The leave vote caught markets off guard. Trustees must be ready for more surprises.
The leave vote registered by the British public on 23rd June caught markets, bookmakers and many pollsters by surprise. It will take months or even years for the impact of this decision on the wider economy to become clear.
The same is true in the pensions sector. But while trustees have been warned against kneejerk responses, they must be prepared for upheaval on multiple fronts.
The reaction of the markets to the vote is the most significant immediate concern for pension schemes.
Share indices across the world dropped sharply, while money flooded into traditional low risk assets, pushing down yields. Meanwhile the pound lost more than 10% of its value against the dollar.
Hymans Robertson chief investment officer Andy Green said: “Financial markets have responded even more dramatically to the result than expected. They are moving sharply, with the FTSE 100 slumping 8.7% on opening [it recovered to end the day 3.2% down]. We’ve seen the pound hit a 30-year low against the dollar with a record intra-day swing.”
Pensions and Lifetime Savings Association chief executive Joanne Segars said that the volatility was unsurprising but unnerving for investors.
“Even though pension schemes are long-term investors with diversified portfolios, continued uncertainty and the increased volatility that goes with it makes it difficult for schemes to protect savers’ interests,” she said.
Segars called for government action to sooth markets, but with uncertainty continuing over the timetable for withdrawal, the nature of the UK’s future relationship with the EU and the leadership of the Conservative party, markets will remain volatile for some time.
The announcement by Bank of England governor Mark Carney that the bank would act swiftly to prop up markets calmed investor fears, but raised the prospect of further a cut in rates to 0.25%. It also suggested ultra-low rates were likely to stay in place longer than previously expected by markets.
The double whammy of falling share prices and low rates and yields has seriously dragged down defined benefit funding levels.
PwC calculates market uncertainty added £50bn to deficits in months leading up to the referendum, and £100bn since March.
According to Hymans, todays movements alone swelled deficits by £80bn overnight, with UK DB liabilities reaching £2.2trn.
PwC pensions partner Richard Cousins said: “Today’s vote to leave the EU will mean more uncertainty and a tough period for DB and DC schemes. Employers with DB schemes will need to work closely with trustee boards to assess the current strategy to deliver a fully funded scheme. Trustee investment committees will need to meet frequently over the coming months to manage this period as robustly as possible.”
Quitting the EU will make little difference to the pensions law for now.
Eversheds head of pensions Francois Barker explained: “In the short term, Brexit is unlikely to have a significant impact on the legal and regulatory framework for UK pension plans, since many of the requirements that stem from EU law, such as requirements relating to plan funding, investments, equal treatment and non-discrimination, have already been enshrined into UK law.”
There is also unlikely to be little change in the alphabet soup of European directives that regulate investment markets and products.
Duff and Phelps commented: “Regardless of whether the UK operates under a European Economic Area model or detaches itself entirely from the union, AIFMD, MIFID II and MAR would almost certainly continue to apply under UK law after a Brexit.”
But there are a few areas – including GMP equalisation – where trustees could see a reduction in regulation. There is also the possibility that UK and European pensions regulation will diverge over time.
Given the far-reaching economic impact of the vote to leave the EU, schemes will have to reassess sponsor covenant.
While some exporters may get a boost from the pound’s slide, many schemes will see a deterioration of covenant.
Hymans head of corporate consulting Jon Hatchett said: “While the short-term economic effects will be predominantly negative, the pain will not be shouldered equally. Companies will be waking up to a new dawn today, and contingency plans will be kicking into place.”
Trustees will need to get to grips with what these plans look like, and reassess their scheme funding strategies accordingly.
They will also have to re-examine any contingent security granted to the scheme, to see whether the value of the guarantees remains.
Wait and see
For now though, the UK remains in the EU, and the exit process has yet to be formally triggered.
So while trustees will need to make sure contingency plans are in place, and must watch developments carefully, now is not the time to rush into action.