TPR published its draft Funding Code on Friday as part of a consultation on the Funding Code and TPR’s proposed twin-track approach to regulation

Consistent with the draft regulations published by DWP, TPR is putting covenant at the heart of setting the level of supportable risk in a journey plan, and the period over which that risk can be taken. We are very supportive of TPR looking at covenant over the period of the journey plan, and thinking about covenant in terms of Visibility, Reliability and Longevity; this is similar to the Journey Planning factors (Affordability, Visibility and Reliability) that we have pioneered over recent years.

There has been considerable commentary on the inflexible nature of DWP’s Draft Regulations, how it is unusual for TPR to publish a Draft Funding Code while the Draft Regulations are still working through a consultation process, and how this all fits together generally. Certain points of detail may therefore change but we would expect the broad principles to remain consistent. TPR’s stated intention is to embed good practices rather than to fundamentally change the shape of the existing pensions landscape, with many schemes likely already doing what would be needed of them under the new guidance.

This update provides our initial high-level observations. We will provide more detail in the New Year and will be presenting a PMI hosted webinar on 2 February focused on practical covenant considerations in the context of the Funding Code Consultation.

Emily Goodridge, Managing Director

1. Covenant is at the heart of journey planning

The Draft Funding Code sets out a funding regime broadly split into two important stages:

1. Planning for the long-term funding of the scheme; and
2. Carrying out valuations to show the current funding position of the scheme

Within the first stage, trustees are expected to satisfy themselves that the risks inherent in a journey plan are supportable by the strength of the employer covenant, by considering both the likelihood and impact of covenant risks crystallising, as well as the ability and time period over which the employer could repair any resulting deficit. The analysis of this “period of covenant reliance” is key as it drives not only the maximum supportable risk but also the time period over which the trustee can build that maximum level of risk into their journey plan.

Further covenant guidance will be coming in 2023 but we encourage trustees to start thinking about covenant as the underpin for scheme risks over a journey plan, rather than just a point-in-time rating.

2. Low Dependency is not the same as “no dependency”

Low Dependency investment and funding principles are defined by the Draft Funding Code such that a need to call on a sponsor for contributions is unlikely, but there remains scope for risk. TPR notes in its consultation document that “certain types of LDIA portfolios with up to 20 to 30% in growth assets could be appropriate, so long as the risks are well managed”. Employer covenant remains the ultimate underpin for scheme risks and, while a solvent employer is needed to ensure members receive their benefits in full, there is a degree of covenant reliance.

Trustees should consider plausible downside scenarios that may lead to members suffering a shortfall, and continue to think beyond the Low Dependency basis to their end game.

3. Covenant assessment is still required even if a scheme is Fast Track compliant

TPR’s Fast Track parameters focus on the Low Dependency basis, and investment risk, technical provisions and recovery plan length as a function of maturity. Covenant has been excluded as a Fast Track metric for practical reasons, including the fact that covenant ratings are relatively subjective and analysis by TPR which suggests a current lack of correlation between covenant ratings and valuation assumptions (e.g. some schemes with strong covenants are well advanced in de-risking).

TPR has been clear that Fast Track is not a legislative tool, nor does it represent the “gold standard”; it is a means to proportionately filter valuations on a risk basis. All trustees are expected to evaluate covenant in accordance with the Draft Regulations and Funding Code, regardless of whether they meet Fast Track requirements, to ensure scheme risks are supportable. Trustees should continue to consider their specific circumstances when undertaking valuations, particularly in light of the legislative requirement to set out these considerations within the Statement of Strategy.