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Global rules on foreign direct investment (FDI)
Cross-border acquisitions and investments increasingly trigger foreign direct investment (FDI) screening requirements.
United Kingdom | Publication | settembre 2022
In July 2022 the DWP opened a consultation on its draft Funding and Investment Strategy and Amendment Regulations 2023 (the draft Regulations). The draft Regulations are being introduced under the Pension Schemes Act 2021, and will implement major changes to the existing DB scheme specific funding requirements. They will be supported by the Regulator’s new DB Funding Code (the new Code) which is not yet available. This briefing examines the DWP’s objective behind the draft Regulations, their key concepts and what trustees can expect if the provisions are introduced as currently drafted.
The DWP’s broad objective is for schemes to set (and report on their progress towards) a funding level which reduces dependence on their employer(s) at a future date when the scheme is mature (a “long term funding objective” (LTO)). The government’s rational for this, explained in the consultation impact assessment, is to ensure that schemes are making investment decisions in a way that results in the highest probability of members receiving their pensions in full.
The draft Regulations therefore require trustees to agree a funding and investment strategy (FIS) with the employer, detailing a scheme’s LTO, and how the LTO will be achieved over the scheme’s lifespan; and consult with the employer on a regular written Statement of Strategy of their progress in achieving their FIS.
In terms of what the draft Regulations say, they propose that from the point a scheme reaches significant maturity, the minimum requirement is for it to have appropriate and sufficient assets so that it is fully funded on a low dependency funding basis and invested in a low dependency investment allocation. The draft Regulations explain these terms as follows:
Significant maturity: the consultation paper describes maturity as “a measure of how far a scheme is through its lifetime” to be measured in years on a duration of its liabilities basis. A scheme reaches significant maturity on the date it reaches the duration of its liabilities in a period of years to be specified in the new Code (expected to be 12 years). Duration of liabilities is the weighted mean time until the payment of pensions and other benefits, and guidance on its use is expected to be set out in the new Code.
Low dependency funding basis: this is when a scheme expects to have sufficient assets under a low dependency investment strategy to provide accrued pensions without further employer contributions being needed. In other words, under reasonably foreseeable circumstances, no further employer contributions will be needed to plug a deficit. Actuarial assumptions used for low dependency funding are to be compliant with the presumption a scheme is fully funded, or has a 1:1 asset to liability funding level and assets are invested in a low dependency investment allocation.
Low dependency investment allocation: this means that assets are invested to produce returns that broadly match the sums required to pay benefits, and the value of assets relative to liabilities is highly resilient to short-term adverse economic changes.
In terms of how trustees are expected to pull together these key concepts into a FIS, the draft Regulations indicate that trustees are to have regard to prescribed matters and principles when determining or revising a scheme’s FIS. These are set out in a schedule to the draft Regulations and include:
The draft Regulations also, for the first time in legislation, define and set rules on how to measure the strength of the employer covenant, as the “financial ability of the scheme employer to support the scheme” considering its cash flow and the likelihood of an insolvency event; and the support from any legally enforceable contingent assets. Other factors considered to affect the performance and development of the employer and which must be considered in any assessment of employer covenant are to be set out in the new Code. Whether the definition is workable and appropriate is to be looked at under the consultation.
The draft Regulations also set out the matters the Statement of Strategy must cover, including how maturity is expected to change over time; the level of investment risk to be taken in the context of the trustees’ assessment of the strength of the employer covenant; the action trustees will take if any risks identified in the FIS materialise; how low dependency will be achieved by significant maturity; how the scheme assets are held in investments of sufficient liquidity; and any comments the employer has requested to be included. Overall the Statement of Strategy must clarify the risks of implementing the scheme’s FIS and the planned mitigation if those risks materialise. A Chair of trustees must sign the Statement of Strategy, and provide it to the Regulator with the valuation to which it relates.
The draft Regulations do not replace wholesale the existing scheme specific funding requirements and they set out how the new requirements are to be interwoven with the Scheme Funding Regulations 2005. One of the most controversial amendments will affect schemes where a recovery plan is required, whereby in setting recovery plans trustees will need to consider what is “appropriate” including a requirement for trustees to follow the principle that deficits “must be recovered as soon as the employer can reasonably afford”.
Trustees must have their first FIS in place within 15 months of the effective date of their first scheme valuation after the draft Regulations come into force, and reviewed within 15 months of each valuation thereafter or if there is a material change in the circumstances of the scheme or employer.
While the implementation date for a scheme’s first FIS could be some way off, the draft Regulations stipulate that the level of investment risk must be considered as the scheme “moves along its journey plan”. Trustees need to therefore understand what is expected of them and not wait for the changes to be in force before taking preparatory action. Questions to be posed now include:
Given the fundamental changes to scheme funding and some relatively controversial proposals, it is expected that the consultation process will garner significant numbers of industry responses and it is hoped that the consultation and new Code will clarify a number of thorny issues.
For example, there has already been some consternation among industry commentators on the actual and practical effects of the requirement to agree an FIS with employers, and a trustee’s ability to freely determine a scheme’s investment strategy under section 35(5) of the Pension Act 1995.
Equally, the proposal to introduce a concept of ‘reasonable affordability’ when setting recovery plans raises questions as to whether, in the current economic climate, this consideration should take primacy over existing factors trustees must consider when setting recovery plans. It is not clear how the introduction of this requirement would sit alongside the Regulator’s current statutory objective to minimise any adverse effect on the sustainable growth of the scheme’s employer.
Further the draft Regulations make no mention of the proposed “fast track” and “bespoke” funding approaches which the Regulator first consulted on in 2020. Again, we await the new Code to see how these plans may have evolved in the intervening period and how they would work alongside the draft Regulations.
As matters stand, without the new Code in hand, trustees and employers cannot yet know what exactly will be required. What is clear, is that the changes will require trustees and employers to work much more collaboratively in the future. This will apply at and between scheme valuations particularly in light of the new statutory requirements for employer covenant analysis, and generally in respect of funding and investment. Trustees and employers alike must therefore watch out for the publication of the new Code and consultation response. The consultation closes on October 17, 2022, with the new Code expected over the autumn.
Norton Rose Fulbright LLP will be feeding into the consultation and will provide updated briefings and blogs as more information from the DWP and Regulator becomes available. If you have any questions on this topic please contact the Norton Rose Fulbright LLP pensions team.
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