Reflections on the DWP’s final draft funding and investment strategy regulations

Against the backdrop of a grey February morning, the long, hot, dry summer of 2022 with the added joys of digesting the first draft of the new funding and investment strategy regulations by the pool, seems like an eternity ago.

That draft prompted a flurry of activity across the pensions industry. We and many others expressed concerns that the proposals were not sufficiently clear and risked pushing schemes towards excessive levels of de-risking and a herding of strategies that would not necessarily be in the interests of members or the wider economy. Eighteen months of industry speculation followed, fueled in part by the Mansion House proposals last summer and DWP’s November announcement that the revised regulations “will make clearer what prudent funding plans look like, make explicit that there is headroom for more productive investment”.

With that packaging, excitement understandably built as I read the Government’s consultation response at the end of January, taking in the heady aroma of pronouncements that, in contrast to the draft, the final regulations provided more clarity and explicit recognition that schemes could take risk where appropriate. But as I peeled back the wrapping and delved into the regulations themselves, I couldn’t help feeling a bit deflated. That nagging feeling that a relative has just re-wrapped last year’s Christmas present and sent it back to you. Yes, there are a few changes, but fundamentally the structure is much the same as the first draft back in 2022, with many of the issues that we and others raised in our consultation responses not having been addressed fully or clearly.

At a high level, the requirements largely relate to the principles that need to be followed, or the factors that need to be taken into account, when determining a scheme’s funding and investment strategy along with what the strategy documentation needs to include. It is important to bear in mind that the new legislation does not prescribe how a scheme actually has to be invested or funded. Few, if any, in the industry that I have spoken with believe that this structure provides a huge amount of clarity, but some might argue that we’re a demanding bunch! The structure of the new legislation is, to say the least, pretty opaque and requires a fair amount of careful reading to pick apart. That creates the risk of trustees and sponsors reaching rather different interpretations, or reaching sub-optimal agreements if they haven’t appreciated some of the nuances in the drafting, and in particular the interaction between how a scheme’s strategy needs to be set and what needs to happen in practice.

Perhaps the biggest surprise in the revised draft is that the Government opted not to amend the ‘low dependency’ definition to provide greater flexibility, particularly given the importance they appear to attach to schemes being able to invest in productive finance assets. Indeed, the ‘flexibility’ trumpeted by the Government appears to stem simply from trustees not actually having to invest in line with their stated funding and investment strategy.

So, what are the main changes to the regulations since the first draft?

So, despite my disappointment that we didn’t see more movement in the drafting, do I have any significant concerns about the regulations as they have landed? I think we are going to have to wait for the new Code of Practice on funding to be more definitive, but I’m currently hopeful that the new regime will provide sufficient flexibility for sponsors and trustees of the vast majority of schemes to continue to settle on funding and investment strategies that take account of each scheme’s unique circumstances. There will however be a new process to follow that will have to comply with the various requirements, which are going to need to be interpreted carefully to reduce the risk of any pitfalls. Clearer drafting would have made that a less tortuous task but we are where we are!

Leaving aside the technicalities and any concerns over how the requirements might be interpreted, the changes will hopefully reinforce the importance of trustees and sponsors pausing to think again about where they are trying to get to, and implementing a holistic strategy through their actuarial valuations to support these ambitions that leads to the best chance of delivering on all stakeholders’ goals.