XPS Pensions Group plc (406.F) Earnings Call Transcript & Summary

Good afternoon, everyone, and a big welcome to today's webcast. It's great to see such a high turnout despite it being the summer season, which I assume illustrates just how keen everyone is to know more about DWP's consultation on the new funding and investment strategy regime and perhaps also a reflection of how long we've been waiting for it. Whilst it is only a consultation and we don't yet have the regulators' draft coded practice, it is an important piece in the puzzle and does provide further clarity on where the new strategy regime is headed. We've seen it starting to emerge already such as the requirement to be fully funded on a low-risk basis straightaway or perhaps being only able to hold very low-risk investments. And today, we're aiming to discuss our views and provide reassurance on what we think it does mean and what it doesn't. To do this, I, Louisa Taylor will be chairing today's session, and I am delighted to be joined today by our panel of experts providing their different viewpoints. Alison Bostock, an independent trustee director from ZEDRA, Faith Dickson, a legal adviser from Sackers; plus our own XPS specialists, Abbie Fletcher, an actuary, who has been central to XPS's work on the new strategy regime since it was first announced and Adam Gillespie, a partner in our investment team. So just some advance warning that there is some new pensions jargon in the draft regulations compared to what you may recall from the first regulator consultation as well as some key terms that you may notice missing. We will seek to explain all this throughout the webinar. So please do bear with us. To start off there, I'd like to ask more of a softer question in terms of how you might be feeling about the new strategy regime so far based on what you've heard. So you should see a question come up on your screen. And so this is how do you feel that your current funding and investment strategy for your scheme or schemes that you're involved with compares to what has been proposed. So the options are you're already ahead, perhaps you're very close to buy out. You think it's broadly aligned, you might just require your tweak here and there. You're expecting some change to be required maybe your long-term goal is okay, but you might need to bring it in a few years or you think significant changes required. For example, your scheme might be mature, but you still have a high allocation to growth assets or you don't know yet. So please do scroll down and select the most appropriate option and submit. Whilst we just wait for these responses to come in, I'll just cover a few housekeeping points. The webinar is due to finish at 4:00 p.m., including questions, and we will stick to time. If you have any questions throughout the webcast, please do submit them using the Q&A tool and we will try to answer as many of them as we can. In terms of the ON24 platform, it's interactive. All the engagement tools are resizable and movable, so you can get the most out of your desktop space. If the webcast is freezed at any point, please just refresh your page. We have also added additional materials for you in the resource list. So now that should be enough time for the questions, the responses to have come in, just see those come up on our screen. So that's a good mix of answers there. I'm sure a sort of good proportion. So around half of you are hoping that there shouldn't be much change. Although not surprisingly, a considerable number of you are expecting to have quite a lot of work to comply with the new regime. It will also be interesting to see if your view changes at all as we go through today's webinar. So in terms of the structure of today's webinar in the first part, we'll focus on setting the scene. Abbie Abi and Adam will discuss the key points of the consultation with a Q&A session with Faith providing her legal expertise. And on the second part, we'll focus more on the practical implementation with Adam discussing the impact of the current market environment and a Q&A session with Alison to understand more about what it means for trustees on setting your strategy and dealing with valuations now. So on that note, I'll hand over to Abbie to start going through some of the key parts of the consultation and explain what it might mean for your scheme. Abbie?

Okay. Thanks, Louisa, and good afternoon, everyone. So in February last year, the Pension Schemes Act introduced into law the requirement that trustees and companies agree some form of long-term strategy, including targets for future funding and investments. The DWP have now released draft regulations for consultation. These build on the requirements brought in under the act and will set out at all defined benefit pension scheme trustees and sponsoring employers must do under law. Looking ahead, the next step after this consultation will be for the pension later to consult for the second time on their new funding code of practice. The code acts as guidance, which explains and supports the legal requirements set out in the regulations, together the code and the regulations will set out the future landscape to defined benefit pension scheme funding and investment strategies. The current expectation is that the new requirements will be enforced for all scheme valuations falling towards the end of next year. So what do the new draft regulations tell us that we didn't already know. The draft regulations make several changes to the existing legal requirements for pension scheme funding and also flesh out the new requirements for long-term strategies. At a high level, the steps we envisage schemes will follow to set and agree their funding and investment strategy was the regulations are in force as set out here. So firstly, to agree a low-dependency investment allocation. secondly, to agree a low-dependency funding basis; and thirdly, to agree event dates for targeting achieving this lower dependency position, and this must be on or before schemes reach significant maturity. These aspects make up the bulk of part 1 of the new statement of strategy and must be agreed between the trustees and the sponsoring employer. Part 2 of the new statement to be produced by the trustees in consultation with the sponsoring employer. And this part consists of various supplementary matters, including an assessment of how the current strategy compares to the long-term strategy, and calculations of the deficit on the low-dependency basis. The progression of the duration and hence, the time frame to significant maturity, plus any comments the sponsor would like to be recorded in this part. The entire statement will need to be reviewed and updated as needed as part of the usual valuation process or sooner, if required. So for me, the fundamental principle of the new requirements if the tall schemes will now be required to target a state of low-dependency on their sponsoring employer by the time they are significantly mature. This is a minimum target and applies whatever the eventual plan is for fully meeting all of our schemes obligations, be that buyout with an insurance company, consolidation or running on and continue to pay benefits directly from the scheme for many years to come. So low dependency means that under reasonably foreseeable circumstances, the scheme is not expected to need further employer contributions. Schemes will now be required to step a low dependency investment allocation and target full funding on a low dependency funding basis, which under the draft regulations is defined as a set of assumptions show them so that future employer contributions would not be expected to be required. So Adam is going to talk a little bit more about what the regulations say about low dependency in a few minutes. But before that, I really want to talk about the idea of significant maturity. So maturity is a measure of how far a scheme through its lifetime. A scheme which has a high proportion of relatively younger members will be relatively immature, whereas a scheme with a high proportion of older members, more pension members will be more mature. And this means that the time horizon before the bulk of benefits will be paid for that scheme will be relatively shorter. So what the draft recommendations tell us is that maturity will be measured using the duration of the scheme liabilities. The time frame significant maturity and hence duration of liabilities is one of the most crucial new concepts in the draft regulations. So I'm really interested to see what you all know about duration already. So on screen now, you should have a new poll. And the question we'd like you to answer and please answer it honestly, is do you know the duration of your scheme now? And what is it? If you're not just involved in one scheme, can I suggest you either the scheme you know least about or that you think reflects that of an average. So just to talk you through the options we've put on the screen are less than 10 years, 10 to 15 year duration, 15- to 20-year duration and over 20 years ratio or perhaps you don't know. So please remember to submit your answer when you have chosen. Whilst we're waiting for everyone to submit their answer, it is worth me saying that duration is sensitive to the basis used to calculate it. And primarily, it is sensitive to discount rates with lower discount rates resulting in higher liability values and longer durations and higher discount rates generally resulting in lower liabilities and shorter durations. So whilst the draft regulations tell us the duration will be how maturity is measured, what they don't tell us is the really important part which is of what duration of scheme will be considered significantly mature. You may recall in the pension regulator's first consultation back in March 2020, they put forward a possible range for significant maturity of between 12 and 14 years. In this consultation, DWP have suggested that there will be the regulator in that funding code and the duration for significant maturity, but this might be 12 years. So okay, thank you to those of you who have completed the poll. The results show that a number of people listening, they will get another duration of the schemes they're involved in, which is there are also quite a lot of people who do and quite a lot of the sort of slightly longer generations as well 20 years, over 20 years. So it's important to remember that duration is sensitive to the actuarial basis used to calculate it, which means duration will be different on different bases and also will change due to market conditions. In the second half of our webinar, Adam is going to explain what recent changes to government bond yields might have done to the durations you already know. But before then, I want to show some example schemes and demonstrate how the duration impact on the time frame for achieving low dependency. So firstly, let's consider a relatively immature scheme with the majority of its members still to retire. This might be typical for a long-established scheme, which closed to new members 10 years ago or so. And the duration for a scheme like the one on the chart here, might be around 19 years. The liability of the scheme is the current value of all the benefit payments to all the scheme members starting now and continuing for many years into the future. If you think about that as just one payment to one member at a single point in time, the timing of that average single payment would be the scheme's duration. So in this case about 15 years from now. So this chart shows a relatively more mature scheme with fewer members who aren't yet retired and more members already received pensions. The duration for a scheme like this one might be around 14 years. As time progresses and members age and retire, duration will naturally fall, which you can see from the lines on this chart. As a rule of thumb, it will take around 3 years for duration to decrease by one year for a typical closed scheme. So both of these schemes need to target full funding on a low dependency basis, by the time they get significant maturity. We can see from this chart how important duration is for these schemes when setting their low dependency targets because the relatively immature scheme has roughly 18 years until 2040 before it reach the duration of 12 years. However, the more mature scheme only has around 6 years until about 2028 before it needs to reach its low dependency target. So that, for me, is the fundamental change introduced by the regulations. But as I mentioned earlier, there are also other changes to existing aspects of the current stream funding regime, which I wanted to highlight. So firstly, scheme deficits on a technical origins basis will remain the key driver for putting in place a recovery plan and therefore, will still be the key driver for cash funding coming into schemes from sponsor employees. However, the draft regulations have amended the requirements for technical provisions so that now they will be set consistently with the low-dependency basis. A key thing to notice is that the regulations as drafted do not require technical provisions to be equal, exactly equal to the low dependency basis, even after you reach significant maturity. Although it is worth remembering that an explanation of any differences will be needed in the statement of strategy and the statement of strategy should represent a true statement of intent. The legal requirement for employer contributions into schemes will, therefore, continue to hinge on the technical provisions deficit. And so all those schemes now need to target being fully funded on their low dependency basis, by the time they get significant maturity, schemes which haven't made it will still rely on the pre-existing technical provisions and recovery fund legislation for closing that gap over time. The second point I wanted to draw is a change to recovery plans. Employer affordability has long been a factor that trustees have considered when setting and agreeing their recovery plans. But the draft regulations have proposed introducing a new requirement into law that when determining whether a recovery plan is appropriate, trustees should follow the principle that funding deficit should be recovered as soon as the sponsoring employer can reasonably afford. The consultation also seeks views on whether this should be made the #1 principle that trustee should follow when determining the recovery plan. I think the idea of reasonably afford is one part of the draft regulations that is drawing some of the most attention. And I know this is something that Faith will pick up later. So just to wrap up my section. I know I've got quite a lot of content, including some new concepts. And Adam is still going to talk through some more aspects of the draft regulations. But before then, I think my 2 key takeaways would be, firstly, the concept of duration. It's going to get a lot more attention going forward than it has in the past. So making sure you have an understanding of that, so you can understand your time frame, significant maturity is going to be important. And secondly, I think the schemes that already have targets in place, be that formally agreed journey plans or perhaps slightly less formal intentions for how the scheme will evolve over time. So now is a good time to start thinking about how the new requirements for low dependency will fit in with those existing funds. Okay. So at this point, I'll hand back to you, Louisa, for any initial questions.

Great. Thank you, Abbie. So whilst I think it's fair to say some of that was expected. There is also quite a lot of new sort of information and concepts there. So we've had a few questions coming in. So one of them is, can you comment on how covenant might factor into the new funding and investment strategy regime?

Yes. So it feels like a bit of an obvious submission from what I've just said. I didn't mention covenant at all. And that's really because the draft regulations don't refer to covenants in the setting of the lower dependency position. The whole idea of the low dependency target is to place a low reliance on the company covenant. And however, there is quite a lot said about covenant in the regulations more generally, and it's a really important part of the journey plan. The schemes to aren't yet at significantly mature. And Adam is going to talk quite a lot more about how covenant really features in detail in his next section. I just also want to mention at this point that there is a question the consultation about whether schemes should be able to take on additional risk after significant maturity and contingent assets are really seen as the justification potentially doing that also links to covenant dependency.

And could you just provide a bit more information about the 12-year duration that you mentioned, so that it's not defined in the sort of draft regulations, but you mentioned that the regulator will be providing more information.

Yes. So as the draft regulations are set out at the moment, they refer directly to the pension regulators code. They say that duration will be the measure and the regulator in that code will tell you what duration is the number. So that's how they're at the moment. And then obviously, we will see in the code, what number potentially gets put in there. However, as I mentioned, DWP did say quite clearly that they -- I don't -- it's a strong hint that they believe the regulator might be saying [indiscernible] which is why we're...

They're effectively giving a sign post to that in the consultation document, but it looks like [indiscernible].

Great. Thank you. So I think at that stage now, we'll move on to you, Adam, to provide more information about what the consultation says on the investment side.

Great. Thanks, Louisa, and good afternoon, everyone. Abbie started talking about low dependency. So I'm going to spend a few minutes now discussing this in more detail and what it means for the schemes or long-term investments. But before we do that, I think it's worth reminding ourselves what we previously thought was the direction of travel regarding investments. So the main investment takeaway from the previous consultation was the idea of having a long-term plan for the assets. So an example on our slide here, our scheme will start today in the bottom left-hand corner in portfolio #1. And over time, as the funded level improved, work away up to portfolio #6, a lower strategy. And at this point, we'll be 100% funded on the long-term objective. And of course, the time line for this was based around the point of significant maturity. So now we have the draft regs. And as a reminder, these are the actual proposed points of law, what has changed? So I could highlight 3 main changes. Firstly, as mentioned by Abbie, our long-term objective has been replaced with this concept of targeting low dependency at a point we are significantly mature. Secondly, the draft regs introduces concept of a low dependency investment allocation. Now these are the assets, the scheme is required to hold when it gets to significant maturity and the regulators set out some requirements, what this means for the asset types. And we'll talk about more about that very shortly. Crucially, though, the low dependency investment allocation is set without reference to covenants. Perhaps it's not a surprise as the idea at this point is at least that we have a low dependency on the sponsor, although low, not no. And I expect some industry participants will probably question this in their response on the draft regulations. And finally, the draft regulation set ups some principles to what derisking should look like over the period between now and certificate maturity and this is based on a time and covenant test. I'm going to focus on these 2 items first. So let's kick off with what is a low dependency investment allocation. So the regulation set slight details of this, and there are 2 requirements that schemes have to meet for the assets they hold at the point of significant maturity. Test 1, cash flow matching, income from the assets we hold, mostly broadly matching benefit payments. Test 2, a high resilience test, high resilience funding. So the scheme's funding level, i.e., the combination of both the assets and the liabilities at significant maturity is required to be highly resilient to short-term shocks. Now I think the first test is very to be straightforward, but it's quite a bit of uncertainty and some activity with the high resilience test. What does resilience actually mean? What is high resilience versus normal? How short is short-term changes? And these are terms are not defined in regulations, but I guess, speaker will give a legal opinion on this later. It may be that phrase highly resilient ends up falling in the same category as it were prudent, effectively left the schemes to decipher. But obviously, as an adviser, obviously, we had to give our investment interpretation and what we think these 2 requirements might need in practice. Now for most schemes, we think a low dependency investment allocation means having no or valid exposure to additional grace assets like equities, instead of having most investments held in credit or contractual income assets that generate stable returns and high levels of cash flow and all supported by an LDI strategy providing maximum levels of hedging. Now those 3 points comes no surprise that any of you attended previous XPS investment seminars, we'll be discussing this sort of credit type approach as a direction of travel for schemes, the most maturing schemes over the last few years. And this approach very much consistent with how insurers invest with the large book of maturing liabilities. But obviously, if they challenge this imitation as well, does this mean I definitely can't invest in great assets like equities. I think my view is that the draft regulations don't strictly stop you from investing a small allocation in more digital assets like equities and multiasset, provided if you can demonstrate the overall assets and liabilities of the scheme are highly resilient. And I'm sure there'll be some schemes out there that want to make the case for this. For example, having equity exposure alongside some derivatives that provide guaranteed downside protection. But overall, we would say that most mature schemes don't need equities because even if you do need some meaningful level of return, you can get these by investing in certain types of high-yielding credit assets. So does this mean all schemes going to end up with the same low dependency investment allocation. While it seems to mean that all schemes should simply invest in government bonds, apart from anything else, there's not enough stable gilts available today to match U.K. pension schemes. Although given some of the recent promises made of politicians who knows where the national debt might be in 5 years' time. But for us, we think there will be differences in have schemes pick their low dependency investment allocation. And we think there are probably 2 main parameters for trustees and sponsors to consider, credit risk and liquidity. Now we said on this slide in a moment, 4 high-level example strategies that schemes could adopt as their low dependency investment allocation, depending on the willingness to take credit risk and willingness of ability to accept some illiquidity. So schemes that are looking to buy out in the next 5 years, say, will not get any sort of long-term illiquidity issue. They want to be able to transact once they can afford it, and so would like it to be one of the donuts on the left-hand side. This is clearly a really important point to note because we've heard lots of stories of schemes been unable to take advantage of the better buyer pricing recently due to the liquidity. Equally, there will be schemes out there who are looking to run a scheming for 10 years or more. And so we'll be able to lock away some of the money and say private markets to generate some high returns. And so maybe looking towards the more right-hand side. What I'm not going to more detail in the portfolio, what is the most interesting for us is looking at these 4 sample portfolios. It's a wide range of expected returns. The highest return this portfolio chart shows a target of gilts plus 1.8% despite still meeting the requirements of a low dependency investment allocation. And while some of this is due to high yields being available in the market today, it also reflects the wide range of credit investments are available to pension schemes from the low returns available for gilt and high-quality investment-grade bonds as we see in the bottom left strategy to high-yielding investment grade alternatives such as commercial real estate debt and have to high-yielding yet credit assets such as senior secured private debt as we see in the top right. Now I want to make a couple of side comments on the size. As mentioned, the low dependency investment allocation should be set without reference to covenants, but I do wonder how much trust responses will actually be able to forget about covenant when thinking about matrix. The covenants like effect whether you're aiming for buyout or medium-term runoff and may also affect how much credit risk team is willing to accept in the strategy. And secondly, more of a technical point, but important point, as we start to use more credit investments than the actuaries and investment consultants want to start thinking very carefully about the actuarial discount rates, in particular, incorporating by corporate bond yields and government bond yields in liabilities. This is more difficult than it sounds, but it's something some schemes are already doing is part of the so-called CDI strategy and very much expect to become much more common over the coming years and will be very important after helping to meet the high resilience test. So we've talked about the end portfolio, but what happens between now and then. The regulators 2 principles for derisking, which I would argue are pretty straightforward. First one, our schemes at closer to significant maturity, they should take less risk. Secondly; however, schemes can take risk on the journey, provided this is supported by the government. And while some people initially have argued that this means schemes are forced to derisk over time, I think the covenant principle is clear. Trustee to sponsor should be able to stay on risk if they want to, over the period [indiscernible] provided they can demonstrate the covenants their support if something goes wrong on the journey. So the 2-day was me are, while this new concept of a low dependency investment allocation is key to the sort new regime and it's definitely worth exploring now what that might mean for you. But also fair not because actually there's perhaps more flexibility and options available to schemes with the long-term investments that many might have previously thought. Louisa over to you.

Thank you, Adam. So having quite a few questions come in. So one of them is once I've set my long-term investment strategy, am I essentially stuck with that strategy forever?

Yes, really good question. So you're absolutely okay to change. The statement of strategy is new document is a statement of intent. It's not a strategy straight jacket for trustees and sponsors. You set out what you tend to do, but trustees are going to have to respond to things that might happen in the future. Plenty of reasons why you might want to change your strategy after you set your statement of strategy, there's been a covenant change or there's been addition of security or the change in financial conditions? Or is it these are all reasons why you could change your strategy as set out in your statement strategy and you simply recall the difference in your next version of the statements. And one thing I'd just add, what is really interesting, though, is that actually everything that applied to pension-scheme investments before these regulations for example, Pensions Act '95, the 2005 investment regulations, they still apply today. So trustees, they're still going to have to set a statement investment principles and we still have to invest in line with the best interest of members. So absolutely all reasons why deviations are absolutely committed.

And you just answer quickly. Can a small allocation to equity actually reduce your risk and therefore, make the scheme more resilient to a shock.

Yes. It depends how you measure your risk. I mean there are some risk models out there that sure actually having a small amount of equity risk actually can act as a diversified to some of the other risks. So it really comes down to this issue of -- how are you -- how are we defining high resilience, there's going to be a quite lot of interest over the coming months in terms of what sort of risk metrics we might use. It might be -- I know the regulators previously talked about trying to standardize risk measures, but obviously, there's nothing in the draft regulations about this. So for example, in the early consultation talked about using PPF stress tests as an example, a way of measuring funding resilience.

Great. Thank you. So I think on that note, we'll bring in Faith to provide some answers from a legal perspective. So good afternoon, Faith. Thanks again for joining us today. And I think one of the first things to ask you is about these new terms that we've heard that aren't defined. So Abbie mentioned the low dependency is defined as meaning that contributions are not expected to be required. But what does not expected really mean?

Yes. It's frustrating and as I think as professional as we get the new business legislation, and we want to try to tie down as much as possible, exactly what other terms mean and what the requirements are for schemes. I'm hopeful. I'm just picking up what a comment then have made earlier. I'm hopeful that I don't agree to some of the sort of not tying data terminology is because as a recognition these things don't necessarily have absolute answers, and it needs to be left to the discussion of trustees that having taken professional advice and the professional advice have their own views on what these things mean. But I mean, so taking a step back and from a legal point of view, looking at sort of just natural meaning if we're expecting something is, and my understanding is that you -- that something is likely to happen, you think something is likely to happen expect it to happen here. The actual [indiscernible] trustees in opinion on whether they think it's likely that in the certain circumstances, the employer is going to have to pay more contributions to the scheme to prepare the deficit or not. The consultation document refers to whether in any reasonable foreseeable circumstances, you think that the employee would have to pay more. I think that's a useful way of looking at it, too, although probably gets the same place, this dictionary definition of what expected, although the definition is slightly harder. But I do query why the key things we're talking about, what's reasonably foreseeable doesn't actually write that into the legislation because I think it has a clear kind of legal meaning sort of press we can draw on. So yes, we will make some clients to that effect in our response to consultation.

Thank you. And is that sort of similar response to the concepts that Adam described on highly resilient and broadly matching.

Absolutely. I mean, I think, again, I think you start looking at dictionary [indiscernible] about the meaning of the word. So you're highly resilient, I think we're looking for assets that can withstand or recover quickly from talks in the market. And then probably lesser than just close to being equal to essentially, but we don't expect perfection. But I know you -- I wouldn't very much sort of champion the idea that it's the investment consultants to discuss with the trustees what in their professional view is by high resilience and so on. And remember, as I was explaining, when you set out your funding investment strategy, you are required essentially to sort of set out your reasons for adopting certain measures and explaining why they're there. So I think you can -- there's going to be so to say we've picked this strategy because and any control on experience of your advisers and experience in the scheme when you do that.

Thank you. And kind of linked to the definitions as well, can you expand on what low reliance means on covenant because I assume that low is not the same as 0.

No, absolutely. I mean I think it's, again, tying into this idea that we -- you're looking at reasonably foreseeable circumstances. So you are not expecting to have to rely on the government. But do you think that the strategy that you've adopted will deliver you benefits on the days of sort of self-sufficiency basis. But we don't have better crystal balls and some things that could change in a way we're not expecting. So anyway, you know what I mean. We should -- so I think it's low reliance because you can't totally eliminate traffic you might have to come back employer in the future. However, how are you trying to stay so you want.

Thank you. And when setting recovery plans, Abbie talked about the new proposed affordability principle. And what does that sort of mean in practice? And do you think that does change some of the balance of power between trustees and the sponsor?

To some degree it's done to my mind, the regulators are laying down -- the regulators pushing schemes to get to the dependency state as quickly as they sort of sensibly have. And I think perhaps it's frustration from the regulator that it thinks that some employers, the more funding is affordable. And then actually, they could push things a little bit quicker. So I think there's this question on consultation about is it right to kind of give us a much promise be giving it that itself, I think is recognizing that it could be shifting with our horsepower a bit. But one thing that I was hoping we do in practice is to encourage engagement on what is the appropriate and that funding to be going into the team on an ongoing basis. And I'm not in the camp of people who is thinking it means that if you've got a strong employee, you have to kind of fund everything on day one. I think it's totally justifiable for employers to say, well, the scheme is a stakeholder. I've got stakeholder here, got our own business. I'm just running -- not just running a pension scheme, and it's appropriate that I need to invest, but appropriate I need to paid on my debt, it's appropriate that I need to pay dividends to my shareholder. So there are compete just because at the balance sheet you think we could afford to some doesn't -- that's not a complete picture. So I think there are group discussions to be had.

Yes. Well, I'm sure that's very reassuring for people to hear. And it sounds like getting advice on that and being able to document all of that's going to be very important in the new strategy regime. And the question of what happens if trustees don't have a suitable sort of strategy in place? Are there any fines?

So it's an interesting one because if you don't have your strategy, your funding investment strategy in place, then yes, you can be fined. Trustees and scheme, although you have to agree certain things with the employer, it's actually, as usual, the trustees liability ultimately if you don't have this in place, you can be fined, but going back to sort of some comments that Abbie and Adam have made. Once you've got it in place, clearly, you're aiming to achieve the strategy you've set out. But it's got to flex over time, depending on circumstances of the scheme of the employee. And there's no -- there's no penalty for not meeting the strategy that you've set out. You would need to kind of, I guess, explain to the regulator potentially if you will lay off from method. The fine is for not having one, not for leaving it essentially.

Okay. Thanks for that, that's interesting. On that note, we'll just bring in Alison. We're going to ask you a few more questions later on when we're addressing some more of the sort of practicalities. But -- just wanted to ask you, really every 10 to 15 years, we get a new funding framework. And Alison, what was your first reaction to this when you read the consultation? Is it what you were expecting?

Okay. Well, thank you for reminding me that I'm old enough to remember the introduction of [ MFR ] specific funding regime. So yes, it's my third time around on this. I think no, I mean there were a couple of things that surprised me. I thought this really is quite specific and prescriptive. I really do need to understand what duration is and how that works. And I'm sure many of your other trustees on the call will be thinking that. And it was very useful to have that explanation earlier. And then I think just finally, I think it is really good to have that end game confirmed because I know I've got some employees that I deal with who it's been very difficult to engage them on the end game discussion, and they're just purely focused on getting to take 100% on technical provisions. So I think it is really helpful that it's clearly set out what we are aiming for now.

Yes. Thank you. That's good to hear. And then also coming back to that first polling question that I asked in terms of how you feel about the proposed regime compared to where your schemes are. Where broadly do your schemes sort of set, are they got a lot of work ahead or are they broadly aligned?

Yes. I mean you probably expect to say, look, all of the above. I've got some where we're very clear on the end game, and we're already in a most low dependency, on where we are in a low dependency type strategy already. I've got others where the employer certainly thinks that equities are the only game in town. And there will be a long way to go, I think, with those employers to explain to them where we need to get to and by when. So I think yes, interesting times ahead.

Thank you. We'll be coming back to you again in a bit. But before I do, Adam was just going to cover a bit more about the sort of current market environment and understand the impact of that, including the rising yields that we've seen and explain how that affects duration today. Over to you, Adam.

Great. Thanks Louisa. I've got 2 slides looking at current conditions. Hopefully the take 2 good reasons why we think schemes should be discussing and we're still taking action of the strategy today. So the first one, so I'm sure many of your scheme -- from your own schemes, funding levels, especially on longer-term measures such as buyout targets have improved significantly over the last 12 months and particularly since the start of the year. The graph on the slide here shows the combined deficit of all U.K. defined better schemes on a very low-risk actual basis of a discount rate of bills of 0.5%. The right-hand side shows a dramatic improvement in funding with the combined deficits moving from circa around GBP 400 billion to around GBP 100 billion in a matter of months. Now clearly, it's worth noting the graph is a combination. So some schemes were doing better than the combined, some are doing worse. It could be quite a wide funnel around it. Now the vast majority for the general improvement will be due to falling liability values, even though schemes that are 100% hedged on a technical business basis will be under hedged on a longer-term basis. And so would have benefited from the recent rapid rise in gilt yields as obviously central banks try to control record-breaking inflation. Just yesterday, we saw a 20-year gilt yields in excess of 3% per annum, a whole 2% higher than 12 months ago and the highest rate for 8 years. So for many of our clients, even before the draft focuses came out, we were raising that now is a good time to reevaluate your journey plan. Many schemes may never be safe of the game before. So today represents an excellent opportunity to consider banking gains and taking risk off the table, if appropriate. Now as well as funding, the second reason we have a call of action is what's happened to duration. We know the duration of 12 years is the magic point or the draft magic point, and given what's happened to gilt yields in the last few months, we've obviously seen some large changes in duration. Now the graph on the slide here shows one of the schemes that Abbie mentioned in her first slide. If the scheme that had 40% pensioners and at the start of the year, had a duration of 19 years. That's the dashed green line. And that meant we'd expect to hit our significant maturity point in around 18 years' time. [indiscernible] is calculated, it is very sensitive to gilt yields. So a few months later, we can recap the duration line for the same scheme. And 6 months on, we can see the duration has actually fallen significantly. And we now expect to hit a significant maturity point 4 years earlier than expected. Now using the rule of thumb or duration that Abbie mentioned, a 4-year reduction in duration would normally take 12 years to achieve, but we've seen acceleration in 6 months. So why is it important? Well, obviously, quite simply, obviously, this scheme now has 4 years fewer to get to our low dependency status, which obviously going to have significant impact on what we can do between now and then to help the target. So this emphasizes the benefit of starting sooner rather than later. So in summary, [indiscernible] recommend trustees continue to check their current journey plans. I said your schemes are likely to be in the best shape for years. We also think schemes should be acting now to get ahead of the game, not least because you may have less time than you think until your certificate maturity point. Now we know there's quite a bit in the industry, you'll say, why don't wait for the regulators code of practice, but we don't think this is necessary. It's also to be the draft relations that set out the requirements and the law. I think these regulations give you what you need to start making your new strategy plans. Now Back to you, Louisa.

Thank you, Adam. So that's very interesting on duration. And I'll just come back to you now, Alison, if that's okay. And just asking, given that Adam shown us how materially duration has fallen for some schemes, do you think there shows a potential difficulty with using sort of a fixed duration as a measure as suggested in the consultation.

Yes. In a word, yes, I think it does. I mean it's always quite surprising, isn't it? Yes, the way that it can just jump towards you like that. It is quite surprising. Again, I mean I mentioned [ MFI ] costing you mind back to the old 10 years and it was 10 years for everyone, but at least being now what 10 years was. So I mean, conceptually, I like the idea, but I do wonder in practice if it can just move around too much and there might need to be some wiggle room and perhaps there's going to be a range that's acceptable.

Yes, that would seem sensible. And do you think this change will affect how you approach sort of valuations and assessing investment strategy at the current time on your schemes.

Yes, it's a tricky one, actually. I mean I -- he was thinking about your most recent experience. I was in a meeting yesterday with an employer and their advisers discussing a current valuation as it happens, it's a fairly immature scheme. My top and -- first question to my actuary was what's the duration, and she told me it was over 20 years. So we all sort of believed this heavily. And then, of course, I was getting the pushback of the year is that, Oh, well, let's not transact, and guess what the regs are going to say, no, let's wait until next valuation and sort it out then. So I think it's always really difficult doing things when stuff is in draft and in consultation and you're waiting for extra codes. We're seeing exactly the same thing on ESG and combined coded practice. Do we go now and have risk coming to redo it? Or do we wait? So it's just -- I think it's the worst possible time, and we've been in limbo as you said, for quite a while, now waiting these draft regs. So yes. I'd like to say I can start to recognize it, but I think it's hard.

Yes, that's a fair point. It's also difficult, as we saw, as Adam showed, if you are much closer to significant maturity than you might have thought. It does show that you also can't wait too long as you say, a difficult balance. And we have seen some sort of stories in the press that these regulations could lead to some severe outcomes for employers? And what were your views on that?

I think, look, for many schemes, there is going to be more time than you think and I think it will come back to this reasonably afford. They wanted as well. And they touched on that, again, it's something we've all seen of employers coming with a whole string of other demands on their money. So I think it's going to be one where our covenant advisers need to really step up and support trustees in having those difficult conversations about reasonable affordability because if the money is not there, it's not there. But if it is, then we need to make sure that we get our fair share.

Yes. So definitely. And is there anything else in the regulations that you think will really change the relationship between trustees and employers and how you work on a day-to-day basis?

Yes. I think, again, I see a whole range of things, really interesting one, isn't it? I mean, I've been trying to say to employers for a while now, a long time now. What I want to do is get to a position where I never have to bother you again that's effectively how I think of low dependency. I'll just sit over here in the corner with my well-funded scheme and a low-risk strategy, and I won't have to come knocking on your door for deficit contributions again. And some of them find that appealing. And some of them say, oh, but I'm a brilliant employer. I'm here for the long term, and I want to provide these benefits at the lowest possible cost. So surely, that means we can keep on with our equity and our growth strategy. So I think those latter conversations are going to be more difficult because as I said, this is really quite prescriptive, while it's helpful that Adam showed us that there's quite a range of different strategies, and we'll perhaps need to get our heads around higher risk credit sorts of assets. There will be some employers who have possibly been insulted by the idea that we never -- we don't have to rely on them anymore. There'll be others who think it's great. And others who say fantastic and when can you buy it out. So some of those relationships, I think, will be a little bit different. And again, coming back to this affordability idea again, if we've got that stick, if the law gives us that stick to beat them with, as trustees, we'll have to use it, and they may not like it.

Yes. Thank you. Definitely some interesting thoughts there. So we've had a few questions come in about open schemes and how the regulations have a draft regulations proposing to deal with that. So it might just come to you, Abbie, if that's okay, to perhaps comment on that because I know that there is quite a bit of information in the consultation, and they have sought to address some of the concerns that people had.

Yes. So that's right. So the regulations themselves aren't different for open schemes. So the same requirements are in place at the moment. This idea that you will need to have some sort of low dependency investment allocation and a long-term sort of strategy. The suggestion is that, obviously, in the calculation of duration itself. The examples I showed earlier work for closed schemes where duration is coming down because there's a sort of a close group of members in that group. But actually, for open schemes either with open to accrual, where benefits are increasing still for relatively younger members are also truly open schemes, if you like, for members with new entrants still, the idea is that duration won't progress, like I showed you earlier. And at that point, you obviously -- you won't be getting close to your time frame, won't be getting shorter, the duration of 12 years. And the idea would be that would mean, although you do still technically have to set the strategy, you won't have to enact it. You won't have to derisk. And as long as your covenant is there, which remains the key point to support the risk, whether an open or a close scheme, which I think is perfectly sensible to still be sort of very, very reliant on the covenant being there to support it, then you don't have to take any derisking steps.

Thank you, Abbie. And the question for you Faith. So coming back to I think what Alison mentioned about sort of difficulties in waiting for the code, but also see Adam has shown us that we can't just necessarily wait for too long. But is it sort of safe for people to wait for the code? Is there a risk if they take action now, then it's not right? And also just on the timing point, where all this come into force at the same time in terms of the code of practice and the regulations?

Yes, I think we -- the 2 parts, I think while they're still consulting on the regulations, I can see to Alison's point, there's some difficulties to trustees in trying to kind of put the conversation because employees are going to say, well, the regulation is still being consulted on, so they may change. I would say that there are some key points in there around the regulator and DWP launching trustees and employers to properly engage on the long-term future of their scheme, whether that is an end game and a low dependency, self-sufficiency sort of target or when the questions being asked about open schemes where actually having a in line conversation with the employer about how are you intending to continue to kick the scheme open for the full foreseeable future. So I actually think that the fact that it applies to all schemes is usually it's just a different conversation. So I think that it is -- I don't think we should assume that just because the foundation that the regulations change substantially. I think there are some sort of key drivers in there from DWP, we can expect to stay in. So we see if there a pushback, but I think we will transact the conversation. To the point about sort of rating for the code and the time period, we did wait for the code. Once, I mean I am assuming that the DLP and TPI will get themselves, it's really nice on this and the regs on the code will come into pools at the same time. But if the regs come into force ahead of the code being finalized, you would start that -- you have to start, in ready to implement our funding investment strategy or get your funding investment strategy in place because the way the regulations are drafted, [indiscernible] in force to get to your next valuation, you're going to have to address the funding and investment strategy. So I very much hope that the code will synchronize with the rates go, otherwise there are going to be some gaps essentially.

And what's about bespoken fast track, some of these key words that we heard a lot about before but haven't actually been mentioned yet today, how do they fit in.

For me, but my understanding is that, well, there's nothing in the regulations about bespoken fast track, I'd be very surprised to see the regulators code being still in those consolations. That's not to say they won't, but I can't see how those concepts could be derived naturally from the regulations the way they're in. I don't know, Abbie, what do you think.

Yes. So yes, agreeing obviously entirely what you just said, it doesn't feature in the regulations. The idea perhaps that we had were as long as you meet all your fast track requirements, then pass the test is not really supportive. Everyone is going to have to do the work here to do the strategy. I guess we might still see a reference to fast track bespoke in the code. It might be that this is useful for the regulator, for example, just to have -- to help it focus its attention. And I guess, possibly as guidance as well for some schemes about what the regulators sort of view is on some of these. But as you said, it's not in the regulation. So you still need to do the work. It will still be scheme specific and you'll still need to come with your own strategy and whether or not it gets mentioned in the code when we get there.

Thank you, Abbie. And a question for Alison. What were your views on whether these changes we're seeing are really needed at the moment given the high inflation and possible recession that we might see?

So I think my view is that overall, these changes are going to be helpful for trustees. I think they give us a really clear framework where you look at the end, you work out your end point, you understand what that investment strategy would look like. You decide when you need to get there and you work backwards, and I find that intuitively quite an attractive framework. And I think it's clear for everybody, and I think the level of prescription is useful for trustees. So ultimately, we are here to make sure the members get their benefits, and I think this will help to achieve that. So Yes, I understand the point, and it's perhaps a bad time for many businesses, but -- comes back to reasonably affordable, doesn't it? And what I said before, if the money is not there, we can't have it, but let's at least work out how we might get there.

Yes, that well, that's a very good point and obviously comes back to, I guess, the purpose of this whole new funding strategy regime in the first place, isn't it? So conscious of time, so we'll begin sort of wrapping up for today. So I'd like to ask each of our guest speakers for their sort of key takeaway for you from today. So you might sort of start with you, Alison, as you've just finished speaking?

Okay. Thank you. I'm going to give you 3, as a trustee. I'm going to say number one, go and talk to your actuary, ask what your duration is and understand how it changes. Number two, start talking to your investment consultant to understand what that end game portfolio could look like. And then in the light of those really, really go away and start talking to your employer because if they've not been interested in this conversation, thus far, then you really need to get them on board very quickly.

Thank you. And Faith?

Mine is really kind of where Alison ended up, I think that we should assume that there needs to be we're going to need to be a much more detailed conversation on the long-term schemes even if that long term is actually quite short term. This already point of significant maturity. But actually being scheme forced to have that discussion about what the endgame looks like or what the longer term looks like. And I think employers, trustees should assume that the regulator is going to continue to push this idea that you can afford to contribute -- it should be contributing, as I was saying earlier, I'm not [indiscernible] that's got to be immediate but -- but I think you can see from these regulations, some important sort of themes coming through from the regulator and DWP and wanting to make sure we see where employers gain to fold excess you to get fully funded.

Thank you. Yes. And so I think they're all very good insights and tie up very well with sort of my key takeaways from today as well and then based on to what Abbie and Adam have presented. So basically, it's really important, I think, to understand how close to significant maturity you are. And as Alison says, if you don't know your duration, do you find that out. It's really helpful to understand the options and flexibilities that are available. And hopefully, that does provide reassurance against some of the comments that we have seen about needing to require significant cash contributions upfront. And I think -- I know there's been sort of various messages around the last point, but I think it's really important that you don't delay taking action. We do know have the draft regulatory framework. And so we are a significant step forward. And given the recent falls we've seen in duration, it really is sensible to start preparing now. So we hope you enjoy today. In terms of future events, do you look out for more detail on our XPS pensions talk 2022 which will be a series of 4 webinars over 14th to the 17th of November, covering a variety of topics. And if you haven't already, you can register now by clicking on the box to the right-hand side of your screen. There was also a CPD certificate you can download at the end of the webinar. I think if you click [indiscernible] icon. And we'd also really appreciate you taking the time to complete your feedback and when it pops up on the screen as it does help us develop future webinars. And that just leads me to say a really big thank you to our speakers today, to our guest speakers, Alison and Faith and our XPS speakers, Abbie and Adam, for all of your inputs. And thank you to the audience today for joining us and for all your questions. We do hope you found it informative, and I hope you will enjoy the upcoming bank holiday weekend. Thank you.