My comments on new DB Funding Code for occupational pensions
NEW DB FUNDING CODE MOVES AWAY FROM RECKLESS CONSERVATISM.
Big improvement on previous proposals which would have driven most schemes into supposedly low-risk bonds, while giving up on long-term investment returns.
Regulations are published at last after six years but new Regulatory Guidance is still not ready – schemes need it urgently to prepare ahead of September 2024 start.
The new code may help some scheme trustees back more productive finance but the delays have meant fewer schemes will do so.
DWP Funding Code rightly moves away from the ‘reckless caution’ and LDI: The Department for Work and Pensions (DWP) has published the long-awaited new DB Pension Funding Code, which is due to be in force from April 2024, and apply to valuations from September 2024. Thankfully this looks much more sensible than the original proposals, having dropped the requirements that would have driven most schemes into supposedly ultra-low-risk assets such as high quality bonds. Herding into such investments would have prevented most funding investing , if anything, in higher expected-return assets such as equities, small cap growth companies, infrastructure and productive capital.
Good to see greater flexibility for open schemes: It is welcome to see that the Regulations explicitly allow for more flexibility in open DB schemes, which clearly have longer time horizons than those heading for buyout and will enable trustees to use a wider range of assets so they can benefit from higher expected long-term returns, and back illiquid assets and patient capital. It is also good news that trustees will be able to take account of employer growth as well as affordability, so that there is room for better returns over time. The original focus on securing past benefits by ‘de-risking’ led to massive falls in asset value and was a wasted opportunity for better returns for many schemes. It is good that the term ‘broadly matched’ is no longer being used, since clearly this misled trustees about the reliability of expected risk-return models.
Closed schemes also need to benefit from more flexibility and tPR should encourage more diversification, to avoid herding that caused large losses: During 2022, low-risk assets and Liability Driven Investing by DB schemes added to market disruption when the Bank of England had begun QT (Quantitative Tightening) and this created massive losses in asset value for pension portfolios. The previous draft code suggested that schemes which are mature, regardless of employer strength, should have 90% of their interest and inflation risks hedged, with a broad cash-flow matching strategy that was destined to ensure little room for higher returns and created added costs and risks as the gilt markets plunged when QE ended. This was not a prudent strategy, even if it had been considered to be so by many. It has long been the case that DB pension funds have been reducing investments in higher expected return assets, that take away the upside potential which can be so helpful in securing long-term benefits.
Although DB funding seems to have improved, the loss of asset value is real and the liability forecasts are only estimates, which may prove flawed: It is important to help DB pension funds take advantage of higher return assets, rather than minimising modelled risks. With so many hundreds of billions of pounds in DB pensions, trustees have a chance to invest in assets that can perform much better than bonds. Minimising risk did not work in terms of asset preservation and, in a post-QE world, where long-term interest rates have been distorted by money-creation since 2009, the concept of investment risk is also less reliable. The case for diversification into other types of asset is strong in this new world.
New Regulatory Guidance is urgently needed: It has taken six years to get the new code, during which the landscape has significantly shifted, so it’s good to see DWP recognising original flaws: The first Green Paper on a new DB Funding Code, to replace the Scheme Specific Funding Regime, was published in 2017 with a Consultation in 2020 that proved controversial. Then, in 2022, a new Draft Code was published, but it failed to take account of the massive changes that saw LDI and low-risk investments causing huge losses. The new Regulations are now published, but the new Regulatory Guidance is not yet ready, despite the intention that the legislation will be in place by April 2024 and will start this September. The Guidance is urgently needed to ensure schemes can prepare themselves.
Will the new code help drive more schemes into productive finance, as the Government wants? The new Guidance will make long-term planning and implementation of higher return investment strategies easier and new flexibilities should allow more diversification of these enormous sums of pension assets. It is important for as many pension schemes as possible to benefit from upside returns available above just gilts or bonds and to also back productive investments or equity markets that can deliver better growth. It is to be hoped that the Regulation will used the discretion to enable more schemes to stop obsessively trying to protect their downside and allow them to aim for higher expected returns over time.
One thought on “My comments on new DB Funding Code for occupational pensions”
The pension company used by my work, failed to pay out what was paid in. Pension money should be kept safe and not used by useless investor schemes.