Are industry professionals right to be concerned and might consolidation help manage this risk?
When the UK government introduced the Pensions Act 2004, the new “moral hazard” powers granted to the Pensions Regulator were meant to prevent business owners from walking away from their pension scheme obligations.
However, after a number of high-profile insolvencies, including BHS and Carillion, left significantly underfunded pension schemes, the government began questioning if the regulator had sufficient powers to police the industry effectively.
Yet as the new Pension Schemes Act 2021 comes into force, many in the industry are now left wondering if the regulator’s revamped powers go too far, says Michael Collins, pensions partner at Gateley Legal.
Stuart Evans, pensions partner at Gateley Legal and director of Gateley’s trustee company Entrust, believes the changes will increase the drive towards a more professional approach to pension scheme governance, including greater uptake of operational consolidators.
Under the new rules, which introduce a number of criminal offences, the regulator can impose far stiffer sanctions of unlimited fines and up to seven years’ imprisonment, as well as wider powers to issue contribution notices to those who have taken actions that either reduce the value of an employer’s resources or reduce the amount a scheme is likely to recover in the event of an insolvency. In addition, liability is no longer limited to just those connected with the employer.
“These criminal offences can be applied to anybody involved with the scheme or its sponsoring employer, so it could cover advisers, the trustees themselves, investors or banks. Anybody involved in a business with a defined benefit pension scheme has to have one mind on this potential criminal offence,” says Collins.
The onus will be on the individual or organisation to demonstrate they were acting reasonably. Consider a bank lending to a business with a defined benefit scheme. If that bank asked for security so it ranks ahead of the pension scheme in the event of insolvency, could the bank be at risk of sanction?
“In circumstances like that you would be confident you could show a defence of reasonable excuse, but your starting position as a bank or a bank’s adviser is you’re potentially treading into criminal territory, so it could put some banks off lending to businesses with defined benefit pension schemes,” says Collins.
Evans adds that anyone looking to invest in a business that has a defined benefit pension scheme is also potentially bringing themselves within the scope of these powers.
“However, any strategy that has the agreement of a professional independent trustee will almost certainly clear the reasonable excuse hurdle,” he says.
As well as potentially deterring legitimate business activities, the new contribution notice powers could have unintended consequences by causing employers and trustees to focus on the short term rather than what is in the interest of the pension scheme in the long term.
“Because of the pandemic, many sponsoring employers are struggling financially,” says Collins. “From a trustee’s perspective, the best chance of members getting their pensions paid in full is if the employer is there for the long term, because if the employer was to become insolvent, the scheme would only get a fraction of what it needs to secure the members’ benefits.”
The potential problem with the new contribution notice powers is they might deter the parties from agreeing to actions that could help secure the long-term viability of the employer, because in the short term they reduce the employer’s resources or the amount the trustees would recover in an insolvency.
“Sometimes a short-term reduction in what the trustees would recover in an insolvency might make that insolvency less likely,” says Collins.
Evans says a professional trustee can help overcome these difficulties by factoring in the pension scheme’s long-term funding target, which is another priority for the regulator.
While the new legislation has only recently received Royal Assent and the regulator is yet to issue guidance on its enforcement policies, employers should still start preparing for the changes.
“Although these new powers will not be retrospective, people should have one eye on them now,” says Collins. “The key will be making sure you can demonstrate you can justify any actions you take. The starting point of that is showing you considered the effect on the pension scheme, took appropriate advice and agreed any actions with the pension scheme trustees. If you can show you have done this, it will be difficult for the regulator to show you didn’t have a reasonable excuse.”
Evans adds that a professional trustee will assist greatly in such scenarios and this will accelerate the consolidation of the pensions market towards more efficient scaled-up solutions, such as shared service platforms and master trusts.
Despite criticism of the breadth of the new powers, Collins is hopeful some of the pension industry’s misgivings prove to be unwarranted, not least because similar concerns about the impact on legitimate business activities were raised in 2004.
He also expects, like in 2004, there will be a spike in clearance applications, where employers can seek regulatory approval for any plans they have by outlining how they would impact the pension scheme, but that these too are likely to recede over time. After the original provisions were introduced in 2004, there were more than 200 clearance applications submitted annually for the first few years, but by 2019 there were just three.
“There will be a period when people are getting a handle on what’s acceptable and what isn’t, and that’s where we as advisers can help,” says Collins.
The industry is also hopeful that the regulator will only use its new powers to prosecute the very worst offenders. The regulator has said it will use the new powers proportionately, which is consistent with its current approach.
“The regulator has only used its existing powers a handful of times; instead it uses its existence as a deterrent,” says Collins. “The regulator has reported several cases where it has stopped short of using its powers, but the threat of those powers has been enough for it to negotiate a good outcome. That will likely happen more often than not with the new powers. If the regulator has concerns, it will investigate and bring all the parties to the table, with the threat of criminal sanctions seen as another tool in its armoury to drive better behaviour.”
For a comprehensive guide on how to deal with the new powers visit gateleyplc.com/pensions