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

Welcome to today's XPS Live. Thank you for joining us today. My name is Helen Ross. And today, I aim to guide you through the web of regulatory intrigue, influencing future defined benefit strategy. We've got some key questions to tackle for you today. What are the new funding and investment strategy requirements? And what is the government agenda on surplus and productive finance? And are these things consistent and into late? How is employee covenant key to determine what schemes do next? And what really is the impact on setting investment strategy and cash contributions? There's an awful lot to take in. If you've ever done a magical picture, we're going to help you step back from the detail and see a strategic picture emerge for your schemes. We're going to focus today on what the key challenges for trustees will be. Welcoming our guest speakers today, we have Ade Awoyinka and Gavin Forsdyke from the DWP; and Richard Knight from Burger Salmon, all offering their insight today. We also have my colleagues from XPS, Arabella Slinger, James Stewart and Pauline McConville here today. So some logistics. We aim to finish at 4:00 p.m. Please submit questions to us farther at all in front of you, and we'll answer as many as we can during the session. And if we don't get to you, we will follow up directly afterwards. The webcast app is interactive. You can move things around and resize them just as you prefer. And if it freezes, just refresh and normally that does the trick. So to start with, I'm going to hand over to Pauline to give an overview of the funding and investment strategy regulations.

Thank you, Helen, and good afternoon, everyone, and it's great to be here today talking to you. So I'm going to start with a quick overview because this already kicked off more than 3 years ago, and I can forgive anyone who needs a bit of a refresher. So the Pension Scheme Act 2021 introduced this requirement for trustees to have a long-term funding investment strategy, I agree with the employer and record the detail of it in the statement of strategy. Now regulations are needed to bring the requirements of an act into force and the final draft of DWP's funding and investment regulations were layer before parliament at the end of January just this year. Now along with a much welcome detail to the requirements of the act, the final draft regulations also brought an effective date of 6th of April 2024 and confirmed that actuarial valuations of schemes on and after 22nd of September 2024, will be the first to fall under the new regime. And anyone who had September 2024 and the sweet sticks really deserves the prize money. Now for these valuations, trustees will have to complete the extra steps required under the new rules and submit their statement strategy and all that within the usual 15-month deadline for submission of natural valuation. Now saying that, and it might be a lot of work to do. I know that most of us are just relieved finally have a data to work towards so that the speculation on there, I say it, the weariness can finally end. And we now just need to revise that enthusiasm that we all had when we first heard whispers of the new funding regime. Now at part emphasizing that the first valuation effective date is just over 6 months away. And we're waiting on a couple of key items needed for the new regime. So the consultation on the form and the content of the statement of strategy was released last week. We expect the regulators updated funding code early June, and we expect final guidance on covenant over the summer. So there's a few things that we're waiting on, but we have the final draft regs now, and we'll go into a bit of detail on what they see. So we know from the act that schemes are required to have a funding and investment strategy when significantly mature. And there's a lot going on just in that sentence alone. The regulations set out the principles that trustees must follow when setting and then later revising their schemes, funding and investment strategy. So key principles are that once a scheme reaches the point of significant maturity, it should be fully funded on a low dependency funding basis. The level of risk taken over time within the assumptions that drive that low dependency funding basis should depend on covenant and on maturity. So schemes that can show that they have stronger covenants and those on the immature side, those, for example, with a higher proportion of pensioner members, you'll be able to take more risk. And the third principle is that schemes assets should be invested so that the benefits are certain to be paid out when they are required and that includes unexpected benefits that might arise. So basically, there should be sufficient liquidity in the assets held. Now I've mentioned this concept of scheme maturity a couple of times and the regulations have confirmed that this is to be measured in years, using a duration of liabilities measure. And we await confirmation as to what exact duration will signify a significant maturity for a scheme, but we expect the duration of 12 that was cited in the draft funding code to come down a little. Some immature schemes may therefore find themselves 10 or more years away from significant maturity while others will be there already. And the regulations there that open schemes may take a kind of future accrual on calculating duration, and that's great to get confirmation on. So we understand the various estimates of duration as the measure of maturity will play a part when determining a schemes, funding and investment strategy, but trustees must also have an objective of being invested in a low dependency investment allocation from the date of significant maturity. And now solidly to drive here is that the first draft of the regulations had one investment point that was set out within the principles that must be followed, and that's now expressed as an objective to take into account. And you'd imagine there was a reason behind this change. And now James will go into much more detail on the investment requirements. But a key question that I and likely many others will have is to what extent having this as an objective rather than a principle will impact on the decisions the trustees will make with their investment strategy. And just finally, for this introduction, I haven't mentioned covenant much, and that is surely a cardinal sent when discussing funding and investment. So the final draft regulations have, for the first time in law, explicitly set out matters to be considered in assessing covenant. And needless to say that Arabella and others will have plenty to say on that.

Yes. And don't worry, Arabella and James, we're going to come to you shortly. But Gavin, can I come to you first, please, so that you could draw a picture for us about the policy intent of the new regulations?

Yes, indeed. So I think when we completed our green paper in 2017 green paper security and sustainability in DB pensions. We examined the pension landscape, and we concluded that most pensions seem to be well run. And even at that time, even though most -- at that time, most scheme to the funding deficit. And the evidence suggested that they were largely speaking being addressed for appropriate recovery plans. But our conclusion was that not good practice wasn't universal. And so our white paper then subsequently made several proposals to strengthen the funding regime. So the funding regime we have is scheme-specific and flexible, and we wanted to remain that way. But we nevertheless want to make it, I guess, slightly less flexible, I guess. We still want it to be flexible to have some considerable flexibility, but we do want to set some stakes in the sand as it were. And in particular, we think the very mature schemes need to be properly funded. So we have set the principle that we want as far as possible to make sure that schemes are properly funded by the time they're pretty mature to ensure the benefits can be paid over the long term. And secondly, we put in that principle that before the date of significant maturity, schemes must be -- the risk extinguishment must be supportable. So they are the 2 principles that we want them. But broadly speaking, what we're driving at is to make sure the pensions people have paid into or accrued to the rights that have accrued are paid. And that's our policy intention.

Thanks very much, Gavin. I mean we've spent so much time reading all the words in the detail that it's good to come back to what the purpose of it all actually is. Arabella, we can see the covenants central to all of this?

Yes, we can. Thank you, Helen, and good afternoon, everyone. As Pauline noted, the regulations do now, for the first time, both defined covenant and require it to be considered as part of the journey plan. And in terms of the changes in the regulations versus the first draft, and that's where I'm going to focus. And I think, to my mind, they've fallen largely into 2 buckets. Firstly, there are some clarifications which largely reflects the consultation feedback. And I just cite 3 examples. The first is the definition of employer covenant, which previously only referred to financial ability, but now does loop in that aspect of financial ability of the employer in relation to its legal obligations. That's the definition we've all been working with for some time. The second one is cash flow where now it refers to that important forward-looking expected cash flow. And then finally, on contingent assets, there was a concern about specificity of the value being attached to continue in assets, and that is now the expected support to be derived from them. Perhaps more significantly, there were items that were previously delegated to the code, but are now sitting in the regulations on a stand-alone basis. The first one of those is really in relation to other matters that are likely to affect the employers future ability to support scheme. So there is greater detail there now, and it includes performance, future development, resilience, the likelihood of insolvency. In fact, all of those aspects, if you cast your mind back to last year that we were thinking about in the context of prospects under the draft code. And secondly, appearing for the first time in the regulations, we've got the concept of covenant time scales. And in particular, this is the period over which trustees can be reasonably certain firstly, that they can rely on their assessment of those matters that will affect the future performance of the business. And I think in my mind, that is a direct correlation to reliability from the draft code. And then the second one is the time span over which the employer will be able to continue to support the scheme. And again, I think that translates back to longevity. All of these elements are going to feed into as the primary factor in determining the maximum level of funding risk that can be taken along the journey plan. One final point to make that's come in as well is that covenant is also now explicitly referred to as something that needs to be taken into account when thinking about the future maturity of schemes that are open. That then brings me on to what's missing or perhaps what is hopefully still to come. Despite the consultation responses, covenant consideration does still appear to stop at low dependency under the regulations. But as we said before, and I wish I'd coined this phrase, but sadly it wasn't one of mine, low dependency is not no dependency. We do expect TPR to provide further guidance on how covenants should be taken into account once you've got to low dependency. In particular, I think trustees and sponsors will need to be mindful of longevity and the ongoing ability of the covenant to support downside risk, including if the sponsor experiences any adverse performance. Clearly, any assessment at that point also needs to be proportionate. And a final point, whilst the direct reference to covenant being a key factor in setting investment risk has been removed the expectation is clearly that covenant will remain the key factor driving both investment and funding decisions. So to a large extent, I think the regulations are broadly as you would have expected, taking account of the code -- of the principles set out in the code and indeed the response to the consultation. But James, it seems that there have been great changes on the investment side.

Yes. Thanks, Arabella. So you're right. There's definitely been some changes on the investment side. And I think they all look to provide trustees with more flexibility around how they can set a low dependency allocation. So that strategy that minimizes the likelihood of requiring further contributions to the point of significant maturity. Now previously, the regs had 2 key principles around how you would construct that type of strategy. The first was the term cash flow matching. So the idea that assets should be invested in such a way that the income paid from those investments would broadly be aligned to the time and benefit payments. That's what we might call a cash flow-driven investment strategy or CDI for sure. . The second concept was the term highly resilient. So here, the idea that scheme's funding position must remain fairly immunized to market shocks. So an objective to appropriately manage and mitigate downside risk. Now a big change in the final draft is that the concept of cash flow match has been removed. Now this was actually something that XPS also responded on during the consultation period. because we felt that, that could be seen as being overly prescriptive if the trustees will efforts no other choice, but to invest in kind of fixed income assets like gilts and investment-grade corporate bonds because, yes, they're more predictable but that comes at the cost of lower returns. And so it could be seen to go into something that's overly prudent or excessively derisked and even maybe something like hard mentality if all trustees are going off and buying the same sort of assets. So I think this is a change that's generally welcomed by most. It helps SKUs make a more efficient use of capital, potentially extract more value from higher return on assets, things like high-yielding credit, emerging market sovereign bonds even private credit, for example. But I think even provides the flexibility for things like equities. So that flexibility, I think, is pretty key because one of the things we can forget if we don't take a step back, is that risk isn't really linear. Whilst it's easy to take off large amounts of risk when a strategy is higher returning, it's particularly punchy, it becomes increasingly more difficult to achieve the same thing without sacrificing more and more return. And that's especially apparent when we're looking at portfolios that feature things like high allocations to get some corporate bonds because of the level of concentration there. Now for some schemes, they're going to have a really clear end-game objective, they're going to value certainty and they're willing to accept the cost because it's simply taking a little bit longer to get there. And for them, I think high-quality CDI type portfolio is probably still the right answer. But by recognizing that in some cases, a risk budget can afford schemes to maintain more moderate levels of return. I think trustees will be surprised that they can construct something that's actually more diverse, increased returns above a level that we might not have otherwise considered and not actually experience a significant increase in risk as they might otherwise have thought. I think that's a pretty good outcome. So then the next question is what about highly resilient, and it looks like that's something that's here to stay. I actually think is quite sensible, although it may be still quite ambiguous. We only have to look at the last kind of 12 to 18 months to see the volatility in gilt market, it hasn't really gone away since the gilts crisis the back end of 2022. And you can see that quite clearly on the chart there. I think interest rate risk, in particular, still has the capacity to have a really big impact on scheme funding positions. So pursuing high levels of interest rate inflation hedging, that's got to remain a critical part of the DB pension scheme strategies. It does raise the question though. Well, what about for those schemes that are really well funded. They've got strong covenant, good governance, all the characteristics that might make them a good or a potential candidate for something like surplus can run on. And I think something like highly resilient, you can ask the question is that going to constrain them in terms of the non-hedging side, the non-hedging assets. And that brings me to the second point, which Pauline alluded to earlier. Whilst there is a requirement to be funded on a low dependency basis by the point of significant maturity, there's no freestanding requirement for trustees to invest in a low dependency allocation. That's not an objective. And so what that means is that there's explicitly no requirement for surplus to be invested in line with low dependency. Some people might hear that and get a little bit concerned. Is that going too far in the other direction? Could it lead to too much risk taking I think it's definitely a fair challenge. You absolutely have to set an appropriate risk budget. I think something that's appropriate is something that considers the context of things like funding position, covenant strength. But equally, it does allow the trustees to retain their powers around investment strategy decisions. They're not handcuffed by something that's overly prescriptive. So they have the flexibility there to refine and change the investment strategy and draw it back if that position changes or the covenant weakens. So I do think it's critical because if you're team that's thinking about a run on strategy, you are setting a 10- to 15-year time frame to invest. Then actually, you do want something that really makes a good efficient use of that risk budget. So I think it's that change that then provides the scope of the schemes to think about different options on surplus, particularly as that consultation evolves.

Thanks, James. And I think it's certainly this area of setting the investment strategy that's had the most discussion. And Richard, I'm going to come to you for my -- about what the legal requirements are in terms of that trustee role in setting the investment strategy and how much flexibility there is under the regulations?

Thanks very much, Helen. That's a really great question. I think there's actually 2 parts to it. Firstly, has the balance of power between trustees and employees shifted at all with regards to investment strategy. And secondly, what impact the new regulations might have on trustees flexibility generally. And as we heard from Gavin, there might be a bit less flexibility. I think the underlying intention is that the existing balance of power for trustees is preserved. But of course, that doesn't equal the same flexibility as now. What do we have at the moment? Well, we have trustees producing a statement of investment principles. And the law is really clear on that. It's actually the 95 Act that says that trustees have to consult with an employer, but it's actually not permissible for anyone to require employer consent to any power to make investments. And then trustees are making all the investment decisions and implementing them. So what about the future? Has anything changed? Well, as we've heard, we're going to have the additional requirement for funding and investment strategy at FIS for short. In terms of balance of power, this is designed to mirror the position for statutory funding. In other words, you need employer agreement to the strategy unless your scheme rules are such that you only need to consult to scheme funding purposes. So that's all consistent with the existing legislation for funding, but what about investment given the investment element to the FIS and given the role of the employer. As we've heard from Pauline and James, there were some changes made during the course of the consultation. So we've heard that the previous draft originally suggested the scheme assets would have to be invested in line with the low dependency investment allocation. That's not changed to an objective. And we've also heard that there's been a shift away from cash flow matching to something around being highly resilient to short-term adverse market changes. So both of those areas are more flexible than the original draft. We're bringing this all together, I think what we can say is the current balance of power has been preserved and the final regulations are more flexible than the previous draft. But I think inevitably, trustees are going to have fewer choices in the future as their scheme matures. The menu of options that are highly resilient to short-term adverse market conditions is likely to be smaller than what's potentially on the table now. And I also think it's fair to say that once a FIS has been agreed with an employer, then there's perhaps limited room in practice to diverge too far from that in terms of the trustees then implementing the strategy, although there is at least the possibility of doing so. All that said, the response to the consultation is clear that this is really the foundation for the next stage of policy development. So we do need to see TPIs revised funding code, but also policy developments elsewhere because as the response says, there is potential headroom here for additional productive investments and investing for surplus with this framework in place. So Helen, I think there'll be a lot more to come.

Thank you, Richard. I know there's a lot more detail still to follow, but I think trustees will take a lot of comfort and confidence from what you've said there about their role. Gavin, I'm just going to pick up on a question that's come in from our audience, actually interlinked with something you said earlier around there being an expectation here that funding strategies will be strengthened under the new regulations. That's the purpose. Do you have a view on the average level of increase you're expecting to see in pension scheme liabilities?

Yes, that's an interesting question. We -- so it is the case that we want a funding of schemes to be strengthened where it needs to be. Of course, a lot of schemes currently have surpluses. So the technical revisions may not be calculated on a dependency basis, and we do want them to be. But our impact assessment suggests that some schemes will be paying more and some schemes won't. So we think that there's a net benefit actually overall. So yes, those figures were calculated in impact assessment is based on 2021 figures. So the position has changed again. So we think generally, schemes -- yes. So overall, we think -- and some scheme are going to pay more and some schemes are going to pay less, as I said. So the position is actually a net gain has fallen that gain.

Yes. it's going to vary large depending on where those current schemes set their technical provisions. There's always a big fear with any strengthening in the funding regime that it will have implications for employers in terms of cash contribution. So Pauline, can I bring you back to talk about cash funding, please?

Yes, Helen, of course. And yes, it's going to be something that everyone is interested in. So as I mentioned earlier, the regulations, they now set like this minimum requirement of being fully funded on a low dependency basis, when significantly mature. And now interestingly, though, we have the draft final regulations, of course. And we can see that same funding in terms of cash contributions, seems to be continue -- seems to be -- continues to be wholly linked to a scheme deficit on its technical provisions basis. So my understanding, and I've taken a deep dive through the documents for any indication otherwise is that no additional requirements have been made in the primary legislation or in the regulations for schemes to pay contributions to fund to the low dependency funding position. Now saying that, it is set out in the Pension Scheme Act itself that scheme's technical provisions should be calculated in a way that is consistent with the schemes funding and investment strategy. So a clear link has been drawn between technical provisions and the funding and investment strategy, albeit what consistency means in this regard is not totally clear. I expect this will be a matter for debate between trustees and employers and perhaps we'll get some comment on this in the regulators' code. So if consistent is interpreted to me in the CM, for example, then this infers that schemes technical provisions basis and the long-term funding strategy basis must be one and the same thing at the point of significant maturity. And where that might prove troublesome for some schemes, for example, is those that have a long-term strategy of buyout. For instance, many employers would challenge being formally obligated to fund to buy out. Now with the regulations do change in terms of cash contributions is with regards to the recovery plan under the technical provisions basis. So the regulations bring into law that well-known mantra that a recovery plan should pay off the deficit as soon as the employer can reasonably afford. And they also add a requirement to consider the impact of the recovery plan on the sustainable growth of the employer. So this brings funding, investment and covenant altogether, each playing a role in determining a recovery plan that meets with the key principles outlined.

Thanks, Pauline. And we're going to come back to the point of affordability shortly. But where there's a point of debate, it's always good to get legal imports. So I'm going to bring Richard back to talk about perhaps what the regulations mean? Do you agree that the regulations don't create a legal requirement, a new legal requirement here for cash contributions, if schemes fall behind and reaching low dependency by that significant maturity date? And interlinked with that, sorry, it's a very long question. What do you interpret as meaning the technical provision should be calculated and why that's consistent with funding investment strategy?

Thanks, Helen. I don't mind long questions, that's fine. Well, I suppose let's build up what the various legal requirements are for the FIS. What you've got under the Pensions Act 2004 as amended now is you have to have a FIS stating the funding level that the trustees intend the scheme to have achieved by the relevant date. And you've got a provision that says, if you don't comply with the requirement to have a FIS, then there's civil penalties for trustees. So that's the GBP 5,000 per individual or GBP 50,000 for a corporate. But I think your question was more around what is the FIS intended funding level target isn't met at all. And there, I would definitely agree with what Pauline has just said. So there isn't a freestanding contribution requirement here if you fail to hit your intended funding level, there isn't anything under this new regime that triggers a debt or an extra cash requirement. And instead, you have to look at the statutory funding regime, which, as I mentioned earlier, is something that trustees and employees have to agree and the scheme rules will require its consultation only. As you mentioned, the new regime says that schemes technical provisions will be calculated in a way that's consistent with the schemes FIS. What does that mean? Well, I think there's definitely room to interpret that as something other than the same. And we will definitely want some TPR guidance on this. But my initial view is this is going to turn very much on where a scheme is on its journey plan, I think there will be scope for some trustees to effectively run 2 different targets where appropriate. So technical provisions on the one hand and a much longer-term journey plan on the other. But I think the scope for difference will reduce as the scheme matures. The other thing we know, of course, is that because there will be new requirements in terms of actuarial valuations, looking at maturity level and low dependency funding basis, the trustees will very much have these 2 questions in mind at the same time or be thinking about them alongside each other. And again, as Pauline mentioned, when it comes to recovery plans, there is now going to be within regulations, the requirement to clearly and as soon as the sponsoring employee can reasonably afford but also considering the impact on an employer sustainable growth. So as I say, again, a lot more to come in terms of guidance from TPR, but yes, I'm agreeing reporting no extra cash contribution requirement here. And as for what consistency means, I think it does depend on the context.

And Gavin, I know you're angling to come in here because obviously, you wrote this with the DWP. What is the intended meaning of this calculation consistently with the funding investment strategy from your perspective?

So yes, I think and as Richard says, it's compatible with or aligned with. So -- and very much shown, and there is no requirement before a significant maturity or the relevant take for a scheme to have low dependency on its employer. And so if it has a lower funding level on that, which we assume any mature scheme will, we expect the funding position over time to strengthen to reach low dependency by the time the scheme is significantly matured. And after that, so the GPs would converge with low dependency. And you're quite right that there is no separate requirement for an employer to pay or for more contribution to be paid to the scheme if it is under the low dependency target. The GPs will converge on low dependency by the time the scheme is significantly mature. And then if the scheme goes under that funding level, a recovery plan will apply as in the current regime. So yes, I hope that covers it.

Thank you, Gavin. And I'm sure we'll see this discussion continue as well afterwards, but there may be some more questions that come in on this point. But I'm going to switch back to affordability now. And Arabella, how on earth can trustees decide what contributions are affordable?

Well, Helen despite the fact, and we've heard both Richard and Pauline refer to it, that we now have these 2 concepts as soon as the employer can reasonably afford and sustainable growth and shines in legislation. I don't think the approach of the trustees take to assessing affordability is going to be materially different to what it has been, frankly, ever since the 2015 guidance. We are going to start with looking at available cash flows and then look at the allocation of those cash flows and consider whether it's reasonable. And as I'm sure everyone is aware, and has probably experienced themselves. The debate typically hinges around covenant leakage otherwise known as dividends or shareholder returns and sustainable growth. And in the context of sustainable growth, trustees are required to be confident of the resulting benefit to the scheme and the employer from diverting -- potentially from diverting funds away from the scheme to that sustainable growth. My personal view is this has always been a bit of a challenge for trustees because in some ways, it requires them to second guess or challenge the directors, company directors, assessment of what is an appropriate opportunity for the business. But if there is a concern, a way of getting around that is to look at how any downside risk might be addressed for the scheme, so possibly through contingent support. I think it's worth reminding people that the draft code set out some principles on these points, which is, first, in relation to covenant leakage. Last year, they were saying the lower the funding basis and the more mature of the scheme, the less reasonable leakage will be. And I just flagged that because I think it's one of the things we're going to be looking out for when the updated guidance comes around. And then finally, in return -- in relation to time scales, there was this point that deficit repair contributions shouldn't extend beyond the period of reliability. Now that was in the code. And as I touched on earlier, I think this concept of a period of reasonable certainty is akin to that reliability period.

Thanks, Arabella. And there is a covenant question that's come in. So I'll come back to you in a moment. But I'm just going to pick up another investment point now. And I know a lot of trustees are in discussion around the roles that liquids can play at the moment, and that's certainly been a topic of conversation since the LDI prices. So James, can I come to you, please? What sort of role can liquids play in a low dependency investment strategy?

Yes. I mean I definitely think they can play a role Pauline mentioned right at the beginning that there's a principle there around liquidity. And that definitely doesn't mean you have to be 100% invested in liquid assets. So there's also the capacity to take a liquid risk. And I think it then falls back to the same investment question that they're always what's the time frame? Because if you've got the time frame to support illiquid assets, then you often provide a better return profile than the public counterparts. So usually a great addition to a portfolio if you can accept them. But if you've got a time frame that's kind of sub 5 years, then it's probably still not appropriate as it wouldn't have been under any other circumstances. So yes, I think it definitely has a role to play in no dependency.

Thanks, James. And there's a question in here, Arabella, about exemptions for all of this for small schemes. And perhaps this is linked with the idea of proportionality. We've got well funded schemes out there. We've got small schemes, but small schemes with large employers. What does proportionately in the context here?

Helen, on this one. I think PC is in the eye of the beholder, right, rather flipping to answer, proportionate, it does mean seem to be something different to everyone. I think from my perspective, this is -- I'd almost translate proportionate into risk-based. What we're trying to do is proportionate is focus the analysis on what could derail the scheme either from its technical provisions or indeed from ultimately its end game. So that will vary depending on the position scheme. But from my perspective, I think you need to be identifying key from a covenant perspective, identifying key metrics that are going to be -- they're going to give you a heads up as to whether there are any potential issues coming down the line from an employer perspective, which will give you sufficient time to take action because what you want to be able to do obviously is catch it on the way down rather than have to deal with a problem as and when it arises.

Thank you. We're just going to move on from the funding investment structure code because I'm very conscious we've got the surplus consultation that's live at the moment. So the question is, does this all fit neatly together, the funding investment strategy regulations and the surplus consultation? Or is this a bit of a curveball for trustees to manage 2 areas of regulatory change? So Pauline, can you give us an overview, please?

Yes. Thanks, Helen. So this surplus consultation acknowledges that many DB pension schemes are experiencing high funding levels at the moment. Many are running a surplus on what could be considered a low dependency funding basis or even on a buyout basis. And then with the new funding rules that we have requiring all schemes to have a low dependency funding target, it's not difficult to imagine that more schemes will fall into this position over time. So we've got the potential for more schemes to be running in a deficit and the government is clear that it wants pension schemes to be able to use their surplus assets productively. Now one of the government's stated in within the consultation and surplus is to make it easier to share scheme surplus with both employers and with scheme members. And thankfully, it also acknowledges that this EM really must go hand-in-hand with addressing the numerous practical and behavioral difficulties that currently exist with surplus extraction. And one such barrier is simply that many schemes prohibit surplus extraction. So a statutory override either to change game rules or to enhance trustee power has been proposed to tackle this. Now to change behavioral barriers and bring surplus extraction into the remit of trustee duties. The proposals are to automated the funding code and to introduce a new surplus code or to provide guidance straight from the pension regulator. And I expect that guidance in any of these forms will be welcomed by trustees because if it offered them support to demonstrate that they took appropriate actions when considering surplus extraction and offered some practical ways of responding to requests for -- from employers who you want to run schemes on for surplus. Trustees will obviously welcome any guidance that would help them with those issues. Now tax can also be a barrier to using surplus to improve member benefits. And the consultation recognizes this and suggests that changes could be made to the tax regime to make one-off payments to members a more attractive option. So this would be to lessen the tax burden associated with unauthorized payments. And trustees now will prefer to share surplus with members through something like a one-off payment instead of increasing the overall liabilities of the scheme going forward. So I expect most would welcome a change like this. And of course, like the big question in all of this is what exactly is the surplus for extraction purposes. So the consultation sets out criteria that are currently being considered and this includes funding above the low dependency funding basis. So this might be low dependency with a fixed or a variable buffer. Another option is funding a both buyout and consideration of a covenant requirement. The trustees and sponsors, they'll need to be mindful that the safety of member benefits must remain paramount and relaxing the current rules on distributing surplus will need to coincide with high levels of member protection. And it's there for a little odd, in my opinion, that the consultation blatantly regards the covenant requirement aspect to all of this as not their preferred option because it is challenging to quantify I expect this will receive some backlash and I know at least 1 covenant adviser who disagrees with this.

We will come back to Arabella in just a moment for her thoughts on that. But Ade, I wonder if I can bring you in on the surplus consultation objectives. So could I ask you what the overall policy objectives are here? And do you view these as being consistent with the funding and investment strategy regulations?

Well, I think the overall policy object has been very helpfully explained. But I think one of the things that we were looking at is the fact that funding is improving for DB schemes, important they get to a low dependency. But we also want them to invest productively. We're hoping that whether they invest productively, it will drive higher funding levels. And we think if it does drive higher funding levels, that is above the low dependency level, that employers should be rewarded and one way of rewarding employers is allowing them possibly to expect some of the surplus. We also think that members should benefit from higher -- from investment in higher growth assets by kind of removing barriers and allow employers to share the benefits with their members. But as it has been said, I want to reemphasize, all of this is predicated on ensuring that members benefits are secure. The paramount part of the policy is ensuring that members are likely or extremely likely to get the pension to which the employer has committed. But I think it's fair to say that it has been noted that when there is -- employers are the ones that fund the downturn in investments, but they don't really get to take advantage of any kind of the upside of investments. So I think this is kind of trying to rebalance that to a certain extent. And we kind of -- we don't see this as actually undermining what has been said or being inconsistent with the direction of travel in terms of the scheme funding regime. I do accept it is something else for trusses and employers to think about. But we're hoping with some guidance on the regulator and the very clear scheme funding regulations, it should be possible for both employers and members to benefit. And if I may, and I might just pick up somebody was asking whether we're envisaging this in the context of schemes that are winding up? I think what we're envisaging the surplus extraction to take where we're envisioning it to take place is more for steams that choose to run on rather than schemes that choose to wind up. I mean, for example, I mean, some of this might and covenant schemes to run on because we're looking at schemes we're not necessarily looking at schemes here that are close to buyout. We're looking at schemes that are achieving low dependency plus some margin basically.

Thank you, Ade. And yes, you're right, there are definitely interesting opportunities around strategy here that may well be productive. It remains quite a concern for trustees as to how they view surplus extraction versus member security. So I'm just going to bring Arabella back to think about that covenant point in the decision-making process.

Thanks, Helen. And you won't be surprised to know that I think covenant is absolutely key to this. Instinctively, everyone I've asked is, well, of course, covenants got to be considered. I do think it's interesting that when you look at the consultation at the moment. It acknowledges the relevance of covenant in that -- in those eligibility criteria. But then it does seem to suggest as poorly outlined, that it's very difficult to quantify and it can change. But if we go back to that concept of low dependency is not no dependency. We can all absolutely envisage some schemes at a low dependency level, where they're taking more risk against the backdrop of a weaker covenant. And in circumstances where something goes wrong, post extraction and some of the surplus, your ability to restore the funding position either through contributions or indeed just the evolution of time for example, where the sponsor to fail means that you actually may not ultimately be able to secure members' benefits. So it's not surprising to me that actually the early results of the survey that XPS has carried out suggested that trustees saw -- 70% of trustees saw some strong employer covenant was the most important factor in managing this particular risk. So I guess the question is, if this is the policy direction, how do you enable this in legislation whilst equally ensuring appropriate protections. I think the direction of travel is an option might be set a threshold in the legislation. And I'd be interested to hear people's thoughts on that for that surplus extraction. That might, for example, be consistent with the schemes, low dependency funding basis. Obviously, that would then end up being scheme-specific, which is important. But also in those regulations refer to the need to consider covenant strength and investment risk and then delegate the details of how that is done to possibly an updated funding code or separate guidance. And very much will be if we can develop a regime for dealing with deficits. We ought to be able to develop a regime for dealing with surpluses. But I think there is the risk of -- if it's not dealt with carefully, extreme risk on trustees and need to consider particularly their position from a fiduciary duty perspective.

Hugely helpful. And I'm sure we'll see a lot more debate about how this all plays out. Can I ask you one direct question that's come in from one of our trustees about how run on might work for a weaker end of the covenant spectrum. Do you see those 2 things as fitting together?

If it really is a weaker covenant, my instinctive reaction is no. That's the simple answer. But everything is open to sort of review and discussion. I mean, I think if you're going to be running on you need to be -- it's going to depend on your funding level, and it is clearly going to depend on buffers within that and then potentially any additional contingent protections that you can achieve in order to secure that position such that actually, given your weak covenant, you're not as reliant on that covenant as you would otherwise be.

Yes. It's a huge ask for trustees, isn't it? But Richard, I'm going to come to you next because the biggest debate here is the fiduciary duty of a trustee and how this fiduciary duty might change in the future, and there are lots of competing priorities and the balance of power is perhaps around member security, discretionary benefits to members and the economic benefit to the employer. So maybe we could just have your thoughts on that rather wide topic.

Yes, it is -- thanks, Helen. It's really interesting. I mean my view is that, at the moment, legislation and scheme rules do obviously cater for the possibility that will be surplus. There are all sorts of rules and regulations and provisions around what trustees should be doing with it. So I definitely see it as a core part of the trustees duty to manage surplus. I accept that if there's to be a regime, I hope there is for appropriate schemes to run on that, that's slightly different in terms of a trusted duty. There's a different mindset potentially to be aiming continually for a buffer and to run off for surplus. But again, I don't see that as inconsistent with fiduciary duties so long as there's good guidance from the regulator and others to support trustees and what they need to be doing.

Thank you very much. And I've got one more question, which is probably for James, actually. So James, there's a question here about the spectrum of assets. that you might be able to invest in on a run-up strategy about productive investments that may be available to insurers, but perhaps not for schemes at the moment. I don't know if you've seen this question come in. Do you have any thoughts on that one?

Yes. It's a really good question. I think if you're going to do a run on strategy properly, you have to take a step back and say what's the most efficient use of capital here? How do I build the most diverse portfolio that both meets the return target that I'm trying to achieve, but equally is in line with the risk budget that I'm going to set? Now if you have a strong covenant, that might support the ability to take those higher returning assets and slightly target a more attractive level of return. But equally, if you don't have that support there, then I don't think you can reasonably turn round and say, well, I'm going to invest in the super punchy private equity-type assets. There's definitely ways you could do it. You can do something like a barbell approach, so you can hold basically assets very much in either end of the risk spectrum. So you'd have a majority of something like gilt and then a little slither of some really high retained assets. But again, I don't think that's the most efficient use of capital. So I'd question those type of investments. So I think it's possible, whether it's optimal is a different question.

And it's really interesting, that's seen all the questions come in, at the moment, that everyone sat at home or sat in the office thinking about their own schemes and their own employees and their own circumstances. So with that in mind, I think it's a great time to come to our polling question, which is do you and your scheme plan to buy out to run on and potentially extract surplus to other potential end game options such as super funds or public sector consolidator, which is another aspect of the surplus consultation that we've not covered today. But of course, this is Ade's area of specialty. So 4 options: buy out, run-on, super fund or public sector consolidator. So what you'll need to do is click on your choice and scroll down on the screen and hit the submit button. So while that is going on, are you considering this question, I'm going to close with some thoughts. There's an awful lot to understand here. And for some schemes, as Pauline alluded to earlier, we've got valuations coming up at the end of this year. There's not a lot of time to be prepared. So trustees clearly need to get to glits with the implications of the funding and investment strategy regulations quite quickly, starting with getting the right building blocks in place for covenant in investment and funding advice. And there are realistic opportunities around what our strategies for many schemes but trustees actually need quite a lot of information and support to consider the risks and implications before jumping in. And actually, we also need to understand the bandwidth and pace for the productive finance agenda within whichever future government we have. And we recognize that there will be a lot of questions in this area over the course of the year. So I wonder if we've got the polling results to bring up on screen now. It's a good split. There we go. We've got lots of schemes still pursuing a buyout strategy, but actually a very good proportion looking at run-on and really wanting to consider how this as an option could work and look like for them in their schemes, which is referencing exactly what Ade said earlier, the intent here to allow that flexibility and freedom to make schemes make the choice that's appropriate to them. Actually, as we are going to be hugely busy this year with the program of webinars on all aspects of pension strategy. You'll definitely see more information from us on surplus consultations. Please fill in our feedback form when it pops up on the page, which will help us design our webinars for what you want to see in the future. Our next webinar is on the 30th of April, where we will be looking at how fiduciary managers have fed following the gilts crisis. So please do register for that one. You can download a CPD certificate for today or if you can't do that, you can receive a copy from us tomorrow. And we encourage you all to complete our specific surplus server, a QR code should hopefully be on your screens or on the portal in front of you. You'll be able to scan that and give us your views on the surplus consultation. We're really interested in your thoughts there, and Arabella alluded to some of the early results during this section on covenants. A huge thanks to our speakers today. So to Duncan, to Ade, Richard, Pauline, Arabella and James, it's a pleasure to have you all here and many thanks to all our audience for watching and for all your questions today. We will see you again soon, thank you very much for joining XPS Live.