Barely a month has passed since the historic result in the UK’s referendum on membership of the European Union (EU). Events have moved quickly, with leadership challenges being triggered by the two major parties and one already being concluded, resulting in a new Prime Minister and a new Cabinet. There has also been considerable debate and discussion about what will happen next, the timing of Brexit and the possible shape of the UK’s future relationship with the EU and beyond.
The new leadership has begun to give some signals about its likely approach to the Brexit negotiations but, considerable uncertainty remains. In spite of this, there are several actions that pension plan trustees and sponsors are taking in response to current events. We have summarised these below, together with some of the key issues pension plans and sponsors need to be considering in order to prepare for Brexit.
Our clients have been taking a number of steps in the immediate aftermath of the EU referendum to mitigate the risks associated with the present uncertainty and to take advantage of the opportunities presented. Some of the key areas that may need attention are summarised below. These reflect some of the themes contained in the Regulator’s recent statement for trustees following the UK’s vote to leave the EU.
Investment – Defined benefit (DB) plans
Investment volatility is going to be with us for some time. This presents both risks and opportunities for pension plan trustees and corporate sponsors. In light of this, trustees of DB pension plans have been:
- monitoring the impact of current market conditions on their plan’s investment strategy and reviewing whether their strategy remains fit for purpose in a post-referendum world
- working with investment managers to take advantage of opportunities to buy assets at advantageous prices as a result of the current market volatility
- assessing the impact of current market conditions on derivative contracts – in particular, trustees ought to assess and be alert to the potential impact of Brexit on the covenant strength of counterparties to derivative contracts and on any potential impact that a further downgrading in the UK’s credit rating could have on their ability to post gilts as collateral under such contracts.
Moving forwards, trustees should assess the impact of Brexit on plan investments governed by the laws of other EU Member States or contingent assets based in other EU Member States to ensure that they remain appropriate and enforceable.
A longer term issue which will impact how pension plans can invest post-Brexit is whether the UK is able to secure passporting rights for investment vehicles such as UCITs and AIFs following its exit from the EU. This issue is of vital importance for the financial services sector in the UK and consequently for the UK economy. It will also impact the regulatory framework of investment vehicles based in the UK and may potentially force plans to change some of the vehicles in which they are invested.
Funding – DB plans
The fall in gilt yields to record low levels following the referendum result has increased the value of the liabilities of DB pension plans in the UK. Depending on the extent to which a plan is hedged against this and its asset allocation, this may have resulted in the size of a plan’s deficit increasing (although this will not necessarily be the case for all plans, as asset values may have also increased– for example, we are aware of some plans where the deficit has remained broadly static or even fallen as a result of recent market conditions).
Where plans are currently undertaking valuations and the size of the deficit is affected by current record low gilt yields and the volatility on financial markets, trustees and corporate sponsors will need to determine to what extent they should take account of current market conditions and the potential impact of Brexit when agreeing the valuation assumptions and the recovery plan. Trustees and sponsors will also need to take a view on the potential impact of Brexit and the fall in the value of Sterling on future inflation.
Even where a plan’s deficit has not risen, the fact that a plan’s liabilities have increased may mean that the value of the plan’s liabilities relative to the size of its sponsor(s) has changed materially. Trustees and corporate sponsors need to be alive to this. They may also wish to take steps to reduce or mitigate the increase in risk associated with this, such as by undertaking exercises to reduce their plan’s liabilities, or by putting in place contingent security for the plan.
As well as assessing the impact of the current market conditions on the plan’s funding position, trustees and corporate sponsors should also assess the potential impact of Brexit on the strength of the covenant standing behind the plan (including the value and enforceability of any contingent security that may be in place). They should consider what steps to take to mitigate any potential adverse changes in this.
In any event, if they have not already done so, pension plan trustees and sponsors should open a dialogue about the potential impact of Brexit and the current market conditions on the plan and the sponsor’s business. Information sharing protocols should be revisited - this is a good time for trustees to assess whether they are comfortable with the information their sponsor has agreed to disclose to them, as well as the regularity and timing of such disclosure.
As a result of current market conditions there may be attractively priced opportunities to conclude buy-in or buy-out deals for plans that currently hold a significant proportion of gilts and are able to transact quickly. Trustees and sponsors of plans that are in this position should take immediate action if they want to capitalise on this.
Investment – Defined contribution (DC) plans
Trustees of DC plans should assess the impact of the current market conditions on their plan’s various investment strategies and check that these strategies are performing as would be expected in these conditions, taking remedial action as necessary. As with defined benefit investments, the outcome of the Brexit negotiations may impact the type and range of funds which DC plans can offer to their members in future.
Defined benefit transfer values may have increased as a result of market conditions, so a review of transfer value factors may be needed.
Some plans have also reported an increase in requests to transfer to overseas plans, due to fears over the UK economy. Pension scammers may seek to take advantage of these fears, so trustees should be extra vigilant when dealing with transfer requests.
Communicating with members
Some trustees and providers have issued a communication to members to reassure them that appropriate steps are being taken to assess the impact of Brexit and to mitigate any risks associated with this. They have also taken the opportunity to address specific concerns being raised by members.
Trustees planning to issue a communication to members should work with their plan’s sponsor to ensure that any communication they issue is consistent with any Brexit communications issued by the company to its staff. Care should also be taken not to overstate the trustees’ ability to reduce or eliminate the risks associated with Brexit.
Impact on UK pensions law and policy
Until Brexit occurs there is no change in the legal and regulatory framework for UK pension plans and they will need to continue to comply with EU law. There is uncertainty over the extent to which UK plans will be required to comply with EU law in the future as this will be determined by the terms of the UK’s withdrawal from the EU. The final position on this is unlikely to be known for some time.
In any event, much of UK pensions law which has its origins in EU legislation has been enacted through UK legislation. Consequently, at this point, it appears unlikely that there will be a significant change in the legal and regulatory framework for UK pensions in the immediate aftermath of Brexit. However, in the medium and longer term, leaving the EU may open the door for UK legislation to deviate from EU requirements in some respects. Furthermore, without the influence of the CJEU in the background, UK case law on matters previously the preserve of the EU prior to the UK’s departure, such as equal treatment and TUPE, may start to take their own domestic direction.
As far as domestic pensions policy is concerned, the fact that we have a new Chancellor and a new ministerial team at the Department for Work and Pensions could see a change in direction. In particular, will the Treasury now play a less active role in setting pensions policy? Will Lifetime ISAs still be introduced? Does the change of Chancellor make it less likely that we will see a radical change in the system of pensions tax relief in the short-term?
We understand that the planned Pensions Bill will still go ahead. This is due to include measures to increase the protection for members of master trusts and capping early exit fees. The debate around how best to deal with distressed DB plans also looks set to continue.
Future EU legislation
Given the uncertainty over the extent to which UK plans will be required to comply with EU law in the future it is unclear to what extent UK plans should prepare for new EU requirements that are not yet in force, such as the new IORP Directive (which is expected to come into force in late 2018), the General Data Protection Regulation (which is due to have direct effect in the UK from 25 May 2018) and MIFID II (which is due to apply in the UK from January 2018).
For the time being, trustees and sponsors should continue to monitor developments in these areas and be ready to comply with them. However, this may change as the terms of the UK’s withdrawal from the EU becomes clearer.
The uncertainty following the referendum result and the eventual impact of Brexit may cause some businesses in the UK to restructure, which may include relocating staff. Where a business is planning any kind of corporate restructuring it is important that the potential impact on the business’ past and future pension obligations to affected staff are considered at an early stage. Issues such as employment law and tax will also need to be considered.
Over the past few weeks events have been moving at a whirlwind pace. Whilst the political scene in the UK is becoming clearer the terms on which the UK will exit the EU are still far from certain. Some clarity may come as the UK Government outlines its negotiating position on key issues. However, the eventual shape of the UK’s exit from the EU will be subject to the vagaries of politics and the outcome is unlikely to be known for some time.
In the meantime, pension plan trustees and sponsors should take steps to ensure that their strategy for managing their plans’ funding and investments is not derailed by current market conditions. They should also assess, as best they can, the potential impact of Brexit on the future of the plan and the sponsor and take action to mitigate any downside risks, where possible.