UK defined benefit pension schemes with an overseas parent could “exploit” the fall in sterling and use it as an opportunity to ask for a cash injection into the scheme from the sponsor.

Speaking to European Pensions, Mercer chief investment officer, UK wealth, Joanne Holden, said Mercer has been encouraging clients to think about the scheme’s employer covenant during this period of preparing for Brexit.

“That’s not just in the sense of reading the latest report that comes with the actuarial valuation that says the employer covenant is tending to strong, or whatever it may be, but actually, engage with the sponsoring employer on what their contingency plans are.

“Could there be a cash flow problem, how long is that likely to last for, where does the pension fund fall within their contingency planning? Doing this means that the dialogue starts way in advance, and not 31 October, when the pension fund realises it has got a cash flow problem,” she explained.

She also noted that overseas parents might see an injection of cash into a UK scheme as attractive due to the current fall in sterling.

“If you’ve got an overseas employer, and you think about what’s happened to sterling, if you’ve got a US parent, putting a cash injection into a UK pension scheme at the moment might actually be quite attractive, relative to where sterling was a few years ago,” she said.

With regards to Brexit, Holden advises schemes to think about the robustness of their portfolios in case the UK leaves the European Union (EU) without a deal. However, she noted that as there has been a lot of time since the referendum decision, a result she said the industry did not expect, a lot of the work has already been done.

“For a lot of clients, we aren’t having to start that education process now so that they have really quick decisions to make between now and 31 October, which is a positive. I don’t think there is going to be any knee-jerk reaction. Instead, we are advising clients to be in health check mode,” Holden said.

For example, she explained that the average UK pension scheme currently has around just 20 per cent allocated to equities, with the majority being global equities. If the markets fall it won’t be pleasant but it won’t be the problem that it was 5-10 years ago when schemes held a lot more in equities, she said.

“What we don’t want is for our clients to be forced sellers because they’ve suddenly got a big transfer value to payout, or the pensioner payroll has suddenly gone up. It’s about planning, and opening that dialogue,” she added.

In addition, Holden advised schemes to stay away from thinking that gilt yields would increase.

“We won’t be making predictions on where yields will go, but everybody knows the direction of travel we’ve seen over the last 10-15 years. I think we’ve got to the point of not being able to say they will go up at some point. I think as well as thinking about tightening up on LDI, and interest rate and inflation hedging, funds need to be thinking really hard about lower for longer or even lower forever,” she said.

Holden explained that as many schemes are approaching buyout, they don’t have ‘forever’ left.

“We do occasionally still see views from trustees as well as professionals and advisers that it’s ok to count on yields rising at some point in the future, but I don’t think it is ok. They might go up, but I don’t think we should be making predictions about gilt yields. I think we need to be dealing with what we’ve got and protecting against downside scenarios, not banking on upside,” she said.

Holden said the Armageddon situation would be a scheme that is facing a range of interlinked problems, starting with a big allocation to equities and the market drops.

“That same scheme perhaps doesn’t have a lot in gilts and none of it is leveraged, it might just be index-linked or fixed-interest gilts, so if yields continue to fall their liabilities will shoot up…you may need to then sell some equities to fund cashflow because you’ve got members transferring out, and you’ve got a sponsor who is in trouble because it hasn’t factored in contingency planning for Brexit,” Holden explained.

She said there would be a “handful” of schemes facing that Armageddon situation.

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