Brexitation: how might UK pensions be affected?
By Ian Neale
Posted: 10th August 2017 08:30
Leaving the EU involves a process; it's not a single event. We might be more careful still with the term and call it 'UKexitation', because of course it is the United Kingdom of Great Britain and Northern Ireland which is a member of the EU, not Britain. The distinction is far from petty, as the people of Northern Ireland – and the Republic of Ireland – will readily attest. For example, much of the legislation governing pension provision in Britain, such as the Pension Schemes Act 1993, does not apply in Northern Ireland (although mirror legislation is commonly enacted). This means considerable duplication of effort will be involved in undoing or remaking any law which follows a final UK exit from the EU.
By common consent, Brexitation – the 'B' word has so embedded itself in common parlance that I cannot avoid it completely – is going to be complex, convoluted and costly: much like UK pensions legislation generally, in fact. In the end, it might prove to be beneficial for pensions, on balance, but only a politician with a crystal ball would dare say so already. This article focuses on the impact of Brexitation on UK pensions, although the wider economic effects cannot be ignored.
Let's start with the key areas of pensions law which are affected. We might avoid having to comply with the new IORP II Directive on workplace pension schemes, which must be reflected in the domestic law of EU Member States by early 2019. One hugely problematic issue for UK Defined Benefit schemes is funding, which is governed by the 2004 Pensions Act and based on EU law. Although the onerous 'Solvency II' proposals have been removed from the final draft, the threat that the requirement to be “fully funded” might return in some form in future cannot be dismissed.
More schemes might be liberated to operate cross-border. With the other main themes of the Directive, scheme governance and communications, the UK is probably pre-compliant. After Brexit we would be free to undo some of the member protections created to comply with the original IORP Directive, though it could be politically difficult.
The same is largely true of the anti-discrimination legislation – principally the 2010 Equality Act – which implemented a slew of EU court cases; but the requirement for gender-neutral annuity factors might be an early target for repeal. Some had also hoped until recently that the DWP would leave the thorny question of GMP equalisation in the long grass where it has lain for years. This issue, another consequence of EU case law, based on the EU Gender Directive, is one the DWP is determined must be addressed regardless of Brexitation and the huge administrative cost involved.
Another issue is that there is some doubt whether the Pension Protection Fund is fully compliant with the EU Insolvency Directive. Several EU court cases have suggested a minimum level of protection of half of accrued rights, which a minority of highly-paid members are currently denied by the PPF compensation cap. So, the UK might escape the need to comply with these judgments if we leave the EU.
Scheme sponsors stand to benefit in a few areas, besides the all-important scheme funding rules. Business sales can be complicated by the TUPE legislation. The general exemption for pensions, i.e. pension rights do not transfer when a business is sold and employees are transferred, has been qualified by two EU Court of Justice cases (Beckmann and Martin) which decided that pension rights on redundancy or early retirement can transfer. This could be abandoned.
The EU VAT Directive, supplemented once again by two recent EU court decisions, controls the extent to which UK pension schemes and their sponsors are liable for, or may recover, VAT. More freedom from this could be significant, though VAT is such a significant part of total UK Government tax revenue that it seems unlikely it would be reduced.
Moving into financial matters more generally, several major pieces of EU law presently (or soon will) impact on scheme investment activities. The European Market Infrastructure Regulation (EMIR), for example, controls dealing in derivatives which pension funds use to hedge various risks. More widely, the Markets in Financial Instruments Directive governs the framework: a revised version is due to come into force in January 2018. Its impact on pensions is indirect however, except on the Local Government Pension Scheme. There will be also no exemption from the Financial Transaction Tax (the so-called Tobin Tax) for pension scheme transactions with institutions in any of the participating eleven EU Member States.
The UK pensions industry is unlikely to escape things like this, even if we separate completely from the EU, because they govern trading and other interactions with EU Member States. Another example is the General Data Protection Regulation, coming into force on 25 May 2018 – which will apply directly, i.e. it will not require any action to transpose it into UK law. It might be that only those schemes and their sponsors which have no dealings whatever beyond the UK can afford to ignore this and rely on existing UK data protection rules – which are themselves a result of the EU Data Protection Directive. Massive fines for non-compliance render this a big risk though. Guidance is awaited from the Information Commissioner's Office, which has indicated that the UK will need at least similar legislation to protect EU to UK data transfers.
One thing seems certain: we are in for a period of at least two years of significant uncertainty (assuming Article 50 is actually triggered, next March or later). Investment markets don't like that, so greater volatility is inevitable. This is likely to have a knock-on effect on employer covenants and willingness of pension scheme sponsors to pay enhanced deficit reduction contributions. It will almost certainly impact on the value of money purchase pots, though it is harder to predict how interest rates and gilt yields might move post-Brexit.
In sum, the general consensus is that trustees are in for a rocky ride. However when (or if) the UK emerges from the turbulent process of Brexitation, the government is likely to have many more immediate targets for reconstruction than UK pensions legislation. Most of the protections stemming from EU law will stay in place (if for no other reason than political convenience), but the investment and tax framework may look rather different.
We must hope that goodwill prevails and Brexitation does not become Brexitosis.
Director, Aries Insight
Aries House, 29 Station Road, Desborough, Northamptonshire NN14 2PN
Ian Neale is a Director and co-founder with Gary Chamberlin of the pensions legislation specialists Aries Insight. He has over 25 years’ experience of serving the pensions industry in a mission to help administrators and others make sense of the legislation. The Aries Pensions System explains all the requirements, not only of UK pensions law but covering a range of overseas regimes as well. A frequent communicator, often quoted in the pensions press, his passion is to save people time. Ian is a science graduate of Monash University (Melbourne) and Loughborough University.