The Pensions Regulator has published its draft DB Funding Code for consultation and the industry is asking a lot of questions. Is what it’s proposing going to work? Will it be too prescriptive and rigid? How much will it all change before it’s implemented? It’s too soon to say but trustees of schemes with a valuation date from October 2023 onwards are likely to have to comply quickly so need to engage with their advisers as soon as possible. We’ve tried to cut through the debate and get to what you as a trustee might need to know now, and what to look out for.

When will the changes bite?

As a trustee, you will, at some point, need to know about the new code and the regulations because you’ll need to comply. But you don’t necessarily need to worry about any of this now. The requirements of the regulations and the code flow from DB schemes’ triennial valuations. As the regulations are expected to come into force from October 2023 they will bite on valuations with an ‘as at’ date after that date, so the first wave will mostly be as at 31 December 2023. The regulations are still in draft and the code is still being consulted on. The first wave of trustees will have to work out how to comply (taking advice from advisers also working the new regime out for the first time). For other schemes, compliance could be 3 years away, meaning you will have the luxury of watching others in the industry get it right (and wrong) first. If you are in the latter camp, you have time to plan for any changes to funding or investment. By the time you need to act, compliance will be a well-trodden path so you can take notice then. If your scheme’s next valuation date is soon after October 2023, you won’t have much time between the changes being made and the code coming into force, so keep reading!

What is a ‘significantly mature’ scheme?

The code and regulations effectively codify two phases for a DB scheme’s funding:

• one phase where the scheme is reliant on its employer covenant (trustees must plan the long-term funding of the scheme with a goal of low employer dependency in mind during this phase); and
• another phase where the scheme is ‘significantly mature’ (trustees must maintain the scheme’s established low dependency during this phase).

These phases and their associated investment decisions were likely already in your thinking as a trustee. What has changed is that you now need to work out when your scheme will reach ‘significant maturity’ as this will be the measure of when your scheme has reached its low dependency stage. You will also need to set a relevant date (a date no later than the end of the same scheme year as the significant maturity date, which will be relevant for reporting of investment decision rationales). Some schemes may want to bring it forward to give themselves more flexibility.

The significant maturity date is a new concept, calculated using a weighted mean duration of remaining benefit payments to members. The draft regulations leave it to the Regulator to set the duration period that will define what is significant maturity. The Regulator currently proposes a duration of 12 years, to apply to all schemes, and to be set in a Code.  Assessing this will require the input of actuaries with assistance from the scheme’s administration team, so it is an important action for you and your advisers to get on top of and it will incur additional cost to get it right. This date will need to be reassessed and may need to be moved with every triennial valuation going forward. It is worth noting that your scheme may or may not already be at this point.

What is a Statement of Strategy and will it be useful?

The code and the regulations will require you to submit a Statement of Strategy document to the Regulator. Some have likened this document to the Chair’s Statement that DC schemes are required to produce. The Statement of Strategy must be submitted alongside the new Funding and Investment Strategy document at every triennial valuation. There is a lot of new detail to be covered, aimed at helping schemes in monitoring investment performance against the scheme’s needs. While there is concern that this will incur further costs beyond your current levels, you can use it to your advantage. If it is used as a risk management tool, it can provide benefit by being a living document which you can refer to during day-to-day management of scheme investments. If the document records ongoing analysis of the scheme’s investment strengths, weaknesses, opportunities and threats, you can mitigate the compliance expenses by ensuring that investments always align with funding needs, as the Regulator has envisaged.

Is covenant advice changing?

Although you may already take covenant advice on a regular basis, for some trustees this will be another new requirement that the code and regulations enforce. The code requires all DB scheme trustees to take covenant advice during each triennial valuation to aid their investment decisions when relying on employer covenant (prior to reaching low dependency and significant maturity). Even if you do not have to seek anything more than your existing level of covenant advice to comply, you should also be aware that, for covenant advisers, the code and regulations introduce much more law and guidance, regulating their advice, than they have ever had before. This will mean they have to take greater care when preparing compliant advice to you, which will incur higher fees (especially in the first year following October 2023).

Are your investment powers changing?

There has been a lot of debate as to whether trustee’s investment powers are changing as a result of the code and the regulations. Although the code states in several places that trustee powers are not being curtailed, the code does also nudge trustees towards matching their actual investments with the investment assumptions mandated by their scheme’s maturity, and towards working collaboratively with the scheme’s principal employer. There has been some concern that the code is too rigid in its prescription of scheme investing and that it will cause scheme investment strategies to converge too much. However, legally, it’s our view that your investment powers remain unfettered by the draft regulations. The new requirements may mean that you have to consider your scheme’s maturity, employer dependency and employer covenant when making and reporting on investment decisions, but you likely do this anyway. You still have your powers of investment, so there is ultimately still enough flexibility in the code to allow for investment mismatch, if they can be reasonably justified.

It is especially important to remember that your investment powers remain yours as the code and regulations require reporting of investment decisions in the Funding and Investment Strategy and Statement of Strategy documents, which require the principal employer’s signature. If necessary, you must remind your principal employer that they cannot dictate investment decisions, even if they form part of a document which requires their sign off.

Will this be implemented as is?

We’ve tried to focus on action needed as much as possible, but it is important to remember that the code is currently being consulted on, based on underlying regulations which are still in draft. This, and the tight timeframes between now and the October 2023 implementation date, are pretty unsatisfactory. Not only has this created uncertainty now, but it will also result in the first wave of trustees, and advisers across the industry, having very little time to begin compliance with the code and the regulations after they are final. If you will need to comply shortly after October 2023, you may want to monitor closely the changes to both code and regulations as both are likely to change, and the extent to which they will change is not yet known.

The key takeaway?

Think about when you next valuation date is. Depending on how close it is to the new regime coming into force in October 2023, you may need to start engaging with your advisers about the implications now.