So covenant strength should play an important part in investment strategy?
There has been a tendency to say if the employer has a weak covenant then they should be taking less risk – and that has tended to lead to holding more in bonds. That is one approach, but there are different approaches to risk management. Our approach is to test the assumptions being made by the trustees and their advisers and in particular to make sure both the employer and the trustees understand the nature of the risks that they are running. And what the potential cost of that could be if their risk management goes wrong.
How sustainable is DB, given more and more schemes are closing?
It’s very unlikely that many people coming into the private sector workforce now will receive DB pension benefits when they retire. I think that those people who already have benefits in DB schemes have a good chance of receiving those benefits in the future, because on the basis of our analysis, the majority of schemes have sponsors that can afford to meet the payments necessary to pay the pensions as they fall due.
So I think we need to not confuse some scary deficit numbers today with the ability to meet cash flows over many decades. There are a minority of schemes that are undoubtedly in trouble, because their employers are also in trouble. Under those circumstances, some of those schemes may end up falling into the Pension Protection Fund (PPF). But that is exactly what the PPF is there for.
Is the message to trustees not to read too much into recent deficit numbers then?
No, I think that they need to take the numbers seriously as a basis for negotiation. They need to sit down with their employers and have a serious conversation about the nature of the risks that are being run in the scheme.
And in particular, if the trustees feel that more should be paid in the way of deficit recovery contributions and the employer is paying out significant dividends, then I think a discussion needs to happen between the trustees and the employers, challenging the dividend strategy.
There have been some high profile cases recently around employers shunning responsibilities to their pension scheme. Do you think we are seeing a worrying trend emerge?
We see no evidence whatsoever of schemes falling into the PPF in a way that will overwhelm the PPF. Do I see an increased number of schemes trying to avoid their liabilities? I don’t think so. There are some very high profile cases, but that is not necessarily a new trend.
And we have some extremely powerful anti- avoidance powers to pursue employers when we think they may be trying to avoid their liabilities to their pension scheme. We will pursue those robustly if we think it is necessary to do so.
What would you like to see change as a result of these high profile cases?
Our chief executive [Lesley Titcomb] wrote to the Work and Pensions Select Committee in June, setting out very clearly what changes we think might help to avoid such cases occurring in the future.
One of which is that clearance should be mandatory in certain limited circumstances. Quite how that would work is yet to be agreed or even agreed in principle. But we think that where there are certain high risk schemes, it may be desirable to require companies to seek approval or seek clearance from us, prior to particular corporate actions or M&A activity.
But any such requirement would need to be proportionate. We think it should only apply to the highest risk schemes and it would simply be an opportunity for the employer to sit down with us and discuss their proposals and we could then make it very clear whether we think that if they proceed on that basis, our anti-avoidance powers will or will not engage.
It has been suggested in some quarters by some commentators that our proposal is that we will block transactions. That is not our position, we don’t think that would be proportionate.
Obviously that compulsory clearance is an aspirational target at the moment?
At the moment, clearance is voluntary. So companies can approach us for clearance, ascertain whether or not we think that a particular course of action will engage our anti-avoidance powers. As has been widely reported, that did not happen in the BHS case.
