Cardano, the pensions advisory and investment management specialist, welcomes the Department for Work & Pensions’ (DWP) draft Occupational Pension Schemes (Funding and Investment Strategy and Amendment) Regulations 2023.

Meaningful assessment of covenant fundamental

The draft Regulations are heading in the right direction in helping trustees and employers in planning their scheme funding over the longer-term. They also support the intention to improve risk management through covenant-driven investment and funding strategies and a long-term objective of reducing reliance on covenant.

As part of any shift to longer-term planning, a clear understanding of how covenant can support risk in the near term and how covenant may evolve over time, needs to be a fundamental input into a covenant-driven journey plan.

Potential unintended consequences

However, Cardano shares some of the industry’s concerns regarding the potential unintended consequences of the draft Regulations, in particular:

• The formalisation of an overly-simplistic and restrictive definition of covenant;
• Dissuading investment in sustainable growth / pushing employers into stress or distress through unaffordable contributions;
• Schemes reducing prudence or extending covenant reliance; and
• Focussing on low-dependency at significant maturity as the “end point”.

Many of these unintended consequences could be addressed by the Regulations focusing on principles, with The Pensions Regulator (TPR) responsible for setting out the practical detail and application of the “comply or explain” approach already communicated as part of the upcoming Funding Code.

There is further a challenging balance between providing too much detail in the draft Regulations (leading to a lack of flexibility) and providing not enough (leading to ambiguity). This is particularly acute given we do not yet have sight of the draft Funding Code of Practice, which would be expected to provide the necessary detail and scope for flexibility.

Emily Goodridge, Managing Director, Cardano Advisory, said: “There has been widespread concern in the industry about the draft Regulations linked to some of their potential unintended consequences. We agree that these unintended consequences need to be addressed but, overall, we are supportive of the intention to improve risk management through covenant-driven investment and funding strategies and a long-term objective of reducing reliance on covenant.

“However, looking beyond the unintended consequences, this is a really good opportunity for schemes and sponsors to engage on managing pension risks, particularly as part of an ongoing valuation process or a strategic reset following the recent turmoil in the gilts markets. A clear understanding of how the covenant can support risk in the near term, and how covenant may evolve over time is key for meaningful input into a covenant-driven journey plan.

“We look forward to the upcoming consultations on the DB Funding Code of Practice, which we hope will provide the appropriate level of detail to flesh out the principles within the Regulations, and the Guidance for Assessing and Monitoring the Employer Covenant.”

Read our full consultation response here.