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Brexit – Are There any Implications for UK Pension Schemes?

Brexit – Are There any Implications for UK Pension Schemes?

Sarah Philips

How time flies.  Two years ago when we were discussing the Scottish Independence Referendum, the potential impact on UK pension schemes of a vote by Scots to leave the United Kingdom was significant.  The question now is: “Do the same issues arise in relation to the referendum on whether the UK should leave the European Union?”.  Thankfully the answer is “no”.  But there are still some issues to consider.   And although it is clear that there would be a lengthy transition period if the UK votes to leave the EU, it is worth considering the risks now in order to identify and put in place any necessary contingency plans.

Much of UK pensions legislation is based on EU law.  The underlying principles of equal treatment between male and female members, protection for members’ benefits in the event of employer insolvency, and requiring employers to meet minimum funding requirements have been part of UK legislation for a significant period of time and are unlikely to be abandoned immediately following a Brexit.  It is not inconceivable in the longer term that elements of UK pensions legislation would move away from the EU position, but I would be surprised if any UK Parliament were to try to pass legislation that has the effect of diluting the protection provided to pension benefits.  Such a policy is unlikely to garner much public support – remember Maxwell!

So, the way in which UK pension schemes operate on a daily basis is unlikely to be affected by a vote to leave the EU.  The areas that are most likely to be impacted by such a vote are employer covenant, contingent assets and pension scheme investments, mainly due to the impact of Brexit on financial markets and the trading prospects of UK companies.  That impact is likely to be most keenly felt in relation to defined benefit pension schemes.

Employer Covenant

One of the key potential negative impacts of Brexit is likely to be on the strength of the sponsoring employer’s covenant.  The Pensions Regulator expects trustees of defined benefit pension schemes to adopt an integrated approach to risk assessment, taking into account funding, investment and covenant.  Trustees should assess and monitor the strength of the employer covenant backing their scheme at regular intervals.  To do so, trustees must take into account the industry in which the employer operates and the economy as a whole.  When trustees and their advisers are carrying out their covenant analysis, they should be considering the impact of a potential Brexit.

If, as a result of worsening trading conditions, the trustees conclude that the strength of the employer covenant has deteriorated, they are likely to ask for increased cash contributions to the scheme and / or increased security to deal with the funding risks and to protect members’ benefits.

Contingent Assets

Many defined benefit pension schemes have contingent assets in place, agreed between trustees and the employer and providing additional security for members whilst reducing the PPF levy payable by the scheme.  If an employer’s financial position is worsened by Brexit, this could trigger additional obligations under the contract or lead to an increase in the PPF levy payable.

Investment Strategy

Trustees of defined benefit schemes may also need to reconsider their investment strategy to ensure a sufficient spread to mitigate against the market volatility that is likely to follow a Brexit vote.  If the UK’s credit rating were to be downgraded it would have implications for bond prices and gilt yields, which impact directly on scheme liabilities.  Trustees will also need to consider the implications of any change in investment strategy on investment costs and on scheme funding levels.

Particular issues may arise in relation to arrangements that schemes have in place to hedge against certain risks, for example longevity or interest rates.  Trustees will need to assess their ongoing and potentially increased exposure.  As with the Scottish referendum, it has been suggested that overseas financial institutions, often the counterparty in such arrangements, may move their headquarters out of the UK in the event of a Brexit vote.

For defined contribution schemes the implications are less immediate.  However, trustees will need to assess whether any changes in trading conditions are likely to impact on the employer’s ability to contribute.  They should also consider whether Brexit could affect the investment options available to members.

We have examined various facts around the EU referendum process, links to which can be found here.  Over the coming weeks and months, our specialists will be publishing further analysis of how their sectors may be affected if the UK votes to leave the EU, to help you understand the areas of uncertainty and assess the potential risks to your business.

Please do get in touch if you have any queries over how your business could be affected by the UK voting to leave the EU.

Sarah Phillips
Partner

LChalmers