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Market volatility following the EU referendum: guidance statement from TPR

Sets out our main messages and key areas for action to trustees of DB and DC pension schemes in light of the recent referendum vote in favour of leaving the EU.

Published: July 2016

Key messages

Our key message to trustees and sponsors of occupational schemes is to remain vigilant and review their circumstances, but continue to take a considered approach to action with a focus on the longer term.

It is too early to understand or assess the full consequences of the outcome of the EU referendum in detail. However, we expect trustees to have an open and collaborative discussion with their sponsor about the possible effects to their business. The referendum vote has also resulted in market volatility, and many commentators have predicted that there is likely to be more in the coming weeks and months. Pensions are long-term investments and trustees should as part of their ongoing risk management review their position, but consider their circumstances carefully before taking action at the appropriate time. Trustees and sponsors should speak to their advisers if they are concerned or need help in understanding the risks.

What you can expect from us

While all UK and EU pensions law currently applies as usual, we will continue to monitor the markets and other economic developments, and we will provide more guidance to trustees of both DB and DC schemes as necessary. Our operational approach remains unchanged.

We will also continue to engage with European institutions such as EIOPA (European Insurance and Occupational Pensions Authority), while we wait for further clarity as to the nature of the UK’s future relationship with the EU and any transitional arrangements.

DB schemes

Any impact will be scheme and employer specific. It is important that trustees and sponsors discuss the issues in an open and collaborative way and review their position and ensure they understand the risks in the scheme’s investment strategy and employer covenant.

Taking an integrated approach to risk management will help trustees and sponsors to do this. Contingency planning is an integral part of the effective stewardship of DB pension schemes and we urge trustees to review their plans and how they interact with current circumstances.

Covenant issues

Following the vote, there will be a period of transition and this uncertainty can be destabilising for employers. While it will be some time before the impact upon sponsoring employers of DB schemes becomes clear, some sponsors may be feeling the effects already and this can have a positive or negative impact on the covenant to the scheme.

The impact on sponsors will be specific to the sector they are in. Even within sectors, it will be employer-specific depending on the nature of their business and strategy and exposures to the EU.

Trustees should consider how exposed their employer may be to the various risks and opportunities which may come with the transition of trading relationships and potential changes in economic fundamentals, for example in the strength of sterling. This will give them a framework to consider the potential impact on covenant strength and to monitor the development of these factors.

Trustees should have an open and collaborative discussion with the employer to understand their views and position, along with the impact of this for their risk appetite in respect of the scheme.

There may be some nervousness around business investment while the impacts of the referendum become clearer and such undertakings may be put on hold or directed differently. Trustees should continue to ensure that where deficit repair contributions (DRCs) were constrained to allow for investment in sustainable growth of the sponsor, that it continues to be used to strengthen the covenant to the scheme rather than being diverted away from the covenant (for example to pay dividends).

Some example areas to consider regarding the impacts on the covenant include:

Currency cost base, reliance on imports or exports - particularly to the EU, plans for investment (and any changes in this) including whether these are reliant on funding from overseas, and the impact on changes in the strength of sterling and interest rates.

Investment and funding volatility

Volatility in market conditions could have a material impact on a scheme’s funding position although the effect will depend on a number of factors including the extent of any hedging and the scheme’s asset allocation. Trustees should not be overly focused on short-term market movements, but it is important to understand how this impacts on scheme funding plans and decision-making, including any issues with regard to liquidity and cash flow management. Trustees should consider with their advisers the extent to which volatility and changing market conditions affect the longer-term view of expected risk and returns, and how this interacts with the scheme’s funding plans and risk appetite. Scenario planning may help with this assessment given the uncertainty of future economic developments.

Where current conditions mean the scheme is exposed to an inappropriate level of risk, taking account of their assessment of the sponsor’s covenant and other relevant factors, trustees should reconsider their investment strategy in that context. Where trustees decide that action is needed, they should consider carefully the timing for implementation and be in a position to take action when appropriate.

Some example areas to consider include:

Interest rate and inflation risks, concentration of investments, currency exposures, managing liquidity and counterparty risks.

For schemes currently carrying out a valuation

If you are currently working on your scheme valuation, there has been no change to the requirements or deadlines so you should carry on as normal. Our recent annual funding statement remains relevant and we would expect trustees to take it into account alongside the additional messages in this statement. You should also refer to our funding code and associated guidance.

Some of the things you may want to consider:

  • more sensitivity analysis to understand the potential impacts of different scenarios on the scheme and joining this analysis up with the sponsor’s ability to provide support,
  • understanding the impact of those scenarios on your recovery plan and strategy to achieve your long-term objectives
  • reviewing your contingency plans and how they interact with the current circumstances
  • evaluating funding solutions which incorporate (for example) more contingent assets or conditional contributions with regular review periods
  • more regular and focused monitoring of the investment, funding and covenant

DC schemes

Again, pensions are long-term investments and trustees should not take decisions based solely upon short-term performance. In line with our DC code of practice, you should continue to regularly review the longer-term performance of individual funds. As with any significant economic event, the impact of the outcome of the referendum on investment markets will be a factor for trustees to consider.

Investment performance

When you review your scheme’s investment performance, it remains important for you to consider how fund performance impacts different members, or groups of members. The impact on DC members’ savings will depend on where they are in their pension saving journey - they may be a long way from minimum pension age, approaching pension age, or already accessing some or all of their pension savings. Many schemes will already have strategies in place that are designed to minimise the impact of market movements on the funds of individual members who are close to pension age.

As the future implications of any withdrawal from the EU become clearer, you may consider it appropriate to make changes to the investments included in the scheme’s default arrangement, and/or other investments offered to members. You should work with your providers and advisers to monitor developments and take steps to manage any emerging risks to the scheme (eg impacts on charges). Remember that poor value for members is a key risk that trustee boards need to manage.

Member communications

Good member communications provided at the right time and in the right format remain vital to help members engage and make decisions that lead to good outcomes in retirement. Members nearing minimum pension age should receive the information they need about their options and the different ways they can access their savings, and they should be encouraged to seek guidance and advice to help them make appropriate decisions.

Pension Wise is available to those aged 50 and over to discuss the options available to them and to help explain the risks attached to each option. The risk warnings that trustees are required to provide will also help members in their decision making. Our guide on communicating and reporting provides further guidance about this for trustees.

Members may be nervous about the impact of the leave vote on their pension savings and may contact trustees or their administrators for further information. You should be prepared to explain to your members - clearly, and in plain English - the approach that you plan to take.

The Pensions Advisory Service (TPAS) also offers free and impartial guidance to people with workplace and personal pensions.

For further information and guidance:

Our DB code of practice, along with our annual funding statement sets out how trustees should approach and manage risk more generally.

Our DC code will assist you when putting in place robust investment governance for your scheme. This will help you to respond appropriately to any longer-term impact that the outcome of the referendum may have on the scheme’s investments.