind of Solvency II-style standards of funding and governance would be imposed on DB pension schemes in the future. Following the UK’s decision to leave the EU, this immediate threat has been removed but questions will now turn to what legislative provisions (if any) the UK Government will put in place in the future to deal with the solvency aspects of DB pension schemes.
Ultimately, the Brexit vote is unlikely to have a significant impact on the legal and regulatory framework for UK pension schemes. Whilst there are clearly areas of concern for trustees (and scheme sponsors), there are proactive steps which trustees can take (as detailed above) to deal with market volatility and the investment consequences as a result of the UK’s decision to leave the EU.