Making Sense of Pensions

Brendan McLean

ESG is on the agenda

There has been a growing demand on UK defined benefit pension schemes to consider environmental, social and governance (ESG) factors. Since October 2019, trustees need to set out how they take account of those issues in their statement of investment principles (SIPs).

This has led to investment managers adjusting their funds to meet the new requirements and satisfy the needs of trustees on considering ESG. However, defining ESG is open to debate. Different individuals have a different view on what it means, which could give rise to ‘greenwashing’, the term used to describe investment managers veiling their funds as greener than they truly are.

To combat this potential issue, the European Parliament has voted on new disclosure requirements for sustainable investments. Also, the Investment Association in the UK has released a framework to try to prevent confusion around responsible investment stemming from inconsistent use of terms and phrases. We believe this will naturally make it harder for managers to greenwash their funds, giving investors more confidence to invest in genuine sustainable funds.

Data issues

A potential issue caused by the increased disclosure requirements is the reliance on ESG data to ensure managers consider sustainability risks and opportunities. Currently, the main ESG data providers have vastly different methodologies for scoring companies, resulting in a wide range of results. One provider may score a firm highly and another, using a different scoring metric, may score it lower. We feel it is important for the ESG data providers to score firms consistently and recognise that the new classification system should help.

Investment managers place a heavy reliance on ESG data, which increases pressure to provide overly positive results for a higher score. Many ESG metrics are currently not audited in the same way as financial information, so it is easier for firms to inflate their ESG credentials. We would hope regulations will prevent this from happening.

No overnight fix

We feel the most important thing pension schemes can do to ensure they are really investing in line with their own sustainability objectives is to discuss the topic more frequently and understand what their aims are. We are pleased to see ESG and sustainability aims are a more common feature of trustees’ meeting agendas. While the change won’t happen overnight, we feel that over time, as more people become aware of the benefits of considering sustainability, it will get much more attention.

Alan Collins


2020 will definitely see progress being made towards a new funding code for defined benefit schemes. The Pensions Regulator has recently made clear that, despite numerous delays to date, consultation on the code will likely begin in January of next year.

Armed with new powers, the new code and its “clear, quicker, tougher” approach, the Regulator’s presence will loom large for many trustees. So, how then, will trustees keep the regulatory “wolf” from the door. 

Top tips

Here are some of my top tips and recent experiences.

1. Recognise and document your long-term objective

For all but the very largest of closed schemes, the end-point will be some form of insurance arrangement (consolidate or buyout).  It is therefore important, as schemes mature, to put a greater focus on this end-point and estimate how long it will take to get there. This will likely mean contributions continuing even after the scheme has a surplus on the ongoing (technical provisions) basis. 

So, trustees should get to know how long the path to buyout is and plan out their strategy to get there (including any investment de-risking along the way). Developing contingency plans with agreed actions for good and bad outcomes will also be very worthwhile.

2. Use an Integrated Risk Management approach to manage and monitor covenant, funding and investment.

Most schemes regularly review funding levels, investment performance and (perhaps less frequently) sponsor covenant. Often, however, these three strands are looked at in insolation and not part of a single “package”. To meet long-terms objectives, it is important to manage all of these risks together.  

I have found it helpful to collate some key metrics for each area into a single one-page dashboard. This allows trustees to review overall progress and importantly review the need to take any action. Funding and investment metrics should be readily available, and it is worth engaging with the sponsor to get regular updates on key metrics in their business – they will be monitoring these so it should be easy to get hold of them to help trustees do the same.

3. Get-together more often

For me, the days of a “once a year” meeting and nothing much in between are gone. With volatile financial markets and the potential for fast-changing outlooks for sponsor covenants, schemes are “businesses” which need more regular attention. 

In my experience, most scheme trustees would now expect to arrange some sort of meeting on at least a quarterly basis to review investment performance, funding progression and administration matters. These meetings need not be long and, with improving technology, need not be face-to-face either. Agendas can also be structured to allow advisers/providers to attend in part.

4. Make sure the basics are done

It sounds obvious, and maybe it is, but getting the basics right is important. Trustees should be making sure that:

  • Data is clean, complete and up-to-date.
  • Conflicts (and potential conflicts) are documented and discussed.
  • Scheme documentation is complete and consolidated.
  • Trustee Knowledge and Understanding is up to date, documented and future training is scheduled in.
  • Investment compliance is up to date (ESG, Investment Objectives documented).
  • Scheme business plans and risk registers are “live” documents, not just pages that gather dust between meetings.
  • Future project work is factored in e.g. GMP equalisation.
  • Be up-front if your scheme doesn’t fit with the ideal expectations of the Regulator

Back in the day, a recovery plan of over 10 years was a warning “flag” that often triggered some regulatory scrutiny. That was all washed away with the more employer friendly “sustainable growth objective”. The new funding code is likely to view 7 years as the benchmark recovery period. Indeed, I have already seen the Regulator gather information for schemes where the current recovery period is above that threshold.

However, it is also fair to say that many schemes, for many reasons, will have longer recovery plans that the Regulator will now view as appropriate e.g. charities, schemes with weaker sponsors.

Here, it is important for trustees to examine and clearly document the rationale for a longer recovery period. If affordability is shown to be constrained, it is likely that a longer recovery period should go hand in hand with a more cautious investment strategy. Taking risk on your sponsor (as demonstrated by a longer plan) should not be compounded by a higher risk investment strategy that the sponsor cannot afford to underwrite.

For me, a well set out and justifiable longer recovery plan with a cautious investment strategy is far better than over-optimistic actuarial basis and a “wing and a prayer” investment strategy which give the misleading impression of achievability.

Hugh Nolan

The Pensions Ombudsman has made a few slightly controversial rulings over the last 12 months, finding maladministration by schemes relative to an extremely high standard and with the benefit of hindsight. His recent ruling on the Hampshire County Council transfer case follows these precedents but goes even further.

In the latest case, Mrs H transferred to a scam pension scheme and the Local Government Pension Scheme (Hampshire Pension Fund) paid the transfer value as she requested and is now being forced to pay her benefits too. It’s great for the member that she will still get her pension benefits but the scheme has to pay twice, though the Ombudsman has kindly said that Hampshire County Council can keep any money it manages to get back from the scammers.

The background to the case is that the scheme paid a transfer of £26,234 to a scheme that had only been set up fairly recently. The member involved was approaching her Normal Retirement Age and lived hundreds of miles away from the sponsoring employer of the new occupational scheme to which she was transferring. Incidentally, the member had also declined to join the Hampshire Pension Fund originally and then joined much later. The Ombudsman took this as evidence that she was not financially astute and, therefore, argued that the trustees should have taken extra care to protect her. The scheme did send her the Scorpion literature and she signed a form declaring that she had read the leaflet and understood it was entirely her own responsibility to make sure the benefits in her new scheme were appropriate.

In fairness to the Ombudsman, the Hampshire Pension Fund seemed to believe, incorrectly, that the member had a right to take the transfer and they had no ability to stop her. In fact, she may have had a right to a transfer but she did not have a right to transfer to that particular scheme, as she was not (and never had been) employed by the sponsoring employer. That is a pretty esoteric point, and one that the transferring scheme did not know, but I can see that they might have checked further if they had realised they did have some discretion after all.

Nevertheless, the transferring scheme did warn her about scams and highlighted her personal responsibility. She chose the receiving scheme (albeit with dubious ‘advice’) and requested the transfer be made. The Ombudsman says that Hampshire should have realised that it was a scam as they didn’t check whether she worked for the new employer, but apparently doesn’t mind the member choosing an occupational scheme that she hadn’t worked for. The Ombudsman says that the recent approval by HMRC was another red flag, rather than placing any responsibility on HMRC (or pension regulations generally) for approving a scam scheme. The Ombudsman criticised the scheme for thinking it was obliged to make the payment, but has repeatedly made clear that it will uphold complaints wherever schemes do not fully comply with their legal obligations within the statutory timeframes, even where there is a strong suspicion and evidence that the receiving scheme is a scam. Successive Governments have declined to introduce legislation to give trustees an option to withhold transfers in suspicious cases but trustees are still expected to police the issue, with little or no support from the Ombudsman or legislature.

I have had conversations with members who have requested transfers to schemes that look suspicious and these members can be upset, frustrated, confused, aggressive and even abusive. I have, however, always eventually been able to persuade them that the trustees were trying to protect their best interests, leading the members to withdraw their requests (even if they later transferred somewhere else).

I thought that was a good example of how we go above and beyond the basic call of duty to administer our schemes in the best possible way. But now it seems that we are only doing what is actually needed to protect ourselves against future claims for compensation. I feel sorry for schemes that haven’t always gone to such lengths and I thank goodness that we set our own standards high enough to stand the test of time.

I am all in favour of high administration standards across the pensions industry. However, I just can’t get completely on board with an Ombudsman who sometimes seems to see trustees as an easy target for compensation, despite their best efforts to look after their members even when they don’t get much help from the rules to do so.

Andrew Kerrin

Welcome to our third Quarterly Update for 2019. We’ve only just said goodbye to British Summer Time, we thought we’d be saying hello to the post-Brexit era, but instead we’ll be wrapping tinsel around our polling cards as we head out to vote in the upcoming General Election. Anyone for a surprise Christmas gift?

You would be forgiven for thinking that there is no other news, and hoping that extensions, flextensions and even political tensions would melt away in the snows of winter … but regardless, the pensions world continues to turn and we’ve compiled our list of topical pension articles from the last quarter.

Inside you’ll find details of the new CMA requirements for trustees to engage with investment consultants and fiduciary managers and an update on your favourite subject (next to Brexit!) – GMP Equalisation. We also look at the ‘legacy’ that is RPI and the anticipated move to CPI. Should there be a professional trustee on every scheme? We look at both sides of the debate. And as if that’s not enough, we’ve got an investment market update, news from the Pension Scams Industry Group and PRAG, a summary of the TPR and PPF Report and Accounts and information on changes to Data Subject Access Requests (DSARs).   

You can’t vote for your favourite, but we do hope that you enjoy reading our take on the latest industry news.

Click on image above or this link to download.

Brendan McLean

Greenwashing

In recent years there has been a huge push for society, and fund managers, to consider environmental, social and governance (ESG) factors. This has led to claims of greenwashing. Greenwashing is when a firm claims to have a greater ESG focus than they actually do.

As people grow increasingly interested in ‘going green’, the issue of greenwashing is becoming a problem faced by all of society, not just pension schemes. Investment managers and companies are seeing opportunities to capitalise on the changing sentiment by making their products appear greener than they really are. A recent example is the fast food restaurant McDonalds. They swapped their single-use plastic straws for a paper alternative. However, in August 2019, a leaked internal document showed that the straws were non-recyclable.

From October 2019, trustees need to set out how they take account of ESG issues in their statement of investment principles (SIPs). This has resulted in a frantic push from managers to make their funds meet the standards – which could encourage greenwashing. A key issue with ESG factors is the lack of clarity on what it means, making it easier for managers to greenwash their funds.

Going colour blind

Pension schemes could have been affected by untrustworthy ‘green’ credentials from investment managers. I suspect many may not realise it has happened as it is difficult for trustees to scrutinise managers’ ESG claims. A concern for trustees is that if they allocate to a manager based on their ESG values, the manager may not act as expected, which would create a lack of trust with ESG investing. Greenwashing could, therefore, destroy investors’ confidence as they may lose faith in companies or fund managers that promote themselves as focusing on ESG issues. This could have a knock-on effect by slowing down the pace of ESG investing, which would be detrimental to the positive impact it can have. Greenwashing also makes it harder to identify managers who are truly trying to make a difference, potentially reducing the pace of ESG innovation.

The grass can still be greener

Often managers state they have been integrating ESG for many years, but their team and head of ESG are all recent hires. Trustees should look for a more seasoned team to mitigate this concern. Many managers make assertions that they have been following ESG practices for many years by excluding certain sectors. However, this is often driven by client demand rather than the managers’ ESG beliefs, so it can be tricky to get a clear understanding of a managers’ ESG credentials.

It is difficult for trustees to ensure that their investments are as environmentally responsible as managers claim. Trustees place a great deal of trust in their investment managers to act in their  best interests, but it is hard for them to monitor. Often, the easiest way for trustees to be confident that their investments are environmentally responsible is to allocate to managers who have a genuine track record of integrating ESG into their investment philosophy and process; and not to those managers who have simply jumped on the bandwagon to include it.

Trustees should look at managers’ track record of stewardship and engagement with companies, and to the quality of their ESG team. They should also work with their investment consultants to help provide a deeper understanding of the managers’ credentials.

Angela Burns

This guide is intended to be a useful reference for companies preparing their 30 September 2019 pensions accounting disclosures, whether under FRS 102 or IAS 19.

In this guide, we will review the changes in the investment markets over the last 12 months and consider the impact these will have had on a typical pension scheme. We will also review recent developments in the area of pensions accounting, highlighting issues that you should be aware of.

With the wealth of corporate advisory experience available at Spence, we are well placed to provide you with guidance in how to best manage your pension scheme liabilities.

The implications of the recent developments should be considered to help you avoid any surprises. Spence can help guide companies through these complexities and have a proven track record in navigating to the best outcomes for our clients.

We would be happy to discuss the options available to you in reaction to the market trends discussed above, including:

  • How to lock in asset gains;
  • Decrease future risk;
  • Reduce funding level volatility.

To discuss these topics further, please contact Spence through your usual contact or connect with our Corporate Advisory practice associate, Angela Burns, at angela_burns@spenceandpartners.co.uk  or by telephone on 0141 331 9984.

Angela Burns

In our last update we provided a summary of the GMP equalisation ruling in the Lloyds Banking Group court case that has required all pension schemes to equalise guaranteed minimum pensions.

Our update was very much ‘wait and see’ as a number of points had still to be clarified. 

There are still a number of outstanding issues but there has also been positive movement in some areas.

The formation of the GMP Equalisation Working Group

The first guidance from the GMP Equalisation Working Group has been issued.

Contrary to previous updates, the working party guidance has more of a ‘get things moving’ feel to it.  The path for equalising GMP’s seems a bit clearer although there are still a number of outstanding issues to be clarified.

The guidance sets out a summary of the requirements of GMP equalisation and includes some helpful worked examples on each permissible method for equalising GMP’s.

There were some interesting comments in the guidance surrounding previously raised issues:

  • De minimis cases – the guidance states that it expects most Trustees would not apply a de minimis amount, as the work required to determine the amount is comparable to the work required to calculate and pay the uplift;
  • No further liability cases  – the guidance suggests Trustees should write to members to determine if contact can be made, prior to agreeing that no calculations should be carried out;
  • Lack of opportunity cases – where members have lost out on an opportunity as a result of having unequalised benefits (for example retiring early) it will not be possible to compensate for this.

The GMP Equalisation Working Group will produce further guidance on:

  • the availability of data to carry out the exercise;
    • impacted transactions;
    • tax issues (alongside HMRC guidance);
    • reconciliation and rectification of GMP’s.

Issues still to be clarified

The following issues have still to be clarified:

  • There will be a further instalment of the Lloyds court case to determine if transferred out benefits have to be considered in equalisation projects;
  • HMRC are producing guidance on how uplifts should be treated for tax purposes.

Actions for Trustees

The guidance expects that most schemes won’t implement a solution until the tax implications are fully understood.  However, Trustees should be speaking to their advisers about:

  • An appropriate methodology given their schemes circumstances;
  • Availability of data and GMP reconciliation (bearing in mind that further guidance will be released);
  • Understanding the Trust Deed and Rules and any forfeiture rules.
Brendan McLean

Recently, the government rejected the suggestion from the British Business Bank (a state-owned bank that helps finance new and growing businesses) to reform the current 0.75% cap on annual charges that defined contribution pension scheme members pay for the default investment strategy. Maintaining the current charge cap can reduce members’ ability to invest in more alternative (and also more expensive) asset classes such as venture capital (VC).

No entry to the dragon’s den

Venture capital involves investing into early stage companies, as in the premise of the BBC show Dragons’ Den. VC investments can grow from minor beginnings into hugely successful companies, e.g. Facebook and Uber. It offers investors the opportunity of significant returns. The government’s rejection denotes that members may find it difficult to get access to a potentially rewarding area of the market which would help diversify and increase their pension pots. However, it will save them from paying high management fees, and also from the risk of their capital being locked away for a long time due to the inherent illiquid nature of the asset class.

Allowing VC and other expensive and illiquid funds to be accessible to DC members would increase member potential returns, but also increase risk. Selecting any investment manager that outperforms net of fees is notoriously difficult and there is little evidence to suggest retail, or even institutional investors, can do this successfully over time. The performance of VC managers varies considerably and there is no way of knowing which would be successful – this would put members’ capital at risk.

What’s the alternative?

A key challenge to changing the charge cap is in answering the question ‘what do we change it to?’. VC fees can become complicated as they charge carried interest, similar to a performance fee. This could result in the member paying many multiples of 0.75%. Carried interest could encourage the VC manager to take excessive risks to get their very lucrative carried interest fee. Perhaps having a higher base fee could be a solution i.e. some funds have two share classes, one with a performance fee, the other with no performance fee but a higher standard fee.

An alternative to VC could be investing into small or micro-cap passive indices as these are more correlated to VC than traditional large cap indices. This may help members achieve higher growth but will increase the volatility of returns. As most members are likely to be invested for an extremely long time (e.g. 30-40 years), many listed and passive funds could provide a similar return to their illiquid active peers without the need to allocate to expensive and illiquid VC funds.

Brendan McLean

Unrated bonds

Rated bonds have been assessed for a fee by a credit rating agency (Fitch, S&P or Moody’s), and the agency issues a rating based on the likelihood of a bond’s default. Unrated bonds are simply bonds which have not been through this process and do not appear in benchmark indices.

Many companies, particularly large multinational firms, have both rated and unrated debt in issue; they may just choose not to pay a ratings agency to analyse a particular bond.

This can be for a number of reasons, including the size of the debt issuance, the cost of obtaining a rating, the need (or lack of) for visibility, and the level of complexity of the issue. Unrated bonds do not necessarily mean less liquid, for example, The Kingdom of Spain government bonds are highly liquid, but not rated. The sovereign (i.e. the country as a whole) is rated but not each bond.

Active bond managers are able to identify market inefficiencies between two similar bonds, one rated and the other unrated. The rated bond will often command a higher price, without necessarily offering better security or value, purely on account of being rated by one of the rating agencies (the enhancement of the rating).

By investing in unrated bonds, investment managers can increase the diversification of their portfolios, enabling them to better manage risks and enhance yield.

We prefer investment managers which can make full use of their credit research skills and investment universe by allocating to unrated bonds and build portfolios that are designed to achieve superior long-term returns.

David Davison

Employers in England, Wales and Northern Ireland LGPS will be bracing themselves for the results of the March 2019 actuarial valuations which should be landing in the inbox shortly (Scottish employers have another year to wait). So, what are they likely to see?

Asset returns have been positive over the period which will have a positive impact on the funding level, all other things being equal. Inflation is also broadly unchanged over the period. There was some optimism around mortality rates although an announcement of a fall in deaths in 2019 has potentially put something of a damper on that.

However, that’s likely to be all the good news. Gilt yields have continued to fall from just below 2.3% in 2016 to around 1.6% in 2019 placing a higher value on liabilities. Gilt yields have continued to fall subsequently with yields down around the 1.0% level now.

The big issues likely to make an impact are likely to be legislative ones. These valuations will see the incorporation of additional liabilities related to GMP equalisation. In July we also witnessed the Government being defeated in the McCloud case with speculation this could cost Funds billions of pounds. The case found that the Government had forced younger members of the Judges and Firefighters schemes to join less valuable schemes while older colleagues were protected by transitional arrangements providing them with valuable additional benefits. The Government was not granted leave to appeal so steps will now have to be taken to rectify the problem. The LGPS has similar transitional protections.

These issues will likely increase liabilities and therefore funding costs.

The uncertainty created is also likely to hit exiting employers and will result in uncertainty around the impact for employers providing out-sourced services who may be left ‘holding the baby’.

Many schemes had been going through a cost cap review which suggested they may have to increase the level of benefits being provided (as there was a cost surplus), however these deliberations were deferred awaiting the impact of these changes.

Employers may have to brace themselves for further cost increases with no real viable route to escape. Hopefully the LGPS England & Wales Consultation will look at offering some additional flexibilities and a more equitable exit basis. Fingers crossed.

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