Publication
Global rules on foreign direct investment (FDI)
Cross-border acquisitions and investments increasingly trigger foreign direct investment (FDI) screening requirements.
United Kingdom | Publication | May 2023
The backdrop to the 2023 DB Funding Statement is a funding landscape that has changed considerably over the past year. The Regulator notes that most schemes’ funding positions should have improved given increased gilt yields; open schemes, particularly immature ones, should benefit from lower estimated costs for providing future benefits. Only a minority of schemes should have seen deterioration in their funding positions, most likely those who were unable to meet LDI collateral calls during the spike in gilt yields in September and October.
Nevertheless, the Regulator has taken a cautious approach with its guidance, emphasising risks that schemes face. Notably, although covenants may now appear “proportionately stronger” as schemes have shrunk, the economic outlook is not favourable. Employers may be affected by ongoing high inflation, lack of economic growth, higher borrowing costs, and uncertainty over geopolitical instability. These same factors, of course, may translate into investment risk.
The Regulator’s guidance has three major sections respectively dealing with the implications of different funding positions for trustees, investment, and covenant.
Funding positions
On funding positions, the Regulator has provided separate guidance for each of three groups of scheme: those with a funding level at or above buy-out (“Group 1”); those with a funding level between technical provisions and buy-out (“Group 2”); and those with a funding level below technical provisions (“Group 3”).
The Regulator separately observes that over the last eighteen months mortality has begun stabilising at a higher level than before the pandemic, which has positive implications for funding levels. It cautions, however, that it will take some time before any new trends become clear and any changes to assumptions should be appropriate and justifiable.
Investment
The Regulator notes that over the past year, asset allocations may have diverged from expectations. With better funding positions, schemes will probably look at de-risking. This may involve reduced leverage for geared LDI, substituting matching for growth assets, and reducing exposure (or at least reconsidering the trustees’ approach to) illiquid assets. On the other hand, open and non-mature schemes may see merit in sustaining their current levels of risk.
Trustees are also advised to refer to the Regulator’s guidance on using leveraged LDI, given the operational risks exposed in September and October 2022.
Covenant
As noted above, the Regulator emphasises the potential impact of a challenging economic climate on employers, even if covenants now look better in relation to scheme sizes. It singles out refinancing risk as particularly relevant given rising interest rates. As a result, it suggests that trustees should undertake different scenario analyses to understand schemes’ sensitivity to changes and how quickly any deterioration could occur. Volatility and uncertainty mean that trustees should be engaging regularly with management to understand forecasts and challenges.
The Regulator suggests that trustees might also wish to expand the scope of their covenant analysis, with a greater focus on the longevity of the covenant. Although the Regulator does not link this explicitly to the principles of the draft funding code, this does chime with the code’s emphasis on more sophisticated covenant analysis.
The Regulator has indicated that later in the year it will set out proposed changes to its guidance on Assessing and Monitoring the Employer Covenant and related guidance. This will include detail around covenant visibility, reliability, and longevity and incorporation of ESG factors into covenant assessment.
On April 21, 2023, the Regulator published its Corporate Plan for the period 2023 to 2024, the final year of its 3-year planning cycle. The Plan confirms:
The Regulator also plans a whirlwind of activity over the next year including:
The Corporate Plan also outlines the Regulator's plans beyond March 2024, including:
The Corporate Plan is packed with ambition and highlights a full regulatory agenda. The Regulator says it will keep its operation under review to ensure it responds to risks and continues to improve. It intends to be “digitally enabled and data driven”, with aiming for advanced, integrated platforms delivering a streamlined operation. To this end, its budget has increased by £1.7m to £118.9m, with a total of 980 staff projected for 2023-24. It will also focus on the value for money it provides. Centring on economy, efficiency and equality, it plans to track its spend across various office processes. It will also relocate to a new office in Brighton where it will aim for a net zero carbon emissions target by 2030.
If you would like to find out more about the issues covered by this briefing or have any other pensions legal query, please reach out to your usual Norton Rose Fulbright pensions contact.
Publication
Cross-border acquisitions and investments increasingly trigger foreign direct investment (FDI) screening requirements.
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