Con is a regular on this blog, here he discusses the Pension Regulator’s role in DB Governance.
Our deconstruction of the narrative promoted by the Pension Regulator occupies around one third of our response to the Department of Work and Pensions DB Green Paper. It is informative that the Regulator’s first response to our attempts at engagement on this has been to seek shelter behind its legally-defined objectives; a course which is highly questionable.
The Regulator is charged with interpreting those laws, and has shown itself to be quick to have them varied. In this context, it will also be instructive to see the contents of the white paper response to the DWP consultation when it is published in December. To date, the Regulator has been selective in its implementation of current legislation Their inaction on leveraged derivatives is remarkable given the baldness of the IoRP Directive prohibition on borrowing: The home Member State shall prohibit the institution from borrowing or acting as a guarantor on behalf of third parties. However, Member States may authorise institutions to carry out some borrowing only for liquidity purposes and on a temporary basis. The emphasis placed by the Regulator on the sponsor’s covenant is noteworthy in another regard; that term does not even appear in any of the volumes of pension legislation.
This overlong prelude brings us to their latest campaign – Good Governance. For DB schemes, the Regulator has stated that its motivation for this campaign arises from a survey they commissioned which considers the extent of trustee compliance with the nine principles of their 2014 DB funding code of conduct. It does not consider in any way that each and all of these principles is disputable, as is evident from our DWP Green Paper response. While good governance is indeed essential, there is a necessary precursor, that the purpose of the scheme be well-defined and understood.
With its conflicted objectives, the Regulator is not well-positioned to advance this definition or understanding in an objective and independent manner. The issue is related to the sponsor covenant, which is perhaps as it should be given that the sponsor underwriting of the implicit investment return on contributions is the defining characteristic of a defined benefit promise.
It is a fundamental feature of English law, and many other legal systems, that a person’s debts and obligations cease to accrue on death. This holds for both natural and juridical persons. The obligations do not transfer to heirs and successors. This is often misleadingly, and incorrectly stated as “your debts die with you”, when in fact they crystallize and become payable, as the value accrued to date. It is self-evident that the person cannot perform the future actions promised; consideration of what might have been is clearly futile.
In other words, it is not the proper purpose of a company to make provision for events occurring after its insolvency. It is as misguided for a company to over-provide security for its pensions promises as it would be for the company to create and fund a trust for the payment of dividends to shareholders to take place after the company’s insolvency.
There is also an issue of equity among stakeholders to be considered. Favouring one class, pension beneficiaries, above all others, is inequitable. This holds true even if insolvency does not occur.
This raises some fundamental questions for both regulation and current practice. The specific questions arising range far and wide, from the trivial to the profound. They include valuation procedures taking present values of projected cash flows that arise after sponsor insolvency, to concepts such as the “self-sufficiency” of the scheme. The central regulatory themes of protecting beneficiary members and funding to reduce Pension Protection Fund exposure are deeply suspect, even if well-intentioned.
Without resolution of this basic situation, governance has no guiding objective. Independent trustees simply function as costly regulators in residence, and another adjunct to an authoritarian, autocratic regime, divorced from reality, and displaying arrogance in consequence. This is likely to accelerate the decline of DB provision, not facilitate it.
The survey that the Regulator should have commissioned would have asked which characteristics individuals actually want and value in their pensions, and would then have considered how they may be voluntarily delivered.
