07 Oct 2019

Pensions snapshot - October 2019


This edition of snapshot looks at the latest legal developments in pensions. The topics covered in this edition are:

An end to RPI?

The Chancellor has announced plans to consult on whether to align the Retail Prices Index (RPI) with CPIH (the Consumer Prices Index including owner occupiers’ housing costs and Council Tax) between 2025 and 2030.

RPI’s status as a ‘National Statistic’ was revoked in 2013, but it has remained in widespread use – not least in many private sector defined benefit pension schemes. A review of price indices published by the Institute for Fiscal Studies in January 2015 recommended that, given the fundamental flaws in the way RPI is calculated, the Office for National Statistics (ONS) should maintain RPI as a legacy measure only. CPIH became the lead inflation index in the ONS’s statistical releases from 21 March 2017.

The Government has previously consulted on whether pension schemes should be permitted to move from RPI to CPI on the grounds of rationality and fairness. The results of the consultation were published in the March 2018 White Paper “Protecting Defined Benefit Pension Schemes”. The Government found there was no clear consensus on whether “fairness” meant protecting employers who may be at a competitive disadvantage if RPI is hard-coded into their pension schemes rules, or protecting pension scheme members who were promised pension increases on a certain basis.

The Economic Affairs Committee’s January 2019 report recognised this challenge but found that RPI’s continued publication in its current form was untenable. It recommended that the UK Statistics Authority (UKSA) request a programme of periodic improvements to RPI.

The UKSA is legally obliged to produce RPI. It cannot, without consulting the Chancellor, change the index until 2030 (when the last relevant index-linked gilts mature) in a way that would detrimentally affect index-linked gilts,. In a letter to the Chancellor dated 4 March 2019, the UKSA made two recommendations:

  1. that publication of RPI should cease; and
  2. since recommendation 1 would require primary legislation and therefore take time, a second parallel course of action: to align RPI with CPIH.

The Chancellor was asked to consent to both recommendations.

The Chancellor’s response of 4 September 2019 noted that RPI is widely used across the economy and ceasing to publish RPI would be highly disruptive. The Chancellor would not agree to promote legislation that would remove the requirement for the UKSA to publish RPI.

The Chancellor recognised the statistical arguments for the second proposal to fix RPI by aligning its methodology with the ONS’s headline measure of inflation. The Chancellor notes, however, there would be significant effects of these changes on users of RPI and time will be needed for those who use RPI to prepare. As a result, he will not consent to such a change any earlier than February 2025. The Government will consult publicly on whether the change should be made earlier than 2030 and, if so, when between 2025 and 2030 the change should occur. The consultation will begin in January 2020 (subject to Brexit being delivered by this time).

Court of Appeal confirms “common intention” test for rectifying pension scheme documents

The Court of Appeal’s recent decision in FSHC Group Holdings Ltd v GLAS Trust Corp Ltd has confirmed the correct test to be applied for the purposes of rectifying (i.e. correcting) incorrect pension scheme documents.

Parties to a legal document, such as a contract or a pension scheme trust deed and rules, can ask the court for rectification of the document where it does not reflect the terms which they consider had actually been agreed. The purpose of rectification, therefore, is to resolve an accidental inconsistency between the parties' common intentions and what was actually recorded in the document.

Whilst this case was concerned with rectifying a contract, the Court cited the rectification of pension scheme documents in order to highlight a distinction between the common intention test for rectifying contracts and the common intention test for rectifying pension scheme documents.

Rectifying a contract

The common intention test for rectifying contracts requires (i) the parties to have had a common intention, and (ii) evidence of a mutual agreement between the parties in relation to those intentions - that is, those intentions must have been communicated between the parties.

Rectifying a pensions document

In line with earlier cases (AMP plc v Barker and Gallaher Ltd v Gallaher Pensions Ltd), the Court confirmed that a pension scheme document made using an amendment power vested jointly in the employer and the trustees (or in the employer with the trustees’ consent, or vice versa) can be rectified if it can be evidenced that the employer and the trustees independently had the same intentions with regard to the document. There is no need for evidence of the parties having communicated this common intention between themselves. The reason for this is that the amending document does not operate by both parties having mutually agreed it. One is approving what the other wants to do. The law for rectifying pension scheme documents therefore remains unchanged.

In spite of this, it is still vitally important that employers and trustees:

  • ensure that their pension scheme documents accurately reflect their intentions and any agreements reached before signing them; and
  • keep a detailed record of any negotiations/agreements entered into before signing the documents, such as meeting minutes and correspondence.

For more detail on this case please see our detailed briefing.

Pension trustees should be aware of the end of LIBOR in 2021

Pension schemes may have investments whose returns are linked to the London Interbank Offered Rate (LIBOR), which is a key interest rate benchmark. LIBOR is a measure of the average rate at which banks are willing to borrow wholesale unsecured funds and is calculated based on submissions from selected panel banks.  It is published in five currencies and a range of tenors.

During the 2007 financial crisis, concerns arose that interbank rates such as LIBOR were being manipulated, leading to greater regulatory scrutiny and wide-ranging reforms to LIBOR.  However, the underlying market which LIBOR measures is no longer liquid, impacting its stability. Consequently, in July 2017, the Financial Conduct Authority (FCA) announced that, after 2021, banks would no longer be required to submit rates needed to calculate LIBOR. It is now therefore widely accepted that it is not possible to rely on LIBOR being available after 2021.

The Bank of England and the FCA have recommended that the Sterling Overnight Index Average (SONIA), a ‘near’ risk-free reference rate, be adopted as the alternative to Sterling LIBOR across financial products and markets. SONIA is an overnight rate, based upon interest paid on certain funds the previous business day.  It is viewed as robust as it is anchored in active, liquid underlying markets.  It is therefore meant to be a better a measure of the general level of interest rates than LIBOR. SONIA will usually result in a rate which is lower than the sterling LIBOR rate.

The transition away from LIBOR to risk free rates presents a huge challenge for the financial markets.  In November 2018 the Bank of England reported that LIBOR underpinned c.$300tn ($30tn in GBP markets) of financial contracts including derivatives, bonds and loans.  Transition is made more complicated by the fact that risk free rates are set by currency.  LIBOR is currently calculated for five currencies (US Dollars, Sterling, Euro, Swiss Francs and Japanese Yen). So, while SONIA is the preferred risk free rate for sterling, other risk free rates will be relevant for other LIBOR currencies.  For example, the Secured Overnight Financing Rate has been identified as the preferred risk free rate for US Dollars.

Some market participants have already started to prepare for the forthcoming changes.  For example, Associated British Ports received consent from noteholders in June 2019 to switch the reference rate for its floating rate notes due in 2022 from LIBOR to a SONIA-based rate.

Trustees should note the likely end of LIBOR in 2021 and the potential impact that this will have on investments (both present and proposed) which use LIBOR as a reference rate. For example, consideration should be given as to (i) how the investments can be amended to take account of a different rate (most likely SONIA for sterling and other risk free rates for other LIBOR currencies), and (ii) the cost implications this may have (for example, whether fees could be charged for amending the interest rate, as well as any effect which altering the benchmark rate will have on returns).

Electronic execution of pension documents

Following the Law Commission’s consultation paper in January 2018, the Law Commission has now published a report confirming that electronic signatures can lawfully be used to execute documents, including deeds, where there is a statutory requirement for a signature.

There are concerns, however, about using electronic signatures as they are more susceptible to fraud than handwritten signatures and there are practical issues such as reliability and security of technology to take into consideration. Uncertainties also remain, in particular with deeds that must be witnessed. The Law Commission believes the legal position is uncertain as to whether remote or virtual witnessing, where the witness is not physically present, would be valid.   The Law Commission recommends that an industry wide working group should be formed to consider practical and technical issues relating to electronic signatures, witnessing electronic signatures on deeds and possible legislation codifying the law.

Given the legal uncertainty, in particular around witnessing of electronic signatures, we would advise against using this method for signing deeds in the absence of further legal clarification. It must be borne in mind that, whilst this report is a useful guide, it does not have the force of the law and the courts may take a different view if asked to decide on any issues raised.