Breaking news: TPR publishes draft Funding Code of Practice

The Pensions Regulator (TPR) has published its long-awaited second consultation on a revised Funding Code of Practice for Defined Benefit (DB) pension schemes, including sharing a draft of the new Code (now known as the General Code) for the first time.

Publication follows the Department for Work and Pensions (DWP) consultation earlier this year on the regulations under which the new funding regime will operate.

TPR previously consulted on their approach to the regulation of scheme funding – and the expected content of the DB Funding Code – in March 2020. Their approach has evolved since then, but the core principles underpinning the new regime are unchanged. 

In particular, in line with the draft regulations, schemes are required to adopt funding and investment strategies that transition to suitably low levels of risk, and ‘low-dependence’ on the sponsoring employer, at ‘significant maturity’. Whilst this will be a big change for some, many DB schemes have been formulating their journey plans towards low-risk / low-dependence for a while now and will be well-placed to comply.  

However, there are several well-documented issues with the DWP’s draft funding regulations – on which the draft Code is based – and it remains to be seen whether further adaptations to the Code will be required once the DWP’s consultation has run its course.

TPR has continued with its previous proposal to have a ‘Fast Track’ approach to compliance. Schemes whose valuations are deemed to meet a series of quantifiable tests – as confirmed by their Scheme Actuary – can expect little or no further regulatory intervention, as they are deemed low risk from TPR’s perspective. However, the Fast Track criteria have deliberately not been specified in the draft Code of Practice but are set out in a separate regulatory approach document. This is to ensure that TPR can adapt its policy to rapidly changing market conditions if necessary, without requiring Parliamentary approval of changes to the Code of Practice. TPR expects to conduct a ‘deep-dive’ review of the Fast Track criteria every three years in any case.

One noticeable change from TPR’s 2020 consultation is that the Fast Track approach will now be covenant-independent. That is, the same Fast Track criteria must be met however strong the sponsoring employer is. The earlier consultation proposed different Fast Track parameters depending on which one of four covenant classifications the employer fell into.

However, TPR still expects all schemes to assess covenant support, albeit the required depth and frequency of assessment should be proportionate to the circumstances. TPR’s regulatory approach document describes how trustees should focus on the three fundamental covenant pillars of “cash, contingent assets, and prospects”. TPR also stresses that Fast Track represents their view of tolerated risk, but it does not represent minimum compliance. Trustees and sponsors still need to consider the detailed requirements of the Code and the legislation and, in some cases, the funding strategy will need to be more prudent than the Fast Track requirements. 

All schemes will be required to submit more information about their sponsors as part of each valuation, regardless of whether they meet the Fast Track criteria or are assessed under the bespoke compliance route. TPR confirms that it will be consulting on proposed changes to its covenant guidance in 2023.

Other points to note from TPR’s consultation

• TPR will be required to define what ‘significant maturity’ means for DB schemes within the confines of the underlying legislation. For the purpose of this consultation, the Regulator has stuck to its original messaging that a significantly mature scheme is one whose average time to payment of future benefit instalments (‘duration’) is twelve years or less. This corresponds to a time when most of a scheme’s members are pensioners. 

However, TPR is conscious that the duration calculation is sensitive to movements in the Government bond market, which has been volatile in recent months, and is actively considering methods which may minimise this volatility to help schemes have more stable long-term target dates – noting that the DWP’s regulations are also still under consultation. 

• Open schemes will be able to make allowance for up to six years’ worth of future accrual (including making an allowance for new joiners over the six-year period) when determining their duration. This will allow open schemes to take comparably more funding and investment risk than closed schemes. TPR has also decided not to include a minimum future service contributions test as part of the Fast Track regime (as had been proposed in the first consultation).
• The key Fast Track parameters cover:
• The long-term low dependency funding and investment target which TPR expects to be measured relative to specified minimum financial assumptions (for example a discount rate of no more than Gilts plus 0.5%pa).
• The calculation of current liabilities (‘Technical Provisions’) which will be assessed against a proportion of the long-term funding target depending on the scheme’s current duration (i.e. how far it is from being ‘significantly mature’).
• The risk in the scheme’s current investment allocation which will be measured via a stress test, similar to that used to calculate PPF levies.
• The length of any Recovery Plan – which should be less than six years (three if the scheme is already significantly mature).
• Where individual parameters are not met, the scope of TPR’s engagement is likely to be limited to those particular areas only. So, for example, if a scheme’s valuation meets all the Fast Track criteria save for Recovery Plan length, then TPR will focus its engagement on how sponsor affordability has been assessed.
• TPR estimates that 51% of schemes will meet all the Fast Track criteria, and a further 8% of schemes will fail the Fast Track criteria on Recovery Plan Length alone. 
• Some simplification of the requirements (for example in relation to how Technical Provisions are calculated, or how duration is assessed) will apply to small schemes with fewer than 100 members.

It is anticipated that the new funding regime will now come into force on 1 October 2023 at the earliest, and will only apply to funding valuations with effective dates after this, although this depends on the progress of DWP’s regulations consultation. Some schemes’ first triennial valuations under the new Funding Code may therefore not be until 2026 or later.

Your usual Barnett Waddingham contact will be in touch shortly with further details and to discuss how the new code will affect your scheme specifically. You can also contact our experts to discuss how they can help you.