27: Pensions Regulator publishes interim guidance on DB superfunds

The Pensions Regulator (TPR) has published new guidance in June 2020 that provides an interim framework for regulation of defined benefit (DB) superfunds prior to the implementation of a statutory regime.

TPR highlights it will take a proactive approach towards superfunds in order to protect members’ benefits and emphasises that clarifying its expectations now will enable it to intervene and take enforcement action before the legislation is finalised.

More detail on certain areas (such as capital buffers) will be provided by TPR in the coming months but the guidance may well signal the green light for DB superfunds to progress transactions.

What is a DB superfund

A superfund is a model that allows for the severance of an employer’s liability towards a DB scheme and either:

• the scheme employer is replaced by a special purpose vehicle employer. This is, to all intents and purposes, a shell employer and is usually put in place to preserve the scheme’s PPF eligibility; or
• the liability of the employer to fund the scheme’s liabilities is replaced by an employer backed with a capital injection to a capital buffer generally created by investor capital (eg institutional investors or private equity) and contributions from the scheme employer.

The guidance relates to capital buffer super funds and key points for trustees and scheme employers to note include:

•  a ‘fit and proper person’ test will apply to key individuals involved in management of the superfund, and superfunds will need to demonstrate robust and effective governance, particularly in relation to investments and the operation of corporate and trustee boards;
• superfunds must have suitable risk management systems in place with robust IT and administration systems. TPR will also need to be satisfied with their approach to member communications and complaints handling;
• all investments must comply with eight principles set out in the guidance, including limits on illiquid assets and requirements for scheme asset management;
• before a superfund (or segregated sections within them) can accept a transfer it must be funded to at least the level of the funds technical provisions (TPR has set out minimum expectations of these) plus the capital buffer. The capital buffer must be risk based such that, when added to the scheme assets, there is a 99% probability of being funded at or above the minimum technical provisions in five years;
• superfunds will be required to report to TPR (and explain how they plan to address risk) as they approach two key points in the superfund’s funding level:
  • assets are equal to or less than 100% of minimum technical provisions in which case the trustees gain complete control over the superfund, including the capital buffer, unless additional capital is provided
  • funding level falls below 105% of the s179 PPF funding level in which case the superfund must wind-up, apart from in exceptional circumstances).
• no funds may be extracted from the pension scheme or the capital buffer unless members’ benefits are bought out in full.  This aims to limit excessive risk-taking and to ensure that the incentives for the superfund’s managers are aligned with those of members.  TPR will review this guidance on profit extraction within three years;
• employers must apply for clearance from TPR for any transfers to a superfund. Trustees will be expected to ensure that a transfer is in the members’ interests, and to conduct due diligence on the superfund’s fees, funding and investment objectives. Superfunds will be expected to provide extensive information so that TPR can complete its assessment before any transactions are completed; and
• trustees should only contemplate a transfer to a superfund if they do not expect to be able to buy out benefits in the foreseeable future (which is likely to mean five years).

Trustees must notify TPR at least three months’ prior to any transfer to a superfund and will need to have considered a number of legal and regulatory issues to justify why their decision is in the best interests of scheme members. These include:

• power to transfer under scheme rules and the statutory conditions for transfer without member consent;
• managing conflicts of interest including advisor conflicts;
• comparing the strength of the current employer covenant and the post transfer security offered by the superfund;
• actuarial and investment advice on the relative merits of a transfer to a superfund compared to remaining with the current employer covenant;
• balance of powers pre and post transfer; and
• discharge of liability, indemnities and insurance for residual risk.

The guidance marks the first step in making superfunds a potentially viable option for trustees and scheme employers although only time will tell whether superfunds will find traction in the DB market. Our pensions team is well placed to advise on this process, including due diligence, trustee duties, procedural requirements and all aspects of DB scheme closures.