MPs in the UK have urged the Department for Work and Pensions (DWP) and The Pensions Regulator (TPR) to “halt” their existing plans for a new defined benefit (DB) funding regime, at least until they have produced a full impact assessment for the proposals.

As reported by our sister publication Pensions Age, the comments were made as part of the Work and Pension Committee’s (WPC) report on liability-driven investment (LDI), which identified two fundamental concerns with the new regime: that the approach is not sufficient to allow open schemes to thrive, and that it will result in greater ‘herding’ in investment decisions.

In the report, the WPC confirmed that it had previously asked TPR to postpone the launch of its consultation on the new funding code until it had completed its inquiry into LDI in DB schemes.

However, TPR said this would push back its commencement until October 2024, instead confirming that it would consider a further consultation if responses suggested this was needed.

The WPC's report, however, suggested that industry concerns were not dispelled by the new consultation and proposed code, with specific concerns raised around the idea that people were being asked to reach a judgement without seeing the final text of the regulations and in the absence of “any meaningful impact assessments".

Given this, the WPC recommended that the DWP and TPR "halt" their existing plans for a new funding regime, at least until they have produced a full impact assessment for the proposals, including the impact on financial stability and on open DB schemes.

Commenting in response to the report, a spokesperson for TPR said: “We note the recommendations in the committee's report and will work with DWP to respond to it.

“We have taken decisive action to learn lessons from the impact of last year’s economic turmoil, including to improve the data we hold.

"Pension trustees are acting on our latest guidance on using leveraged liability-driven investments which clearly sets out our expectations. We continue to work closely with the Bank of England and other partners to ensure a well-functioning system.”

A DWP spokesperson said: “We welcome the committee’s report. We will fully consider its findings and respond formally in due course”

Understanding the lay of the land

More broadly, the WPC’s report highlighted the September 2022 LDI episode as demonstration of the potential for the investment strategies used by DB schemes to give rise to systemic risks, noting that while action has been taken to address some of the weaknesses which were exposed in this episode, there is still more work to be done.

In particular, the WPC said that while it supported the Financial Policy Committee’s recommendation that TPR should specify minimum levels of resilience for the LDI arrangements in which pension schemes may invest, TPR does not have the data to check whether its guidance is being followed.

Given this, it called on DWP and TPR to report back by the end of October 2023 on how they plan to monitor whether LDI resilience is being maintained, including a timeline for TPR’s commitment to become a more digitally enabled and data-led organisation, with plans to resource it.

Given the extent of leverage and the concentration of DB investments, the WPC also argued that more should have been done to follow up on the risks identified in 2018 by the Bank of England.

"Collecting better data on LDI is part of what is needed to improve management of systemic risks in future," it stated.

"It will also be essential that DWP and TPR work with other regulators and the Bank of England to analyse its implications. DWP and TPR should report back by the end of October 2023 on how they intend to ensure this happens."

The WPC also suggested that TPR should require trustees to report certain data on their use of LDI and develop a strategy for engaging with schemes based on the results more closely, warning that trustee boards will continue to have complex decisions to make about whether and how to use LDI.

In particular, the committee encouraged DWP and TPR to consult on whether introducing disclosure requirements on pension schemes relating to the use of LDI through the annual report or investment statement, would help improve standards of governance.

Although the WPC suggested that what data is appropriate to collect should be decided via a consultation with stakeholders, it suggested that consideration be given to: the maximum leverage allowed in the LDI funds in which the scheme is invested; the type of LDI they invest in; compliance with minimum resilience levels; and data on the pension schemes’ asset allocations, by growth and matching assets.

It also suggested that, if requiring pensions schemes to report regularly on their use of LDI would place an undue burden on some schemes, TPR and DWP should explain the basis for allowing such schemes to continue to use leveraged LDI.

Managing system risks

In addition to collecting greater data, the WPC agreed with the FPC's recommendation that TPR should have the remit to take into account financial stability considerations, arguing that when the LDI episode arose, the regulatory framework was “complex and fragmentary, and not fit for purpose when it came to managing systemic risks”.

As part of this, the WPC asked the DWP to report by the end of January 2024 on how it proposes to take forward the FPC’s recommendation that TPR be given a remit to take account of financial stability considerations and how it plans to ensure that TPR has the capacity and capability to deliver on this.

The committee also backed calls for the government to bring investment consultants within the Financial Conduct Authority's (FCA) regulatory perimeter, suggesting that such plans should be brought forward before the end of this parliament.

In addition to this, the report acknowledged the potential role of scheme consolidation in improving scheme governance, arguing however, that consolidation needs to be into a safe vehicle, which requires legislation.

Given this, it called on DWP to respond to its 2018 consultation on DB consolidation "no later than the end of October 2023", and to work with TPR as a priority to improve the regulation of trustees and standards of governance, as it has said it intends to do.

However, the committee argued that, given the time it will take to consult on, legislate for, and implement measures to improve governance, DWP should consider whether the use of LDI could be restricted, potentially by testing a trustee board’s ability to understand and manage the risks involved.

Understanding the impact

The committee's report also noted that while evidence from TPR suggested that the majority of pension schemes emerged from 2022 with improved funding levels, external analysis has raised questions as to how confident the industry can be about these improvements.

"We are concerned that some schemes had their funding levels negatively affected as a result of the events of September 2022," the report stated.

"In addition, the aggregate value of scheme assets, according to the Pension Protection Fund (PPF), was £400 billion less at the end of 2022 than it was at the beginning. It is important that we understand what the impact was and what led to these results so that the system can work better in the future."

In light of this, the committee encouraged DWP to work with TPR and the PPF to produce a detailed account of the impact on pension schemes of the LDI episode, "by the end of 2023".

Indeed, the WPC recently heard mixed views as to the current state of DB pension scheme funding, as industry experts were divided on whether recent funding improvements were as strong as the industry has been led to believe.

Commenting on Twitter, the PPF stated: "We welcome the WPC's report following the inquiry into DB pensions with LDI.

"We’re considering what the recommendations may mean for our investment principles and strategy, as well as how they may impact the schemes we protect."

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