In this section we look at the latest developments on scheme funding, including the likely timescale for the Pensions Regulator's new DB funding code of practice, and key points for trustees in the Regulator's annual funding statement.  

Regulator's Corporate Plan indicates timescale for new DB funding code and other measures

In its Corporate Plan 2021-24 the Regulator says that it expects its final revised DB funding code of practice to be in place by December 2022, with scheme valuations submitted to the Regulator under the new guidelines from the point at which the code comes into force. (There is a slight discrepancy here with the Regulator's annual funding statement which refers to the code being in force late 2022 "at the earliest").  The plan also confirms that the Regulator expects its criminal sanction and expanded "moral hazard" powers to take effect from October 2021, and says that the new notifiable events provisions are due to be commenced in 2022.

Pensions Regulator publishes single code of practice for consultation

On 17 March the Pensions Regulator published for consultation its draft amalgamated code of practice which combines ten of its existing codes of practice into a single web-based code.  The majority of the new code's content is drawn from existing codes, but there are a number of areas with new content, including:

• role of the scheme's governing body;
• how to meet the statutory requirement for an effective system of governance;
• a requirement for schemes to carry out a documented "own risk assessment" within one year of the amalgamated code coming into force and then annually;
• risk management and internal controls;
• IT systems and cyber-risk;
• ESG and stewardship.

Although codes are not legally binding as such, they set out the Regulator's expectations of trustees, and the courts are required to have regard to relevant code provisions.

Our thoughts

The consultation period for the amalgamated code was short, considering that it contains some important content that is completely new.  If the code is brought into force in its current form there will be some significant new requirements for trustees to comply with.  We will report in more detail once the consultation response has been published and it's clear what the new code will look like.

Annual funding statement 2021

On 26 May the Pensions Regulator (TPR) published its annual funding statement 2021.  The statement is particularly relevant to schemes with valuation dates between 22 September 2020 and 21 September 2021(known as Tranche 16 valuations).  The statement has a similar format to recent years with a table setting out TPR's expectations for schemes in different categories according to employer covenant strength, the scheme's funding position and its level of maturity.  However, the statement has been updated to take account of recent events, in particular the impact of Covid-19 and Brexit.

The statement says that TPR will regulate Tranche 16 valuations according to existing legislation and guidance, and that TPR does not expect its new DB funding code to come into force until late 2022 "at the earliest".

The statement highlights the following points for schemes currently undertaking a valuation:

• TPR encourages schemes to use scenario planning as part of their integrated risk management strategies;
• inflation: trustees should choose assumptions carefully taking into account the UK Statistics Authority's plans to align RPI with the Consumer Prices Index including owner-occupied housing costs (CPIH);
• mortality: there are divergent opinions on the impact of Covid-19 on the course of future longevity improvements.  If trustees weaken mortality assumptions materially, they should consider monitoring and contingency plans in case the assumptions are not borne out in practice;
• post-valuation experience: taking into account employer affordability, TPR would usually expect any changes from factoring in favourable post-valuation events to reduce the length of the recovery plan rather than the level of annual payments;
• liquidity risk: where schemes are closed to new members and therefore maturing, trustees should actively monitor and mitigate liquidity risks;
• covenant assessments: trustees should consider obtaining independent specialist advice to support covenant assessments, particularly where the covenant is complex, the outlook for any Covid-19 related recovery is unclear, Brexit implications appear significant, the covenant is deteriorating, or the scheme has a high level of reliance on the covenant, eg due to a large deficit or high level of investment risk;
• Covid-19: where Covid-19 is having a material adverse impact on the employer covenant, trustees should not assume there will be a full recovery in employer covenant support without good justification.  In circumstances of employer stress and uncertain outlook, TPR expects covenant leakage, for example through dividends, to be minimised and for the employer's focus to be on protecting creditors such as the pension scheme;
• Brexit: TPR expects trustees to review the employer's covenant to understand whether any impacts of Brexit are short-term or represent a more fundamental challenge;
• affordability and deficit repair contributions (DRCs): where external developments such as Brexit and Covid-19 have had a limited impact on the employer's business, TPR expects trustees to take a "business as usual" approach to setting recovery plans and not reduce DRCs or extend recovery plan end dates.  Where the employer has recommenced or continued to make shareholder distributions, TPR views this as being inconsistent with the scheme having to agree lower contributions.  TPR also expects any deferred DRCs to be repaid in such circumstances, "ideally before any shareholder distributions recommence".  Where trustees do agree to DRC deferrals or reductions, TPR expects them to agree appropriate mitigations, eg all forms of dividends and other shareholder distributions to stop while DRCs remain at the lower level;
• contingency plans should be in place to enable trustees to react appropriately to changes in the employer covenant.  Ideally trustees should have an agreement with the employer regarding agreed trigger points that will result in specified actions taking place.  TPR expects trustees to be able to demonstrate that they have discussed key risks and trigger points with the employer;
• corporate transactions: trustees should take a rigorous approach to assessing the impact of  any corporate transactions and negotiating mitigation where appropriate;
• long-term funding targets (LTFTs): although the Pension Schemes Act 2021 requirements for long-term funding objectives are not yet in force, TPR encourages trustees to incorporate this approach into their thinking and agree it with the employer;
• scheme maturity: TPR expects scheme maturity issues to assume greater significance for setting funding and investment strategies;
• IRM and governance: TPR continues to expect trustees to focus on the integrated risk management (IRM) of three broad areas of risk: the ability of the employer to support the scheme; the investment risks and the scheme's funding plans.  Trustees should consider the impact of climate change on IRM.  Once TPR's amalgamated code of practice comes into force (expected to be late 2021), schemes with 100 or more members will be required to document and maintain an "own risk assessment" within 12 months.

Developments regarding the Pensions Regulator's criminal sanction and moral hazard powers

The past quarter has seen several developments related to the Pensions Regulator's new criminal sanction powers and broadened moral hazard powers under the Pension Schemes Act 2021 which are expected to come into force in October.  The Regulator has consulted on its prosecutions policy for its criminal sanction powers; the DWP has consulted on regulations fleshing out some of the detail on the moral hazard powers; and the Regulator is currently consulting on its draft code in relation to contribution notices. We consider each of these developments in more detail below.  

Once the new powers are brought into force they will criminalise an act or failure to act which reduces the likelihood of accrued scheme benefits being received.  It will also be a criminal offence to prevent a debt on the employer becoming due under section 75 of the Pensions Act 1995, compromise or prevent recovery of such a debt, or reduce the amount that would otherwise become due.  Both offences are subject to a "reasonable excuse" defence.  Anyone can be prosecuted for the new offences other than an insolvency practitioner acting as such.

Under its existing "moral hazard" powers, the Regulator already has broad powers to require scheme employers and others (including companies in the same group and individual directors) to provide extra funding for a defined benefit scheme.  When the changes made by the Pension Schemes Act 2021 come into force, it will be possible for the Regulator to impose liability under its moral hazard powers if an act or omission reduces the amount the scheme would be able to recover from the employer(s) on a hypothetical insolvency (the "employer insolvency test"), or if it materially reduces the value of the employer's resources relative to the amount of the debt due from the employer if a statutory debt were triggered under pensions legislation (the "employer resources test").  

The Regulator's draft prosecutions policy

The draft policy says that Government policy is that the criminal offences are not intended to cause a fundamental change in commercial norms or accepted standards of corporate behaviour.  The new powers are intended to enable TPR to address more serious intentional or reckless conduct that was within the scope of its contribution notice powers under the "moral hazard" provisions (or would have been had the person been an employer or other person against whom a contribution notice can be issued).  The Regulator says its approach will be guided by the Government's policy intention.  It will consider a case for prosecution in broadly the same circumstances in which it would consider seeking a contribution notice.

The "reasonable excuse" defence

In relation to the "reasonable excuse" defence, the legal burden is on the prosecution to prove the absence of a reasonable excuse.  TPR expects the basis for the reasonable excuse to be clear from contemporaneous records such as meeting minutes, correspondence and written advice.  Three key factors which will be significant in determining whether there is a reasonable excuse are:

• whether the detrimental impact on the scheme/likelihood of accrued scheme benefits being received was an "incidental" consequence of the act or omission as opposed to a "fundamentally necessary step to achieve the person's purpose";
• the adequacy of any mitigation provided to offset the detrimental impact; and
• where no, or inadequate, mitigation was provided, whether there was a viable alternative which would have avoided or reduced the detrimental impact.

Factors relevant to the decision whether to prosecute

TPR will select cases for prosecution being mindful of the policy intent behind the new offences, for example where the primary purpose of the conduct is the abandonment of the scheme without appropriate mitigation.

Consultation on draft code on contribution notices code of practice

On 27 May the Pensions Regulator published a consultation on a draft new code of practice on the circumstances in which it intends to use its "moral hazard" powers to issue a contribution notice under the new "employer insolvency test" and "employer resources test".  In the Code-related guidance accompanying the draft code, the Regulator sets out examples of actions that could become the subject of a contribution notice if no or inadequate mitigation is provided to the scheme.  These include:

• an intra-group restructuring in which the sponsoring employer ceases to own a subsidiary with substantial property assets and in return receives only an unsecured, non-interest-bearing inter-company debt that has no repayment date;
• the sponsoring employer pays a significant dividend to its parent company which is much larger than dividends paid in previous years and is greater than the company's net profit generated over the same reporting period; and
• the sponsoring employer makes an unscheduled repayment of an intercompany loan when it is facing financial difficulty and has diminishing financial headroom.

The consultation closes on 7 July 2021.

Our thoughts on the prosecutions policy and draft contribution notices code

As a matter of law, there is no reason why a pension scheme trustee could not in principle be prosecuted for the new criminal offences.  However, the complete absence of any mention of trustees in the draft prosecution policy is perhaps an indication that TPR is likely to focus its attention on corporate decision-makers rather than trustees.  Nevertheless, trustees should take care that their acts or omissions do not expose them to potential criminal liability, bearing in mind that they could be investigated years later with the benefit of hindsight.  Making sure there is an appropriate "paper trail" in place will be important in relation to acts or omissions which could potentially impact accrued scheme benefits so that trustees can demonstrate that they had a reasonable excuse for acting as they did.

Trustees also need to be aware of how the new powers (both the criminal sanctions and the broader "moral hazard" powers) impact the behaviours which the Regulator expects of the scheme's sponsoring employer and its wider group.  Trustees should be prepared to engage with the sponsoring employer in circumstances where its corporate activity could potentially bring it within scope of the Regulator's powers.  It may be that the new powers prompt more applications to the Pensions Regulator for clearance, though the clearance procedure is only available in relation the Regulator's moral hazard powers, not the criminal offences.

Consultation on regulations re contribution notices and information gathering powers

The DWP has consulted on two sets of regulations relating to the new powers to be granted to the Pensions Regulator (TPR) by the Pension Schemes Act 2021.

One set of regulations relates to the detailed test for establishing whether there has been a material reduction in the employer's resources. The draft regulations provide that the resources of the employer are the "normalised profits" of the employer before tax.  TPR is given the power to determine whether an item is to be treated as non-recurring or exceptional for the purposes of the normalised profits calculation, the value of any non-recurring or exceptional items, and the effect of the act or failure to act on the resources of the employer.

The other draft regulations set out the matters to be included in an interview notice when TPR uses its new statutory power to require a person to attend an interview.  They also set out the fixed and escalating financial penalties which the Regulator can apply if a person fails to comply with an interview notice.  The fixed penalty is £400.  For an escalating penalty the daily rate for an individual is £200.  For a person other than an individual the daily rate starts at £500 and increases by £500 on each subsequent day up to day 20, from which point a daily rate of £10,000 applies.

Pensions Regulator and PPF joint consultation on collection of asset information

On 29 April the Pensions Regulator (TPR) and PPF published a joint consultation on proposals to alter the asset information collected from defined benefit pension schemes via the scheme return.  TPR uses the information collected to help measure investment risk, and the PPF uses it to help calculate the PPF levy.

The consultation proposes collecting more detail about the investments held, particularly in relation to bonds and equities.  

The consultation closes on 10 June 2021.

Regulator publishes climate change strategy

On 7 April the Pensions Regulator (TPR) published its climate change strategy setting out its key objectives and regulatory strategy in relation to requirements that apply to occupational pension schemes and relate to climate change risk.

TPR will publish guidance which will consider how schemes should take account of climate change in integrated risk management.  It will also add new questions to the scheme return asking for the web address of climate change-related documents.  TPR says it will take appropriate enforcement action where trustees fail to comply with requirements to prepare and publish their SIP implementation statement.

Corporate strategy published

In March the Pensions Regulator published its corporate strategy setting out its vision for the next 15 years.  It lists its strategic priorities as:

• security: ensuring DB schemes are funded to meet the promises made to savers; ensuring contributions are paid promptly; driving consolidation when this is in savers' interests; and protecting savers from scammers;
• value for money: ensuring savers' money is suitably invested and that charges are reasonable;
• scrutiny of decision-making: monitoring decision-makers across all scheme types; scrutinising decisions that "pose a heightened risk to the quality of outcomes" and increasing focus on savers' exposure to economic risks, including environmental social and governance risks;
• embracing innovation: encouraging innovation, "facilitating the development of technology and sharing of good practice, and collaborating with the market to encourage security, efficiency, transparency, simplicity and choice";
• bold and effective regulation: acting quickly and being tough where needed; adopting a principles-based approach where appropriate; taking a proportionate approach and demonstrating the Regulator's own effectiveness and value.