The political crisis of the post-Brexit world means pensions professionals’ in-trays are full. Domestic and EU regulation is up in the air, markets are challenging DB schemes and annuity purchasers, and tax relief changes are back on the agenda. John Lappin reports
With the detail of the UK’s new relationship with the EU potentially years away, there has probably never been a more uncertain time for the UK pensions industry in the post-war era.
Whether the UK will secure a deal similar to that of Canada, Norway, Switzerland or Turkey, or something else entirely, will not be known for some considerable time – yet consultants and advisers must continue to guide clients to the best outcomes for their workplace retirement arrangements.
When it comes to regulation, we are in the midst of a phoney war – while the level of regulatory uncertainty has increased, at the same time not much has changed. Much of the framework for financial services is global albeit with a European dimension, and even European Economic Area members such as Norway have to abide by EU directives if they want to play in the single market.
The FCA has emphasised that all EU rules apply and suggested there is unlikely to be a bonfire of regulations.
The Pensions Regulator has been more proactive, warning schemes against knee-jerk reactions to market volatility. TPR executive director for regulatory policy Andrew Warwick-Thompson has said that DC scheme trustees might need to look at default and AVC arrangements as the future of Brexit becomes clearer.
Yet most of the TPR focus has been on DB, sponsors and scheme covenants. The TPR guidance issued this July says: “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.”
Yet in the wake of much publicised problems at high-street retailer BHS – which is now defunct – and stresses on DB schemes in general, TPR also has some tough words about deficits and dividends. It says: “Trustees should continue to ensure that, where deficit repair contributions were constrained to allow for investment in sustainable growth of the sponsor, 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.”
LCP principal Andrew Cheseldine says: “The impact depends enormously on the industry you are in. If you are in import/export, it could bring a covenant issue.
“With the hospitality industry, let’s assume anyone from the EU who is here in the UK already can stay. But what if people decide to leave? You can see the strains.
“With investment banks in Canary Wharf, how many staff are European? Irrespective of whether we allow them to stay, they may choose to leave if the interesting jobs go elsewhere in Europe. We are talking to providers and asking: how at risk are you from these people going?”
However, Cheseldine adds that for the industry in general the bigger issue may be the living wage, with wages increasing to £9.20 an hour by 2020, which makes even auto-enrolment seem trivial.
“Having said that, in final salary terms negative nominal yields are truly scary. It is only one measure of how you value your debt but, from an accounting point of view, it does make a difference.”
Lawyer Freshfields Bruckhaus Deringer, in a note on covenants to trustees, says: “Some companies – particularly those in the financial services sector, but also potentially in other sectors significantly affected by EU regulation – may conclude that they need to restructure their operations to relocate parts into an EU member state to ensure continuing full market access.
“This could also cause consequential implications for the scheme funding. In certain circumstances, employee transfers could result in employing companies triggering debts to pension schemes under section 75 of the Pensions Act 1995, equal to those employers’ shares of the buyout deficit in their pension schemes. These debts are often material and the prospect of them may require corporate groups to negotiate with pension scheme trustees to apportion the section 75 debt liabilities or otherwise ensure that the debt is reduced or not triggered.
“At the same time, a reorganisation might mean that part of the employer covenant that supports the UK pension scheme will disappear or be moved from the direct reach of the pension scheme. A weaker covenant is likely to drive up funding costs as pension scheme trustees look to reduce risk and accelerate deficit funding payments. This may require corporate groups to offer appropriate mitigation to offset the impact on the covenant, such as intra-group guarantees (potentially from entities in EU member states) or security over assets.”
In terms of pending European legislation, the occupational pension directive final text was formally approved on 30 June 2016. It comes into force in two years’ time and, as law firm Sackers points out, this means that the timetable for implementation is likely to run in close parallel to the Brexit negotiations.
“The extent to which the UK will ultimately need to comply with the directive will very much depend on its exit terms,” it says.
But Sackers emphasises the ‘wait and see’ nature of things.
PTL managing director Richard Butcher says: “There is a lot to be determined. There is not a lot of action so the message to trustees is: be aware.
“First of all, we are still in Europe until the end of the Article 50 process. At the end of that we could still be in Europe, but it depends on the negotiations. If we end up with no association or requirement to comply with anything Europe has done, there is still unlikely to be a bonfire of rules and regulations – a wholesale scrapping of laws.
“There is a lot of law we haven’t absorbed into UK legislation, so some will have to be written in and some could be changed then. There will still be equal treatment of men and women requirements. A lot of the onerous stuff on DB longevity is not a matter for legislation, although indexation is. These things are unlikely to go as a result of Brexit.”
AHC head of client services Karen Partridge says: “The main challenge for pension managers communicating with their members about Brexit is that it may feel like they don’t know anything, and so the natural inclination is to say nothing. But the issue for the member is that they hear ‘nothing’ as a worrying sound. Members fill the void with their own assumptions.
“I think this is one occasion where we have to say something even if we don’t know the extent of all of this. People want reassuring messages because, whatever way they voted, something happened that we didn’t expect and it has an economic impact. So people can go to negative places quite easily.
“Pension managers are used to reporting on facts. It is a fairly factual environment with some assumptions around the edges but here we have something where there are a lot of things we don’t know. But that is not a reason to not communicate.”
On the DC side, and annuities aside, investments look to have come out of the referendum relatively well. But while an uplift in sterling-denominated equities resulting in the downgrading of the pound may look good on paper, what Brexit means for the long-term prospects for the UK economy, to which DC savers are massively exposed, is considerably less clear.
Ajeet Manjrekar, co-head of investment consultancy and fiduciary manager P-Solve, part of River and Mercantile Group, says: “Pension schemes have entered a new realm of uncertainty following the Brexit vote, with the next few years especially unclear for UK and European assets while politicians negotiate the terms of the UK’s departure from the EU.
“Uncertainty is of course uncomfortable, but the situation is not necessarily all bad. This could be a period of opportunity for those investors nimble enough to take advantage of it, and willing to diversify.
“For example, in the aftermath of the referendum we saw an initial rise in volatility, a widening in credit spreads and an increase in investors’ appetite for liquidity. As a result in July, where we had discretion, we increased our clients’ exposure to on-risk assets, while being ready to evolve these positions as market conditions played out.”
Master Adviser partner Roy McLoughlin, who speaks to employees in DC schemes every few days, says he keeps being asked whether being in or out of the EU will affect their pensions. The answer he gives is ‘No’.
Most schemes are quite recently established AE schemes with a long-term investment horizon so, in market return terms, the short-term impact of the referendum will be limited, he argues. However, he believes Brexit fits a narrative where people are concerned about the withdrawal of government support.
“Some people are asking why there is so much kerfuffle around risks to the state pension and other helps like pension reliefs, and whether they can rely on the state. Post Brexit, I think the message is reinforced that it is not wise to do so.”
The annuity market, meanwhile, is severely challenged by the post-Brexit financial landscape. Retirement Intelligence director Billy Burrows is downbeat.
“With the effect on yields, the game is over for annuities for a while. For the longer term, why are interest rates being reduced so low? The Bank sees there is trouble ahead. Maybe the stockmarket is overpriced.”
He adds that anyone in cash drawdown may need to take care not to end up paying the drawdown provider for holding their money.
Butcher says: “For DC, a large number of people still buy an annuity and for the majority it will still be sensible as they get older. If you are buying now, you are buying at a low price but there are no guarantees the price will get better.
“But you need to be aware you are buying low. Every pound of pension costs more at the moment. As a trustee, you need to make sure members understand the cost of buying an annuity.”
Tax relief fears
Hargreaves Lansdown head of pension research Tom McPhail is worried about what a possible downturn could mean for a nation with low DC contribution rates.
He says: “What happens if we get an economic slowdown in 2017/18 just at the moment when workplace pension contributions are increasing on the back of AE? What if we get inflation driven by the fall in the pound, and rising commodity prices, with those increasing pension costs on the back of phasing of increased contributions? That is not a good combination. It’s not a direct consequence of Brexit, but it is still very challenging.”
McPhail wonders if trade unions are distracted by DB to the point that they are failing to concentrate on getting increased contributions into DC. And perhaps most important of all is the much debated unknown of pension tax relief.
He says: “The key thing to bear in mind is what could emerge in the Autumn Statement. We think pension taxation is possibly back in the policy mix amid concern about keeping the economy ticking. A cut in pension tax breaks would mean more money going into the economy and less money coming out of the Treasury. It’s a double win for the Government.”