11 October 2018
FCA finalises further rules on DB transfer advice
The Financial Conduct Authority has completed the next stage of its belated efforts to improve the quality of advice for those thinking of transferring away from their DB pension schemes. This is through the publication of its response to a consultation launched in March (see Pensions Bulletin 2018/13) along with final rules.
The FCA is proceeding on the basis on which it consulted, other than for its proposal to amend the definition of pension transfer, which is to remain unchanged. The timescales for implementation are as follows:
- Immediately – guidance on two advisers working together (ie where one advises on the transfer and the other on the proposed investments in the receiving scheme), assessing the client’s attitude to the general risks associated with transferring away from DB (as well as their attitude to investment risk), and preparing a suitability report in all circumstances
- 1 January 2019 – perimeter guidance on triage (see below)
- 6 April 2019 – revised pension increase assumptions
- 1 October 2020 – pension transfer specialist qualifications and appropriate exam standards
The FCA notes that many advisers currently operate a triage service as part of their DB transfer advice process – ie they have an initial conversation with potential customers, in order to give sufficient information about safeguarded and flexible benefits to enable the customer to decide whether to take advice on the transfer or conversion of their pension benefits. However, the FCA is concerned that some forms of triage are moving beyond generic information. It has added a series of examples in its Handbook to the effect that any reference to a client’s personal circumstances is likely to be straying across the regulatory guidance/advice perimeter.
The FCA has also decided to undertake further work into contingent charging structures. Back in March it sought views on a possible ban, but did not propose any rules. The feedback to this aspect of its consultation was polarised – those in favour of a ban saw such charges as a cause of conflicts of interest, whilst those against (a small majority) were largely concerned about the availability of advice should such a ban come into being. If as a result of its further work, the FCA considers changes to its rules are appropriate it will consult on them in the first half of 2019. This in turn may affect its attitude towards the provision of an effective triage service.
Many will be disappointed that the FCA has not signalled a tougher line to come on contingent charging. It is also not clear what further work the FCA has in mind before it can reach a decision on whether or not to intervene in this aspect of market practice. But any rule change would appear to be at least two years away. Until then DB members remain at risk of receiving biased advice, depending on who they turn to for assistance with a huge decision.
Regulator intervenes on a flexible apportionment arrangement
More than a year after the matter was settled, the Pensions Regulator has published an account of how it came to intervene after being notified of a flexible apportionment arrangement.
These arrangements, available since January 2012, enable an employer to pass its DB scheme responsibility to another employer without a buyout debt being triggered. It depends very much on its successful operation for the trustees to conclude that it is the right thing to do by the members, with the Pensions Regulator being notified, but not having a formal role in deciding whether or not the arrangement should go ahead.
In this case, involving the Martin Currie Retirement and Death Benefits Plan, the Pensions Regulator was not happy with the transaction that had taken place, concluding following an investigation, that the flexible apportionment arrangement was “materially detrimental” within the meaning of the moral hazard provisions of the Pensions Act 2004.
This enabled the Regulator to impose a Contribution Notice. However, the outcome was not this, but instead a further flexible apportionment arrangement, agreed with the Regulator, under which its concerns were addressed. The Regulator’s investigation also revealed significant concerns about the conduct of the trustees and as part of the agreement all those involved in the initial flexible apportionment arrangement decision stood down and an independent professional trustee was appointed.
There is no suggestion in the Regulator’s report that any of the conditions necessary for a flexible apportionment arrangement to take place (in particular the “funding test”) were not met and so it seems that it is possible to meet these conditions whilst potentially falling foul of the moral hazard law. As such, this is a useful reminder that when an employer wishes to depart, without paying its share of the buyout debt, that the terms of the deal need to be scrutinised for any sign of member detriment and where such exists, adequate mitigation is put in place.
DB consolidation vehicles and employer covenant
The Employer Covenant Working Group has produced an interesting discussion document setting out some questions the DWP asked as it worked up its forthcoming consultation document on DB consolidators.
Using the PLSA’s "Model 4" superfund idea, the discussion paper provides answers to the following questions:
- How could a potential gateway to stop those who can afford buyout from entering a superfund work?
- What would trustees need to consider when assessing whether to transfer to a superfund in relation to the employer covenant?
- Does the employer covenant advice market have the capacity to provide this advice and how likely is it that trustees would be able to understand the information?
- How could you assess the covenant of superfunds?
The DWP has a difficult line to tread if it wishes superfunds to operate in a space that most definitely falls short of buyout. The Working Group puts forward some ideas as to how that line could be drawn, and concludes that a principles-based, rather than formulaic approach is needed, with (unsurprisingly) the need for professional covenant assessment in determining whether or not a scheme should transfer to a superfund. It also suggests that an independent professional trustee could be required to be appointed to assist with the decision.
Will DB schemes buy into a falling bond market?
The Bank of England has published a working paper that looks at the likely investment behaviour of DB pension schemes in the face of various “exogenous shocks”. Using results generated from a structural model of DB pension funds’ asset allocations, based on a stochastic framework recognising both investment and covenant risk, the paper suggests that such schemes are sensitive to shocks that change their funding ratios.
In particular it says that:
- Deteriorations in funding ratios encourage DB schemes supported by financially weaker corporate sponsors to switch some equity holdings into bonds – because reduced funding ratios weigh on the perceived vulnerability of already weak corporate sponsors
- Similar deteriorations in funding ratios encourage DB schemes supported by financially stronger corporates to increase their equity holdings to benefit from their higher expected returns; and
- Shocks that result in material improvements in funding ratios – such as those resulting from a large rise in interest rates – encourage all DB schemes to increase their bond holdings to “lock in” those improved positions
This last point is of particular interest given the prospect of further interest rate rises. In the authors’ view, in the face of the resulting improvement in funding ratios, DB schemes would support bond market liquidity by behaving counter-cyclically – that is, buying as bond prices fall. However, they note that this support for bond market liquidity “may prove limited due to the typically slow moving investment behaviour of pension funds”.
This Pensions Bulletin does not constitute advice, nor should it be taken as an authoritative statement of the law. For further help, please contact David Everett at our London office or the partner who normally advises you.