2020 has been a uniquely challenging, unpredictable and eventful year, dominated (as we all know too well) by the impact of Covid-19, which has changed the way we live, work and do business, and also by the preparations for Brexit. Both of these themes will undoubtedly continue to dominate the economic and political agenda in 2021 in what is likely to be a challenging environment for many businesses.
Against this backdrop, 2021 will provide an immediate test for the new criminal offences, regulatory powers and funding requirements contained in the Pension Schemes Bill, as well as the new insolvency procedures introduced by the Corporate Insolvency and Governance Act 2020 during the UK’s first national lockdown earlier this year. We can also expect the Government to try to regain the initiative by setting outs its plans to rebuild and restructure the UK economy in a post-Covid, post-Brexit world. The Government’s focus on environmental, social and governance issues will also continue as the UK prepares to host the UN climate change conference, COP26, in Glasgow next November.
All of these issues are likely to affect the pensions industry during the course of next year, either directly or indirectly, and we consider their potential impact below.
Economic recovery and restructuring
The pandemic continues to cast its shadow over our personal and working lives and over the UK and global economies. Over the past few months, governments around the world have continued to address the risks posed by Covid-19 with many, particularly in Europe, fighting to control a second wave. The untimely news of a more prolific strain of the virus raises the prospect of a third national lockdown for the UK as we enter the New Year and threatens to isolate the UK on the global stage at the worst possible time. However, hope remains that a successful roll-out of the Covid vaccines will offer a route back to “normality” (whatever that means) in the not too distant future.
While the true economic impact of Covid-19 is not yet known, many are warning that we are in the calm before the economic storm. It is likely that we will see a number of insolvencies in the first and second quarters of 2021 as the impact of further lockdowns take their toll and as Government assistance comes to an end. In light of this, trustees will need to continue to keep a close eye on their sponsor covenant and their scheme’s investment strategy.
The uncertainty regarding Covid-19 is compounded by the ongoing uncertainty surrounding Brexit. With less than ten days to go until the UK officially becomes a third country vis-à-vis the EU we still do not know the terms on which this will happen. In particular:
- Will goods traded between the UK and the EU27 be subject to tariffs?
- How far will the UK be able to deviate from EU law in the future? And what might the consequences of this be?
- How will Brexit impact UK and EU businesses and financial markets over the short and the longer term?
Within a matter of days, we should discover the answers to some of these questions, but the full impact of Brexit will not be known for many years. Having said that, we can expect the UK Government to outline its plans for a post-Covid, post-Brexit economic recovery early in the New Year. This is likely to include new capital expenditure, a focus on building a greener economy and measures to implement the Government’s levelling-up agenda.
Given all of this uncertainty, businesses and trustees should have already identified the key risks associated with Covid-19 and Brexit and taken steps to mitigate them. These risks to businesses and schemes will need to be monitored closely as 2021 unfolds.
New regulatory powers
The Pension Schemes Bill has nearly completed its prolonged passage through Parliament and we can expect the Regulator’s new criminal and civil powers to come into force during the course of 2021. This will provide a significant test for the Pensions Regulator who will be under pressure from some quarters to make use of these new powers at a time when, if it is to support the sustainable growth of scheme sponsors, it will need to show pragmatism, creativity and flexibility, with many businesses being forced to restructure and to make difficult decisions due to the challenges that they face.
Directors, investors, sellers, purchasers, lenders and advisers to corporate sponsors of defined benefit (DB) pension schemes, should already be taking account of the new criminal offences and regulatory sanctions contained in the Pension Schemes Bill, as they may:
- restrict the scope for businesses with DB pension schemes to secure fresh investment or take on additional debt, particularly where the scheme has a material deficit, and
- impact the feasibility, manner and desirability of restructuring or selling the whole or part of a business or group with a DB scheme.
In addition, there may be scope for some of these new powers to be used retrospectively, and in any event, where transactions are being contemplated these new powers may impact post-transaction activity, such as any re-financing or restructuring.
Funding and journey plans
One area in which we may get an early indication of how flexible and pragmatic the Regulator will be is in relation to its new funding Code. Having launched the first part of its consultation on the new Code at the beginning of March (before the first national lockdown), DB sponsors will be keen to see to what extent the Regulator has adjusted its proposed approach in light of the economic reality that we now face.
Speaking at the Pensions Age Northern Conference 2020 this month, Neil Bull, investment consultant at the Pensions Regulator, confirmed that the Regulator plans to publish the second consultation on its proposed DB funding code in mid-2021 (having originally planned to do so this year). This will give it time to consider the record 130 responses that it has received and to take account of how the start of next year unfolds.
Assuming the Regulator decides to press ahead with its plans to introduce a new Code at this time, it is to be hoped the content will adequately recognise the need to promote the sustainable growth of scheme sponsors (as well as to protect DB scheme members) and that the proposed parameters for the new fast track approval process (for example, the prescribed recovery plan lengths and the ability for schemes to take account of asset outperformance in their recovery plans) will be adjusted to give sponsors time to recover from the impact of multiple lockdowns.
As well as addressing their immediate funding challenges, trustees of DB schemes will also be required to agree a legally binding long-term objective (LTO) with their scheme sponsor – be it buy-out, consolidation or low-dependency. This target will drive the scheme’s future funding requirements.
Some schemes are already approaching the end of their journey. Despite the economic uncertainty, the number and value of buy-out transactions remained high this year. A recent report by Barnett Waddingham found that the bulk annuity market has demonstrated “remarkable resilience” despite the Covid-19 pandemic with an estimated £25bn to £30bn worth of transactions due to have been completed this year. We expect the buy-out market will continue to operate at these levels over the next 12 months.
2020 has also paved the way for the emergence of so-called DB “superfunds”, with the Regulator issuing its interim regulatory regime and related guidance for trustees, sponsors and consolidators. The two main players in this market have said that they expect to complete their first transactions in the first half of 2021. If this materialises it could lead to the rapid growth of this sector.
One of the positives arising out of 2020 is that we have seen environmental, social and governance (ESG) issues climb up the agenda and receive much greater attention from policymakers, regulators, businesses and investors. We anticipate that ESG considerations and, in particular, climate change will continue to receive a lot of attention within the pensions industry (and more broadly) next year as the UK prepares to host COP26 at the end of the year.
The Government has also made clear that it intends to put the green agenda at the heart of the economic recovery as it seeks to “build back better”. This is reflected in the Government’s ten point plan for a “green industrial revolution” and its plans to launch the UK’s first ever sovereign green bond in 2021 and to make the City of London the global centre for green finance.
The UK Government also intends to be the first in the world to make it mandatory for companies, banks, asset managers and institutional investors (including pension schemes) to publish disclosures aligned with the recommendations of the Taskforce Climate-related Financial Disclosures (TCFD) by 2025 with many of the new requirements applying from 2023.
The DWP has made clear that it sees pension schemes (as significant UK asset owners) having a vital role to play in the energy transition and the fight against climate change. Trustees, pension providers and asset managers face a steep learning curve in the coming years as they get to grips with the new requirements. Those who lag behind face the growing threat of legal challenges from scheme members and civil society groups.
Employers must also be mindful of the approach their scheme is taking on climate-related issues and other ESG matters to avoid the embarrassment and reputational damage that could be caused if their scheme is out of step with the company’s own corporate values,
From ESG to GMPs. Following the judgment in the 2nd instalment in the Lloyds GMP litigation, trustees of schemes which provide GMPs accrued between 17 May 1990 and 5 April 1997 now know that they need to revisit and, where necessary, top-up historic cash equivalent transfer values (CETVs) that have been undervalued. Most schemes are still grappling with how to equalise the benefits of existing members and pensioners, following the 1st Lloyds judgment, with the majority of schemes likely to complete this exercise in the next two to three years. However, these projects will now need to be extended to include former members who have taken a CETV since 17 May 1990.
Roll on 2021
So as we say goodbye (and, in many respects, good riddance) to 2020, let’s hope that 2021, with all of the challenges we know await, will be a year in which we can wipe away our tiers (and GMPs), embrace our LTOs and look forward to a new, more global, more vibrant and greener future.