Regulation must adapt to protect members in consolidation deals

This means schemes relinquishing their own sponsor covenant and passing the relevant liabilities to a commercial consolidator in exchange for a cash top-up on entry.

This might not seem like a big step, but it could be a seismic change for the DB landscape and the regulation underpinning it.

The Pensions Regulator would continue with its statutory objectives to protect members’ benefits and minimise future calls on the Pension Protection Fund, but it will need to adapt its existing regulatory guidance and approach to cover consolidation deals.

Clear guidance will be needed from the regulator on the relevant matters that need to be considered by trustees, and the advice they should receive in evaluating transactions

Transactions involving these vehicles place a much greater spotlight on the employer covenant. In our view, this is all about covenant – and trustees would need to seek advice confirming that the security of members’ benefits does not suffer by releasing their existing sponsors.

While some in the industry would wish to distil analysis into standard stochastic models in order to ‘green-light’ transactions, transactions will be very scheme-specific, and indeed sponsor-specific.

The appropriateness of each transaction will demand careful consideration by the trustees of interrelated relevant factors as part of a robust decision-making process, and models will be just one element to be considered.

Regulation and guidance both needed

With a Department for Work and Pensions consultation forthcoming this autumn, the rules for this nascent marketplace are still in the very formative stages. We believe regulation will need to adapt in a number of ways.

Clear guidance will be needed from the regulator on the relevant matters that need to be considered by trustees, and the advice they should receive in evaluating transactions involving a clean break.

These considerations and the required level of scrutiny are likely to significantly exceed that of regular trustee deliberations.

This guidance could cover:

• How trustees should assess whether member benefits are expected to be no less secure in the consolidation vehicle – is the test ‘at least as safe’ or ‘demonstrably better’?

• How to ensure the scheme receives ‘fair value’ for the loss of the existing sponsor covenant;

• Testing if the transaction is the best available among a range of alternatives, and how trustees can demonstrate to the regulator that they have pushed the existing sponsor hard enough to achieve this.

Learning from the recent Competition and Markets Authority investigation into the investment consulting industry, any new regulation must ensure robustness and transparency from inception.

It should highlight that different propositions will offer different levels of security, and that the trade-offs between price and security will need to be properly understood and evaluated in a way rarely conducted when procuring bulk annuity deals.

Trustees need clarity before sign-off

Regulation must ensure transparency around the varying economic models of providers, ensuring trustees (and members) are clear on what the risks and rewards are for all stakeholders.

As with DC mastertrusts, which are shortly to go through authorisation, it may be that consolidators need to be formally authorised, including frequent assessment of regulatory capital and risk management processes.

Regulation should be also outlined to trustees, members, and stakeholders across the DB pensions landscape, in situations where consolidation could provide a helpful alternative approach.

Putting in place the above (or some other combination of relevant tools) to safeguard member benefits in superfund transactions will take time.

Clearance could bridge gap

The market is moving fast and the DWP is looking to consult shortly. In the interim, providers and trustees may seek to use TPR’s clearance regime.

Though not necessarily intended for the purpose, clearance is one method of gaining regulatory insight and comfort on early stage transactions. 

Commercial consolidators could offer a new option for those DB schemes backed by weaker covenants.

However, allowing an existing sponsor a clean break could prove risky without the proper safeguards and regulation being in place from the outset – after all, most of the clean break models marketed to employers back in 2006 dissolved into thin air with the publication of the regulator’s abandonment guidance.

Darren Redmayne is managing director at Lincoln Pensions