The new Funding Code, alongside the updated Regulations, will represent a step-change in the way DB pension schemes are expected to approach funding and investment decision making. We were grateful that we had the opportunity to provide feedback to The Pensions Regulator (TPR). Our response is provided on behalf of the Cardano Group, and so is primarily focused on covenant and investment matters.

Our key observations are as follows:

Positive to see covenant at the heart of setting schemes’ level of supportable risk

It is positive to see that the draft Funding Code, like the draft Regulations published by the Department for Work and Pensions, puts covenant at the heart of setting the level of supportable risk in a scheme’s journey plan and the period over which that risk can be taken. Similarly, we’re pleased to see that much of the Funding Code detail regarding covenant is in line with industry best practice. For example, the factors influencing an employer’s ability to support its defined benefit scheme (Visibility, Reliability and Longevity) are similar to the “Journey Planning factors” (Affordability, Visibility and Reliability) that have been used in our covenant assessments over the past few years.

Pleased to see a flexible and pragmatic approach from an investment perspective

From an investment perspective we are pleased to see that the guidance is consistent with what many well-managed schemes have already been doing; setting long-term targets, de-risking gradually over time and proactively planning how to deal with liquidity and cashflow challenges. We also believe sensible judgements have been made to create sufficient flexibility of investment approach within clear boundaries and we are supportive of the pragmatic approach taken in many areas (such as using the PPF stress figures in Fast Track to avoid the unnecessary creation of a parallel risk assessment system).

Use of duration as a measure of scheme maturity

The rises in gilt yields over 2022 have effectively shortened scheme journey plan timeframes by around seven years, which is a material change and demonstrates the significant shortcoming of using a static duration figure as the definition of Significant Maturity, with 12 years duration no longer providing sufficient time to reach low dependency for many schemes. If a change is not made, many schemes may be forced into non-compliance or they may have to fundamentally change their approach with corresponding consequences on the sponsor and/or to their risk profile, which is not the intent of the Code as we understand it.

Some concerns regarding the potential for unintended consequences as drafted

The contents of the Code and some of the reaction from the market have highlighted that the current drafting may have significant unintended consequences that would run contrary to TPR’s stated aims. In particular, we note the significant possibility of “covenant complacency” being introduced into the industry, with the risk that trustees may lose sight of the underlying covenant risks through “box-ticking” or a false sense of security linked to meeting Fast Track or low dependency parameters. Similarly, and linked to the idea of “covenant complacency”, it is worth highlighting the risk of low dependency being seen as “job done”, with the limited references to the journey past low dependency resulting in the belief that low dependency means no dependency on covenant. Clear communication on these points from TPR would be most welcome.

Smarter covenant advice will almost always be better than prescriptive covenant advice

While positive that covenant is placed at the heart of journey planning, this is not easy to implement in practice. The bespoke nature of schemes means that any attempt to over-simplify, be prescriptive or formulaic risks forcing trustees to take decisions that are not in the best interest of their members (e.g. re-risking, or de-risking and extending reliance on covenant without holistic consideration of the scheme specific circumstances). As an example, the maximum risk equation is a helpful but simplistic illustration which is not flexible enough to be tailored to scheme specific circumstances and should, therefore, not represent a mandated or prescribed approach. “Smarter” covenant advice, focussed on scheme specific risk management driving bespoke funding and investment solutions, would avoid the risks of a prescriptive one-size-fits-all formulaic approach, such as poor decision-making, unnecessary costs and potential trustee / sponsor relationship strain.