Rosalind Connor

Managing Partner

NEWS   |    May 19, 2016

Rosalind Connor in Lexis PSL Pensions on Brexit’s impact on pensions

This article was written and published before the outcome of the Referendum on EU membership was known but the guidance and commentary within it remains applicable now that the UK has voted to leave the EU.

Pensions analysis: Rosalind Connor, partner at Arc Pensions Law, explains that while the vast majority of UK pensions law is unlikely to immediately change as a result of a potential Brexit, there are surrounding legal issues, such as the interpretation of employment discrimination law, that would impact trustees and employers.What are the immediate issues for pension schemes in the run up to the referendum, and what are the key legal issues for occupational pension schemes should the UK vote to leave the EU?

In some ways, Brexit may not have too much impact on pension schemes. There is currently little or no European influence on the majority of UK pensions legislation. This includes:

  1. member nominated trustee processes under section 241 of the Pensions Act 2004 (PeA 2004)
  2. restrictions on amendments to benefits under section 67 of the Pensions Act 1995 (PA 1995)
  3. automatic enrolment under Part 1 of the Pensions Act 2008, and
  4. tax pension freedoms under the Taxation of Pensions Act 2014

Indeed, many of those pieces of legislation have received attention from Europe as possible policies to copy. Furthermore, the system of the Pensions Regulator (TPR) and its powers, as well as the Pension Protection Fund (PPF) under PeA 2004, Pts 1 and 2, take their inspiration from the US’s Employee Retirement Income Security Act of 1974 (ERISA) legislation from the 1970s, rather than any European influence.

Regardless, contrary to the rhetoric on both sides of the referendum debate, the effect of Brexit would not immediately impact pensions legislation. The EU legislation that affects pensions has been enacted by directive‚ the legislation would, therefore, survive any exit from the EU. All that would change would be the ability of Parliament to repeal the legislation. This legislation includes:

  1. the Equality Act 2010 and other employment discrimination legislation, which even the most hardline Brexit campaigner is unlikely to criticise in principle, and
  2. the structure of the scheme funding legislation under PeA 2004, Pt 3

The latter, incidentally, is generally considered a great improvement on its predecessor, the minimum funding requirement under PA 1995, and would be difficult to replace. As such, it is unlikely that the majority of pensions regulation would change swiftly, or at all, following Brexit.

However, there are certainly areas where changes are likely in the medium-term. Pension schemes should be aware that the interpretation of employment discrimination law is likely to develop, which will affect pension scheme structures and benefits based on age, sex, sexual orientation, and disability. At the same time, the coming EU regulation on data protection would not, post-Brexit, affect UK schemes. This might potentially give scope to dealing with certain challenges that data protection legislation holds for pensions, such as a member’s right to be ‘forgotten’.

In addition, schemes with a ‘cross border’ element with members from other EU Member States would find themselves under much less regulation, and those that pulled out of being cross border as a result of the 2003 Pensions Directive 2003/41/EC (particularly the so-called Anglo-Irish Schemes) might find it easier to return to the old structure.

What are the potential implications of Brexit on pension schemes and their sponsors in the short-term and the long-term, and what appropriate contingency plans should be made?

There is no doubt that the referendum and the uncertainty about the result is affecting the markets for certain investments. The referendum result itself will have further effects. Trustees ought to be aware that this political process is affecting their assets without, in any sense, affecting liabilities. Trustees should ensure that their fund managers have reviewed any likely exposure and hedged appropriately, and should, potentially, look to review their statement of investment principles. In relation to defined benefit pension schemes, employers have a direct interest in this issue, as they are obliged to make good any deficit caused by these market movements and they should be raising this with trustees.In the longer-term, as noted above, employers may look at options to open schemes out overseas following Brexitas the EU rules on cross border schemes cease to apply.

Whether the UK government will wish to encourage them, or allow tax treatment to remain in place if a scheme expands into Europe, is yet to be seen, but the government may well see this as a way of encouraging ongoing EU trade with the UK.Employers might also find business and asset transfers become much simpler from a pensions viewpoint followingBrexit. Due to the fact that the European Court of Justice (ECJ) maintains that the Transfer of Undertakings (Protection of Employment) Regulations 2006, SI 2006/246 do not fully apply the EU Acquired Rights Directive 77/187/EEC and the Acquired Rights Directive 2001/23/EC (which subsequently replaced it) in relation to pensions, pension rights have caused significant difficulties for asset transfers for the last 15 years. However, this issue would cease to apply on Brexit and, moreover, the regulations themselves are a likely candidate for simplification and remodelling if the UK were to leave the EU.

Are there any policies in the middle of being implemented that would be abandoned?

Pensions legislation and regulation is always under review both in the UK and across Europe. In recent years, European focus has remained around ensuring appropriate funding levels for pension arrangements, which has often stumbled because of the difference in the forms of pension arrangements across the EU.However, the European Insurance and Occupational Pensions Authority (EIOPA), which includes the UK’s TPR in its membership, has been driving this issue forward. The initial suggestions of funding on the basis of commercial insurers (so-called Solvency II) has been replaced in recent years by the concept of a holistic balance sheet, by which the pension scheme’s funding is considered in the context of investment returns and risk, employer strength, and funding levels. This is yet to be implemented at an EU level, and would of course never apply to the UK following Brexit.

Nevertheless, in practice, TPR has been very supportive of the idea and is promoting a concept of integrated risk management (IRM), which is based on the holistic balance sheet despite there being no legal framework by which the idea can be enforced. It may well be the case that TPR would promote this idea much less strongly when no longer affiliated to EIOPA.One particularly complex challenge for pension schemes in recent years has been the issue of whether guaranteed minimum pensions (GMPs) should be subject to the rule to equalise retirement ages for men and women. This comes out of an argument about whether a GMP is a state pension (as they are provided by the scheme as an opt out from the state pension), which don’t need to be equalised, or a private pension, which is therefore ‘pay’ and so does need to be equalised under the Treaty of Lisbon.

The law on this is uncertain, as is the process by which equalisation should happen. A ministerial statement in early 2010 announced that GMPs did need to be equalised and that legislation would follow but, following a change of government and the extreme complexities of the process, nothing has formally followed from the government itself. It would seem likely that Brexit would lead to this policy being officially dropped, and many trustees grappling with the issue may feel that this is a good enough reason to vote for Brexit on 23 June 2016.

Should employers also consider the potential impact on their business, and what is the likely impact on the employer covenant?

From the point of view of international employers, there will be some questions around the enforceability of TPR’s ‘moral hazard’ powers across the EU. These powers can be used against group companies and shareholders of the employer of a UK-defined benefit pension scheme and sit as an ordinary debt to the trustees.Historically, it has been assumed that these would be enforced as a private debt using Regulation (EC) 44/2001(Brussels I), which would no longer apply if the UK were to leave the EU. In practice, there is no doubt that some international enforcement agreements would be reached and, furthermore, a number of EU Member States already enforce overseas judgments for a wide range of countries. However, employers will be aware of the lessening of TPR’s international reach, which might affect behaviour in extreme circumstances.

In terms of covenant strength, it is, of course, important for the Brexit impact to be considered at the current moment. It would ultimately depend on the business and structure of a particular employer as to whether Brexitwould strengthen or weaken the covenant, but it is certainly an issue that trustees should be including at present in the valuation of the scheme or any other circumstance where the covenant is being reviewed.

What will be the impact on the state pension of UK expatriates currently living in other EU countries?

Under the provisions of various EU regulations (most recently Regulation (EC) 883/2004 on the coordination of social security), state pension contributions can be credited when working abroad in the EU by paying local social security contributions. Outside the EU, there are a large number of co-ordination and double taxation agreements and it is likely that something of this nature would be put in place. However, it would, in all likelihood, operate in a different way from the present system so expatriates and their employers will need to keep abreast of the developments to ensure employees do not lose their benefits by working in other jurisdictions.

What action should trustees take in the run up to the referendum to protect their schemes and their members?

Much of pensions law is ultimately unlikely to change as a result of Brexit, and what is likely to change as a consequence of the referendum is immensely uncertain at the moment. Unfortunately, to a large extent, this means that trustees will need to wait, not only for the result, but to see what kind of post-Brexit world develops, before action is taken.However, trustees do need to ensure that their investment principles and instructions to fund managers take account, wherever possible, of the effects of all this uncertainty on their fund returns and risks. In addition, any present covenant assessment of the employer must take into account the likely effect of Brexit on covenant strength.

Read the full article in Lexis Nexis PSL Pensions here.

The views in this article are intended for general information purposes only and should not be used as a substitute for professional advice. Arc Pensions Law and the author(s) are not responsible for any direct or indirect result arising from any reliance placed on content, including any loss, and exclude liability to the full extent. Always seek appropriate legal advice from a suitably qualified lawyer before taking, or avoiding taking, any action. If you have any questions on the points raised in the above, please do not hesitate to get in touch.

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