Published on October 22, 2014
1. Teach-In Dealing with tPR’s New Scheme Funding Code October 2014 Dealing With tPR’sNew Scheme Funding Code22ndOctober 2014
2. Teach-In Dealing with tPR’s New Scheme Funding Code October 2014 An Evolving Pension Landscape 2 Time 2006 2014
3. Teach-In Dealing with tPR’s New Scheme Funding Code October 2014 1.“Schemes must minimise any adverse impact on the sustainable growth of an employer, with risks being understoodand managed appropriately.” 2.“Emphasis on collaborationbetween trustees and employers in regards to the scheme’s risks.” tPR’sNew Scheme Funding Code 3
4. Teach-In Dealing with tPR’s New Scheme Funding Code October 2014 Peter Ford, Partner Norton Rose Fulbright Peter Ford is head of the pensions department at Norton Rose. His experience includes pension scheme mergers and reorganisations, scheme winding-up, investment and custody and pensions litigation. Peter has previously been a director of two trustee companies and has recently been re-elected as a member of the Main Committee of the Association of Pension Lawyers. Peter was the lead legal adviser to the Government sponsored Pickering Review into the simplification of private pensions and is a member of a number of pensions organisations. Peter is recognised as an ‘excellent analyser and communicator’ and ‘a heavyweight in the field’ who ‘finds solutions rather than problems’ by Legal 500 UK 2013. He is noted“as a strong and dynamic performer” in Chambers UK 2010. 4 T:+44 20 7444 2711 F:+44 20 7283 6500 Email: firstname.lastname@example.org
5. The Pensions Regulator’s New DB Funding Regime Peter Ford Partner Norton Rose Fulbright LLP Wednesday 22 October 2014
6. Introduction • New DB Scheme Funding Code • Regulator’s Statutory Objectives • Key Funding Principles • Key Themes • Practical Issues 6
7. New DB Scheme Funding Code • Issued with effect from 29 July 2014. • Replaces previous (2006) Code. • Reflects Regulator’s new statutory funding objective: “to minimise any adverse impact on the sustainable growth of the employer.” 7
8. Statutory Objectives The Pension Regulator’s statutory objectives are: • to protect the benefits of pension scheme members; • to reduce the risk of calls on the PPF; • in relation to scheme funding only, to minimise any adverse impact on the sustainable growth of an employer; • to promote and improve understanding of, and good administration or work-based pensions; and • to maximise compliance with the duties and safeguards in the Pensions Act 2008 (i.e. Auto-enrolment). 8
9. Balanced Approach TPR has stated that the same weight will be given to new statutory funding objective as to other objectives including protection of members benefits and reducing risk of call on the PPF. Clear desire to promote a more balanced approach between employers and trustees “in particular, the Code recognises that a strong ongoing employer alongside an appropriate funding plan is the best support for a well governed scheme.” 9
10. Key Funding Principles The Code sets out 9 key funding principles for DB schemes: • working collaboratively; • managing risks; • taking risks; • taking a long term view; • proportionality; • balance; • good governance; • fair treatment of the scheme by the employer; and • reaching funding targets. 10
11. Key Themes • Proportionality and balance. • Collaborative approach. • Integrated approach to risk management. • Less prescriptive intervention. 11
12. Key Themes – Proportionality and Balance Requirement for proportionality and balance permeate the Code. Trustees should balance the need to pay the promised benefits whilst minimising the adverse effect on the employer’s sustainable growth – but paying the promised benefits remains the key objective for scheme trustees. 12
13. Key Themes – Collaborative approach Key emphasis on collaboration between trustees and employers to achieve the appropriate funding outcome. Balancing the need to pay promised benefits against potential adverse effects on employer’s sustainable growth will require co-operation. However, it is clear that sustainable growth will mean different things to different employers: “for some growth is a real prospect whilst for others it may be more about maintaining their position or slowing a business decline.” 13
14. Key Themes – Integrated Approach to Risk (1) • Clear focus on the interaction between employer covenant, investment and funding risk. • Recognition that a change in one of these three key risks will affect the other two. • Requirement for trustees to identify, assess, monitor and address these risks appropriately and effectively – but not necessary to eradicate risk completely. • Importance of understanding covenant in establishing funding targets and investment strategy is key. 14
15. Key Themes – Integrated Approach to Risk (2) • Trustees should set an appropriate risk appetite. • Need to recognise the importance of covenant over time and undertake scenario testing. • Agree appropriate management actions and contingency. • It is clear that covenant will be a key factor in developing investment strategy. 15
16. Key Themes – Integrated Approach to Risk (3) 16
17. Key Themes – Less Prescriptive Intervention • Removal of trigger based approach (e.g. length of recovery period). • Risk indicators: – covenant strength (weak; tending to weak; tending to strong; strong); – funding; – investment risk; and – governance. • Target resources on schemes posing the greatest risk and where can have greatest impact. 17
18. Comparison of Old and New Codes 2006 Code 2014 Code Main focus on funding risk Integrated risk management (covenant, funding and investment) Prudent assumptions Balanced outcome Mechanical approach to interventions Interventions based on assessed risks Deficit eliminated as soon as the employer can reasonably afford Deficit eliminated over an appropriate period 18
19. Practical Issues • Valuations – still a requirement for assumptions to be prudent but focus also on balanced outcomes. Issues still likely to exist for schemes with weak covenants/poor funding. • Integrated approach to risk – to some extent reflects existing best practice. Regulator now asking to see VaR analysis. • Covenant advisers will also start looking at VaR analysis. • Helpful advice on dividends – recognition that dividend payments can be consistent with sustainable growth and funding objective. 19
20. Disclaimer Norton Rose Fulbright LLP, Norton Rose Fulbright Australia, Norton Rose Fulbright Canada LLP, Norton Rose Fulbright South Africa (incorporated as Deneys Reitz Inc) and Fulbright & Jaworski LLP, each of which is a separate legal entity, are members (‘the Norton Rose Fulbright members’) of Norton Rose Fulbright Verein, a Swiss Verein. Norton Rose Fulbright Verein helps coordinate the activities of the Norton Rose Fulbright members but does not itself provide legal services to clients. References to ‘Norton Rose Fulbright’, ‘the law firm’, and ‘legal practice’ are to one or more of the Norton Rose Fulbright members or to one of their respective affiliates (together ‘Norton Rose Fulbright entity/entities’). No individual who is a member, partner, shareholder, director, employee or consultant of, in or to any Norton Rose Fulbright entity (whether or not such individual is described as a ‘partner’) accepts or assumes responsibility, or has any liability, to any person in respect of this communica tion. Any reference to a partner or director is to a member, employee or consultant with equivalent standing and qualifications of the relevant Norton Rose Fulbright entity. The purpose of this communication is to provide information as to developments in the law. It does not contain a full analysis of the law nor does it constitute an opinion of any Norton Rose Fulbright entity on the points of law discussed. You must take specific legal advice on any particular matter which concerns you. If you require any advice or further information, please speak to your usual contact at Norton Rose Fulbright. 21
21. Teach-In Dealing with tPR’s New Scheme Funding Code October 2014 Dealing With tPR’sNew Scheme Funding CodeRobert Gardner
22. Teach-In Dealing with tPR’s New Scheme Funding Code October 2014 Integrating Covenant, Funding And Investment 23
23. Teach-In Dealing with tPR’s New Scheme Funding Code October 2014 tPR’sApproach To Measuring Covenant Strength 24 Reducing Risk Budget for Investment & Demographic Risk Strong Tending to Strong Tending to Weak Weak Sustainable growth plans Keep covenant strong through security in place Monitoring of covenant risks Payments that weaken covenant a concern Likely to be in a position to handle risk Managed solutions Maximise covenant value Funding plan to reflect covenant risks Risk taking needs significant management Strong target needed reflecting investment strategy and weak support for risks Scheme viability a concern 24
24. Teach-In Dealing with tPR’s New Scheme Funding Code October 2014 How Does Covenant Strength Impact AScheme’s Ability To Take Investment Risk? 25 0 20 40 60 80 100 120 140 160 CG1: Strong CG2: Tending Towards Strong CG3: Tending Towards Weak CG4: Weak Limiting the Risk Budget Risk Budget Maximum Covenant Load
25. Teach-In Dealing with tPR’s New Scheme Funding Code October 2014 What Levers Can We Pull? 26 £(m) Time Liabilities Deficit £10m £15m
26. Teach-In Dealing with tPR’s New Scheme Funding Code October 2014 What Levers Can We Pull? 27 Investment return Contributions Time 3yrs 12yrs 6yrs 9yrs 2.0% 2.5% 1.5% 0.5% 1.0% £10m £15m £5m
27. Teach-In Dealing with tPR’s New Scheme Funding Code October 2014 28 How Do We Measure The Impact Of Investment Risk On The Sponsor Using Contributions at Risk?
28. Teach-In Dealing with tPR’s New Scheme Funding Code October 2014 How The Covenant Load Varies As You Move The Levers 29 £(m) Contributions at Risk £30m £ Contributions £15m Investment Returns £30m Contributions at Risk £20m £ Contributions £20m Investment Returns £20m Contributions at Risk £16m £ Contributions £17m Investment Returns £17m 75 60 40 Increase contributions Extend Time Horizon
29. Teach-In Dealing with tPR’s New Scheme Funding Code October 2014 Objective Measurement PerformanceIndicators Performance(30 Jun 13) Status Primary Funding Objective To reachfull funding by  based on discount rate of Gilts + 1.00% (Technical Provisions basis) Expected Returns (ER)>Required Returns (RR) RR: Libor + 275bps ER: Libor + 200bps Difference: -75bps SecondaryFunding Objective To reach full funding ona buyout basis by  based on a Gilts Flat discount rate Expected Returns (ER) >Required Returns(RR) RR: Libor + 250bps ER: Libor + 200bps Difference: -50bps RiskBudget The investmentstrategy should not risk the deficit worsening by [20%] of liabilities over a 1 year period VaR95< [20%] of liabilities VaR95:30.0% Covenant Load The sum of annual contributions and the 1 yearContribution at Risk Contributionsat Risk < [£50 Million] Contributions at Risk:[£100Million] Hedging Strategy Nominal/Inflation hedge ratio should be maintained within +/-5% of the funding ratio. Funding Ratio (Gilts + 1.00%) 60% NominalHedge Ratio (Gilts + 1.00%) 20% Inflation Hedge Ratio (Gilts + 1.00%) 25% Collateral Maintain sufficient eligible for meeting collateral requirements that may arise from the Scheme’s current derivative positions over a 1 year period. Total available eligible collateral £300m Remaining collateral after VaR95 event £200m Integrating Covenant Into Your Pension Risk Management Framework 30 Status Metricis at or above target Metric is within [10%] of target Metric is more than[10%] away
30. Teach-In Dealing with tPR’s New Scheme Funding Code October 2014 What Does This Mean In Practice? 31 Covenant Investment Strategy Funding Covenant strength Downside protection and management of volatility Deficit Contributions Benefit changes Security arrangements Asset backed funding Cash flows needed to meet member benefits
31. Teach-In Dealing with tPR’s New Scheme Funding Code October 2014 How Do We Get The Right Balance Of Growth, Risk Control And Cash Flow Matching? 32 Meeting the Gap Assets with Cash Flows Smoothing Volatility Gilts Index Linked Gilts Credit Equities Private equity Risk Parity VolControlled Equities Multi-Asset Illiquid credit LDI hedging Secured Leases
32. Teach-In Dealing with tPR’s New Scheme Funding Code October 2014 A Shift In Mind Set 33
33. Teach-In Dealing with tPR’s New Scheme Funding Code October 2014 Conclusions 34 Integrate your approach An integrated approach to managing risk means taking account of employer covenant, funding and investment risk when managing a pension scheme. Categorised sponsor covenants The pension regulator has classified sponsor covenants in four levels from Strong to Weak. Constraints due to weak sponsors Weak sponsors will lead to significant constraints on risk budgets. Different levers are available In order to reduce Contributions atRisk, contributions can be raised or the time horizon extended. Contributionsat Risk Contributions at Risk are a useful measure that enables a pension scheme to equate existing risk budgets with risk to the sponsorthrough the potential requirement for additional contributions. The PRMF The constraints can be built into an existing PRMF (Pension Risk Management Framework). Gettingthe balance right Finding the balance between assets for growth, risk management and cash flow matching. Mind set A collaborative approach i.e. a shift inmind set from win-lose to win-win.
34. Teach-In Dealing with tPR’s New Scheme Funding Code October 2014 13-15 Mallow Street London EC1Y 8RDTelephone : +44 (0) 20 7250 3331www.redington.co.uk Please Get In Touch 35 Disclaimer Forprofessionalinvestorsonly.Notsuitableforprivatecustomers. Theinformationhereinwasobtainedfromvarioussources. Wedonotguaranteeeveryaspectofitsaccuracy.Theinformationisforyourprivateinformationandisfordiscussionpurposesonly.Avarietyofmarketfactorsandassumptionsmayaffectthisanalysis,andthisanalysisdoesnotreflectallpossiblelossscenarios.Thereisnocertaintythattheparametersandassumptionsusedinthisanalysiscanbeduplicatedwithactualtrades.Anyhistoricalexchangerates,interestratesorotherreferenceratesorpriceswhichappearabovearenotnecessarilyindicativeoffutureexchangerates,interestrates,orotherreferenceratesorprices.Neithertheinformation,recommendationsoropinionsexpressedhereinconstitutesanoffertobuyorsellanysecurities,futures,options,orinvestmentproductsonyourbehalf.Unlessotherwisestated,anypricinginformationinthismessageisindicativeonly,issubjecttochangeandisnotanoffertotransact.Whererelevant,thepricequotedisexclusiveoftaxanddeliverycosts.Anyreferencetothetermsofexecutedtransactionsshouldbetreatedaspreliminaryandsubjecttofurtherduediligence. Pleasenote,theaccuratecalculationoftheliabilityprofileusedasthebasisforimplementinganycapitalmarketstransactionsisthesoleresponsibilityoftheTrustees'actuarialadvisors.RedingtonLtdwillestimatetheliabilitiesifrequiredbutwillnotbeheldresponsibleforanylossordamagehowsoeversustainedasaresultofinaccuraciesinthatestimation.Additionally,theclientrecognizesthatRedingtonLtddoesnotoweanypartyadutyofcareinthisrespect. RedingtonLtdareinvestmentconsultantsregulatedbytheFinancialConductAuthority.Wedonotadviseonallimplicationsofthetransactionsdescribedherein.Thisinformationisfordiscussionpurposesandpriortoundertakinganytrade,youshouldalsodiscusswithyourprofessionaltax,accountingand/orotherrelevantadvisershowsuchparticulartrade(s)affectyou.Allanalysis(whetherinrespectoftax,accounting,laworofanyothernature), shouldbetreatedasillustrativeonlyandnotrelieduponasaccurate. ©RedingtonLimited2014.Allrightsreserved.Noreproduction,copy,transmissionortranslationinwholeorinpartofthispresentationmaybemadewithoutpermission.ApplicationforpermissionshouldbemadetoRedingtonLimitedattheaddressbelow. RedingtonLimited(6660006)isregisteredinEnglandandWales.Registeredoffice:AustinFriars,2-6AustinFriars, LondonEC2N2HD 2-6 Austin Friars, London EC2N 2HD Redington Publications Robert Gardner Founder and Co-CEO Tel: 0207 250 3416 Email: email@example.com Twitter: @robertjgardner
35. Teach-In Dealing with tPR’s New Scheme Funding Code October 2014 36 The Endgame: What are the Illiquid Credit Opportunities? ILS: Insurance linked securities CRE: Commercial Real Estate Debt
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