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Pension Funds
Insider

Contingency plan

For pension trustees, cash will always be king. However, the employer may not have the cash available to pay into the pension scheme at the rate that trustees would like. Or the employer may simply not want to pay that amount of cash into the pension scheme, preferring to invest it in the business. Contingent assets can be a workable compromise. They allow employers to pay cash into the pension scheme at a lower level or for a longer period while providing trustees with protection against risks which are of concern to them.
There are various scenarios in which a contingent asset may be used, including:
• as part of the funding package agreed by trustees and employers in relation to actuarial valuation discussions;

• as mitigation where there has been a deterioration in the employer covenant;

• to underpin investment risk taken by the trustees; and

• to obtain a reduction in the Pension Protection Fund (PPF) levy (in which case the contingent asset must be in the PPF's standard form and meet the other prescribed PPF requirements).

A contingent asset sits outside the pension scheme unless a 'trigger event' occurs, at which point trustees may call upon the contingent asset and seek to realise value from it.
The trigger events are usually keenly negotiated. Employers do not want to 'lose' the assets into the pension scheme too soon, whereas trustees want to ensure that they are adequately protected.
The starting point for trustees considering contingent assets is to identify what risks they are seeking to mitigate. Insolvency of the employer is a standard trigger event but others can be catered for, such as a funding level trigger whereby if the scheme funding level falls below a particular level, amounts tip from the contingent asset into the scheme.
Identifying the risks will assist the trustees in determining what type of contingent asset may be appropriate, although ultimately what type of contingent asset is available will depend on what assets the employer has in its business and the type of support it is willing to provide – this is a negotiation after all.
The most common types of contingent asset are:

• guarantees: the guarantor agrees to pay amounts to the scheme if the employer fails to;
• escrow arrangements: the employer places cash and/or securities into a third-party account held by a custodian. Assets tip from the account into the pension scheme following a trigger event;
• legal mortgages: the employer provides the trustees with a mortgage over real estate. Trustees can sell the property and realise value upon the occurrence of a trigger event;

• letters of credits/surety bonds: a third party bank (letter of credit) or insurer (surety bond) issues this in favour of the trustees. The trustees claim money direct from the bank or insurer when a trigger event occurs.

• asset-backed contribution structures (ABC): the employer places assets in a special purpose vehicle in which the trustees have an interest. An ABC typically has a dual function – to fund a pension scheme deficit by way of regular cash distributions and to provide contingent asset support, by way of access to the assets, in the event of a trigger event occurring.

Each type of contingent asset has its own pros and cons. Which one is best will depend on the specific circumstances and what the trustees and employer are seeking to achieve. However, the range of options available and increased familiarity with them in the pensions industry means a growing number of trustees and employers are finding that contingent assets are a viable solution.

Vicky Carr, Finance Partner, Sackers

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Pension Funds
Insider

No news is good news

Pensions experts are breathing a sigh of relief following the minimal changes announced in the latest Budget.

Despite speculation that pension tax allowances might be cut or adjusted, no such proposals were made. Instead, a 3% state pension rise and an increase in the lifetime allowance from £1m to £1.03m are the main pertinent components.

The Budget appears to have been designed with younger people in mind, with measures including changes to stamp duty for first time buyers - a move that makes political sense following the results of the last election where Labour took 64% of the 18-29-year-old vote, compared with just 21% for the Conservatives.

Barnett Waddingham's Malcolm McLean, welcomed the change in focus and lack of dramatic changes: "This was very much a steady as you go Budget, with no major surprises," he said.

While the focus was distinctly on the younger generation, the change to the Lifetime Allowance (LTA) is still significant for pension funds. The LTA has been adjusted in the opposite direction in recent years, making the increase a largely positive step. The LTA has seen several reductions since 2012, including from £1.5million down to £1milion in 2014.

The move was not a surprise either. Most of us in the industry expected to see the increase, but some feared an unexpected U-turn might be on the cards.

Kate Smith, head of pensions at Aegon, said: "Fortunately, there was no U-turn in the LTA and this is good news, even if on the surface the increase isn't large. A small increase is welcome for those nearing the limit, but this is a complex area where people seek financial advice to avoid paying unnecessary tax."

One other advantage for fund managers is the additional security the greater amount provides; giving advisers an even more solid background when they are working with clients.

The 3% state pension rise was also a relief, while not being much of a surprise thanks to the Triple Lock, which is in place until 2020.

Overall, the quiet Budget and distinct lack of action on pensions point to a Government looking to steady the waters after what has been a turbulent time for both pensions and the wider financial community. The impact of Brexit is widespread and pensions have experienced huge changes in recent years.

A calmer period for the industry will no doubt give people a greater opportunity to adjust the status quo.

"No news is good news for pension investors," said Tom McPhail, head of policy at Hargreaves Lansdown.

"The stability of no change is a welcome relief after years of political interference and the salami-slicing of reliefs and allowances. There may have to be further changes at some point in the future, but in the meantime, investors can make hay while the sun shines."

Elsewhere in the Budget?

1. Individual Savings Account (ISA) allowance for 2018/19 to be frozen at £20,000
2. Annual subscription limit for Junior ISAs and Child Trust Funds for 2018-19 will increase in line with CPI to £4,260
3. Annual pensions allowance for the 2017/18 tax year is £40,000 and will remain the same for 2018/19

lindsay.sharman@wilmingtonplc.com

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Pension Funds
Insider

Spotlight on transaction cost disclosure

In line with the growing regulatory pressure on trustees and governance committees to deliver value for money for their members, the issue of cost transparency has been an area of increased focus for UK pension funds and their providers in 2017.

The FCA's Asset Management Market Study, which was published in June 2017, broadly criticised the investment industry for being uncompetitive and providing low levels of transparency. Since then, the FCA has established a working group tasked with standardising the disclosure of all costs and charges.

In parallel, the Local Government Pension Schemes launched a code of transparency in May 2017, outlining a standard method for all asset managers to report investment costs. In Europe, new regulations – in the form of MiFID II and PRIIPS – are increasing disclosure standards around investment costs from January 2018.

Why is this happening?

The FCA report highlighted uncompetitive pricing practices and opaque cost structures across the asset management industry, and announced its intention to address these shortcomings. Improving reporting standards is one strand of this process.

Auto enrolment has brought a greater fiduciary responsibility to workplace pensions, and the government is clearly keen to avoid any miss-selling scandals. Increased litigation in the USA around costs may also have heightened this fear, and the UK is therefore following Europe in terms of raising standards in this area.

Where is the spotlight falling and what is it going to reveal?

Since April 2015, trustees and independent governance committees of workplace pensions have been required to assess and report, through their Chair's Annual Statements, whether transaction costs and administration charges offer value for money. However, there was no corresponding imperative for asset managers to provide the transaction cost data required, nor a standardised calculation methodology, until the FCA ruled on this in September 2017.

Moving forward, investment firms managing funds on behalf of DC pension schemes must, from 3 January 2018, provide data on their funds' transaction costs, using the 'slippage cost' methodology. This is effectively a measure of the market impact – often referred to as the hidden costs – of buying and selling securities. Historically, this has been absorbed by the fund and not been reported separately.

The problem for asset managers is being able to accurately calculate and report transaction costs, and 'slippage costs' in particular. The challenge for trustees will be to interpret and assess this information, not least because of the variable results that are likely to arise from using the 'slippage cost' method.

These obstacles aside, the new disclosure standards will undoubtedly shine a light on many of the variable practices that exist in the asset management industry, ranging across the costs and revenues incurred in trading, such as broker commission and research, stock lending and box profits, to name a few.

What will be the likely outcome?

These new disclosure standards will help investors better understand the incidence and nature of transaction costs in their funds. It will also highlight the impact of higher portfolio turnover and poor capacity management – including in expensive asset classes – and point to the true cost of investing in popular multi-asset fund-of-fund structures.

Ultimately, it will show who pays for what. Competitive pressures will likely mean that fund costs will fall as managers cap fund expenses or pay more of these costs themselves, such as broker's research, for example. At the end of the day, while comparing a fund's net-of-fees performance to its investment benchmark is an appropriate long-term measure of success, over the short term investors also need to assess whether the costs they are paying represent good value for money.

Donny Hay, Client Director, PTL

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