Lesley Titcomb – Institutional Investor: UK and Ireland summit DB conference
Tuesday 13 June 2017
Thank you very much for inviting me here today – and not least to enjoy the glorious setting.
A lot has happened in the pensions landscape since this same event last year. We thought then that we’d faced a lot of changes – and since then we’ve had Brexit, unsettling political and financial markets, a handful of headline grabbing cases and of course a general election.
Last week’s result sparked market movements and we can expect further volatility as various things, including our likely future relationship with the EU, play out over the next few months. Our message to pension trustees is not to over-react to market events. Pension schemes plan and invest for the longer term, but they should of course regularly review contingency plans in light of current conditions.
So it’s a difficult environment for many of you to operate in. But it’s important for all of us to take stock and learn from the events and challenges of the last year. I’m not just referring to schemes here, I mean TPR too – it’s important as a regulator that we also recognise the changing landscape and adapt our regulatory approaches accordingly.
Today I’d like to provide an overview of TPR’s current priorities and our direction of travel for the next few years, and I look forward to taking your questions at the end.
Annual Funding Statement
Starting with defined benefit schemes.
Last month we published our Annual Funding Statement, or AFS, which highlights the key issues facing those schemes with 2017 valuations. And today we published the accompanying analysis of the economic environment for those schemes.
Those of you who have read the AFS might have noticed a new tone from us this year.
We are being much more directive. We are being clearer, not just about what we expect from our regulated community, but also about the type of situations in which we might intervene.
The issue of the balance between dividend payments and scheme funding has attracted a good deal of interest and comment.
If the government decides to bring forward new legislation (whether arising from the defined benefit (DB) consultation or from manifesto proposals), this would take time to come into force. In the mean time we do expect employers to treat their scheme fairly.
Let me emphasise – we are not against companies paying out dividends across the piece. If the employer covenant is strong and will remain strong after the proposed dividends are paid out, we have no issue. But it is important that the employer strikes the right balance between the interests of the scheme and that of its shareholders. It’s important that trustees make sure that their sponsoring employer recognises its legal obligations to the scheme as a creditor, ahead of the shareholders.
So if we see a situation where we believe a scheme is not being treated fairly, we will intervene. If a company is paying out more in dividends than in deficit reduction contributions, we would expect to see a short recovery plan. And we would expect that recovery plan to be underpinned by an appropriate investment strategy.
We’ve set out very clearly in the AFS what our expectations are. For example, where we expect to see a higher level of contributions into a scheme, and where we expect a scheme to reduce risk to an appropriate level or to seek legally enforceable support from its group or parent company.
We’ve aimed to be as transparent as possible – for example, by explaining how we’ve assessed schemes, and in particular how we assessed their risk from our perspective as a regulator.
We have also acknowledged that there is a wide range of schemes and a variety of circumstances they are in. If we listened to all the headlines from last year, we might think that all DB schemes were in dire straits. But our analysis of Tranche 12 schemes found that 85 to 90% of schemes have employers with sufficient affordability to manage their deficits, and don’t have a long term sustainability issue. Tranche 12 schemes had their valuations between 22 September 2016 and 21 September 2017.
To unpick that figure a little more, about half of Tranche 12 schemes we believe are strong enough to maintain the same pace of funding, and many of those will be able to increase their contributions if the circumstances of the scheme require it.
For just over a third of Tranche 12 schemes we think their current contribution or risk strategies pose unnecessary longer term risks, which could be addressed by increased funding now, combined with a reduction in the level of risk.
We plan to publish our annual Scheme Funding Statistics later this the week, which will show how ‘Tranche 10’ schemes (with effective valuation dates falling from September 2014 to September 2015) responded to economic conditions compared to where these schemes were three years earlier.
Many schemes are performing well. A small proportion are stressed.
So we’ve targeted our messages rather than giving generic message across all schemes. We’ve acknowledged those schemes that are doing really well, and have delivered clear messages for those that are stressed. We’ve set out what we expect struggling schemes to do, including, where appropriate, closing to future accrual.
But we also want schemes to be aware of and make use of the flexibilities within the funding framework. To be aware for example that a ‘Gilts plus’ valuation is not a regulatory requirement. TPR is always open to innovative ideas. We have a statutory objective to minimise the impact on the sustainable growth of the employer. So we place similar weight on the financial health of the sponsoring employer as that of the pensions scheme it sponsors.
We are ready to work with trustees and sponsoring employers of schemes that are struggling, in order to achieve the best possible outcome in difficult circumstances.
In extreme circumstances, where the employer would otherwise become insolvent, this may involve TPR being approached with an application for a Regulated Apportionment Agreement, or RAA for short. This is a mechanism, provided through legislation, where if an employer is genuinely struggling to survive and can prove inevitable insolvency in the next 12 months, then it is possible to sever the employer’s obligation to a pension scheme to enable the employer to continue to trade.
You may have read about some cases – Halcrow, Tata Steel and Hoover – all of these involve RAAs. But again, let me be clear. An RAA can only be used in a very rare set of circumstances. To put that in perspective we have approved only 27 in total over the life of TPR.
Successful RAAs must meet a stringent set of criteria. We need to be satisfied that the employer’s insolvency is inevitable and that the RAA provides a better outcome for the scheme than could be achieved either through insolvency and/or through our anti-avoidance powers. We also examine the circumstances of the wider employer group and whether the scheme is being treated equitably compared to other creditors. An RAA must also be agreed by the trustees and receive no objection from the PPF.
The DWP’s Green Paper does address the challenge of how it might be possible to pursue a range of possible outcomes for stressed schemes and we will continue to work closely with them to explore all these options.
This is perhaps a good time for me to move onto the DWP’s Green Paper, which looks at the sustainability of DB schemes, and includes consideration of TPR’s powers.
There was strong consensus last year from DWP’s informal consultation that, on the whole, the regulatory regime is working, and that the funding regime sets a fair balance between the interests of scheme members and those of the employers. We are encouraged by that consensus – and it’s borne out by our own findings. But the landscape we operate in is continually evolving, as you know, so it’s right that we all periodically review the framework and look to address any areas that could be improved.
At TPR we do believe there are several amendments that could help to make the DB framework more efficient and effective.
We’ll be publishing our formal response to the Green Paper in due course, and I will highlight a few of these ideas now.
The first area relates to scheme funding. There is a great deal of flexibility in the current system for trustees and employers to agree their funding levels. This flexibility is essential as it helps to achieve the balance between protecting members, minimizing the burden on the sponsoring employer and reducing the risk to the PPF.
However, we believe there is a lack of clarity around some of the terms in the legislation, particularly around the definitions of 'prudence' and 'appropriateness'. These widely drawn terms permit a variety of approaches across schemes towards their funding strategy and this can pose a challenge to both trustees and to TPR. We think it would help trustees if we clarified what we expect schemes to do with regards to funding, through clearer terminology.
There are two ways we could achieve that greater clarity. Either the clarity could be achieved through amending the legislation directly. Alternatively – and this is our preference – TPR could be given the power to set out clearer definitions or parameters in binding standards, with these standards being supported by a 'comply or explain' regime.
This would mean there would be an onus on schemes to show how they have complied with our codes and guidance; and if they haven’t complied with them, to explain adequately why they’ve taken a different approach.
This second option would require a less significant legislative change and would allow TPR to act quickly and respond to emerging risks much faster than if more detailed definitions were set out explicitly in primary legislation.
The Green Paper also questions whether the balance between protecting members and the demands of the employer should be altered. Like the DWP, we don’t believe there is a case for across the board change. However, there could be a case for treating schemes whose sponsoring employer can afford to make higher contributions differently to those where the employer is under financial constraint.
Our casework shows that there are some sponsors who are, or were once, in a position to make higher deficit repair contributions. We can see instances where profitability has increased and, in some cases, dividends have been made but DRCs have stayed the same. Of course, profitability can deteriorate quickly along with the employer’s ability to meet its funding obligation. So in our view there is a case for introducing measures to encourage those employers who can afford to repair their deficits more quickly, to do so while they can.
A second area which we believe needs to be addressed is the issue of planned corporate transactions – another topic of hot debate.
As I have said several times publicly, we feel that a blanket requirement for parties to obtain clearance ahead of any planned corporate transaction would be too much. It would be disproportionate – for the UK economy, for TPR and for the schemes we regulate.
However we’re open to proposals that would strengthen our clearance powers in certain circumstances. In particular, those which enabled us to prevent transactions that would have a negative impact on a scheme. We also think there may be value in exploring the Green Paper’s suggestion of a fining system – which could deter poor behavior and nudge employers to engage with us early in the process.
We believe these amendments to the system would be effective deterrents; that if a company suspected a scheme might be adversely impacted, and that we might use anti-avoidance powers against them, they would be encouraged to seek clearance before they went ahead with the transaction.
The third area we think could be addressed relates to TPR’s relationship with its regulated community, in particular when it comes to information gathering.
The new master trust regime, where schemes will have to be authorised and supervised by TPR, will shift the dynamic between TPR and those schemes. Because they will need to apply to us for authorisation and be able to demonstrate to us that they continue to meet the conditions for authorisation on an ongoing basis, it is now very much in a master trust’s interest to co-operate with us, and to provide information to our satisfaction when we request it (not just in annual returns, for example) – as we will have to do in order to authorise the trust in the first place and to monitor its compliance on an ongoing basis. We would like to see this co-operation and willingness to provide information on an ad hoc basis extend beyond master trusts, to cover all schemes.
This would give us a comparable set of regulatory tools across all aspects of our casework, whether DB, defined contribution (DC), master trusts and monitoring employer compliance with automatic enrolment. And it would help us in becoming a more proactive, more effective regulator.
All our suggestions are based on creating a regulator which can respond more quickly and effectively to risks, particularly where DB schemes are underfunded, or where we suspect avoidance.
21st Century Trustee
Turning to other issues which are relevant to all schemes.
Let me now talk a little bit about our work to drive up standards of trusteeship, which is a priority for us. This is what we have called our 21st century trustee initiative.
We want to see trustees as a knowledgeable, empowered first line of defence for scheme members. There is a lot of good practice out there but our research shows that there are still significant gaps and not all schemes are meeting the standards we expect.
Our 21st century trustee work is a long term piece of work and over the coming year we’ll be focusing on three key areas.
The first is yet again about making our expectations clearer for trustees. In September we’ll be launching a communications campaign, aimed at trustees, employers and advisers. This focuses on the fundamentals of good governance – that means having a skilled and engaged board, led by a strong Chair, having robust risk management in place, and good relationships with advisers and third parties.
Just as we’ve targeted our communication to schemes about funding, we will target our communication on what we expect in terms of governance. We intend to really focus in on schemes that are not complying and what they need to do differently.
We’re also working with industry to help develop an accreditation framework for professional trustees. Professional trustees can add a lot of value to pension boards and we do expect higher standards from them. So it’s important that we have a clear definition of what a professional trustee is and what standards we expect from them.
Secondly it’s about taking action. We are already taking enforcement action against those schemes which don’t comply with basic duties, such as completing the Chair’s statement, but we intend to broaden our focus on schemes that don’t comply with our expectations on wider governance. So for example we’ll be looking at schemes which fail to manage conflict of interest properly, or fail to hold third party providers, such as the scheme administrators, to account.
And thirdly we’ll be encouraging consolidation where appropriate and feasible. This is about making sure that those schemes which can’t deliver good outcomes or value for members are consolidated into better run, larger schemes. There clearly are challenges with consolidating DB schemes – we do recognise that, but we’re looking to work with government and key partners to come up with workable solutions.
Before I finish I’d like to speak a little bit about what we call ‘TPR Future’. You may have heard me talk about this when it was launched at the end of last year.
During the last decade the pensions system has undergone momentous change. And our role and responsibilities at TPR have increased significantly. The economic environment in which we operate has been hugely challenging, as you know.
So we had to take stock of all these developments. And we had to look at the challenges ahead, for example the continuing shift in provision from DB to DC, the UK’s exit from the European Union, and the implementation of the new Pension Schemes Act. Then there are the lessons that we have learned from ten years of TPR operation, including a number of high profile cases.
So TPR Future is a big project for us, designed to deliver a sustainable approach to regulation across DB, DC, public service schemes and in our automatic enrolment responsibilities, for the next five to ten years.
The diagnosis and analysis phase of our work is now nearly complete. We’ve consulted with our stakeholders, the wider industry and our staff. We’ve also looked at other regulators who have experienced similar change in their industry. And we will say more publicly, along with our ideas about how we need to change as an organisation, next month.
So as you can see it’s a busy time for us, responding not just to the outside environment, but also looking internally at how we do our business as effectively as we can.
I hope I have given you a useful insight into our priorities for the coming months; what our expectations are for the community we regulate, how we will be directing trustees and their sponsoring employers to meet those expectations, and how we too are improving and evolving.
The new government will be taking shape over the coming weeks and the DWP will be working through all the responses to the Green Paper through the summer. We are likely to see a White Paper in the autumn, so will have a clearer idea then of what changes, if any, will be made to the regulatory system.
We know that many of you are facing difficult challenges every day – political and economic uncertainty, low interest rates, high scheme deficits. Be assured that TPR is committed to helping trustees, and you, as their advisers, to navigate those challenges to bring about the best possible outcomes for your members.