Brexit: The implications for UK Pension Schemes
Many sponsors and trustees of UK pension schemes are concerned about the possible detrimental impact on their schemes and loss of security for member's benefits after the UK voted to exit the European Union ("EU") on 23 June 2016. We outline the relevant issues and potential impact for UK pension schemes below.
There is speculation amongst the financial community that Brexit could lead to the following consequences:
- Difficulties with negotiating free trade agreements with non EU countries like China and the USA;
- Uncertain EU regulatory requirements to allow the UK continued access to EU financial services markets;
- Reduction in levels of direct foreign investment in the UK as a result of economic uncertainties;
- Skills shortages in UK if migrant controls are put in place.
In turn this could have an adverse impact on the UK's capital markets:
- There could be a weakening of the value of sterling, which could have a negative impact on UK investment portfolios;
- The bank base rate may stay at lower levels for longer or even go to negative levels;
- Slower UK growth could lead to a fall in the value of UK equities
These perceived risks of "interest rate" volatility (and possible negative rates) may lead more defined benefit schemes towards entering into contracts to protect or "hedge" against these risks.
If the UK's credit rating is downgraded there may be termination risks under "hedging" arrangements. If financial institutions choose to relocate their headquarters outside the UK (as some analysts predict) then schemes may have to review their "counterparty risks" where they are parties to existing hedging contracts.
This is all speculative but the investment climate is likely to experience considerable uncertainty over the coming months. This is bad news for both defined benefit pension schemes (where the sponsor takes the investment risk) and for trustees and members of defined contribution schemes, where the investment risk sits with the member.
Steps to consider taking:
Investment review - Trustees of defined benefit schemes may wish to monitor the risk profile of their schemes with their investment advisers and possibly adjust their investment strategy accordingly.
Sponsor Strength - Trustees should review their internal procedures to test the strength of the sponsor's covenant and assess the likely impact on the covenant of Brexit. This will be relevant to both the sponsor and any guarantors (who may also suffer business difficulties as a result of Brexit). The terms of current guarantees should be reviewed and any reporting issues considered. New or revised security arrangements may be required to protect the scheme depending on the funding position of the scheme and the impact of Brexit on the financial covenant of the sponsor.
Regulatory impact - Many legislative and regulatory requirements for pension schemes have their origins in EU law, such as the requirement for pension schemes to equalise pension benefits for male and female members, which stems from decisions of the European Court going back to the "Barber" decision in 1991. This equality principle stems from the European "equal pay" requirements (and the view of pension benefits as a form of deferred pay).
Much of EU law has been applied directly by UK law, like the Equality Act 2010 which implements the equal treatment provisions of the Treaty of Rome. Post Brexit it may be more difficult to challenge UK legislation by arguing that it fails to implement relevant EU law. Practically this could make it more difficult to argue that "guaranteed minimum pensions" should be fully equalised for male and female members (these benefits being based on historically unequal state pension benefits). Also challenges to the limited equality provided in respect of member's civil partners and same sex-spouses could be more difficult as well.
It may be that the terms of any exit strategy would place requirements on the UK to ensure future compliance with EU pension laws. Areas like international data-protection and funding for UK cross-border schemes come to mind.
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