How to protect your scheme when Article 50 is triggered

The response of pension schemes to the actual Article 50 trigger should be entirely neutral – little will change from the day before to the morning after – but the clock is then ticking for the two-year run-up to formal Brexit. But will the uncertainty end even then?

There is an expectation that we will face a 'hard' Brexit, with the likely outcome that many more years of political and economic uncertainty will follow while the UK seeks to agree trade deals and forge its identity on a standalone basis. As this new reality emerges, there will inevitably be fluctuations in financial markets, as well as the outlook for many pension scheme sponsors.   

Brexit is just another risk

Future uncertainty is clearly nothing new for pension schemes, and the Article 50 and Brexit challenge is another risk to be considered as part of wider integrated risk management considerations, which should already be central to pension schemes' risk management and financing processes. If an IRM framework is not already in place to understand the key risks to pension schemes, now is absolutely the time to kick off that process. 

The foundation of IRM is of course the sponsor covenant and its ability to underwrite future risks and remain able to support the pension promise. 

In much the same way that the EU referendum result has seen winners and losers, the formal Brexit process will see sponsors that emerge stronger and those that are weakened from the process. It is accepted that at multinational entity level, the impact of Brexit may be less significant, but the wider group is not always the sponsor that schemes will have legal reliance on.

Risks to sponsor covenants may in turn be positively or negatively correlated to investment and funding risks in pension schemes, and these need to be carefully considered as part of future scenario analysis. Sponsors should therefore collaboratively share their Brexit plans with their scheme trustees.

The key challenge of IRM is, however, not just the identification of risks but also the management of those risks now and in the future. Known risks today (for example passporting challenges for sponsors in the financial services sector) may be addressed where possible through a combination of leveraging covenant strength for cash funding or contingent funding solutions, or managing investment, inflation and other scheme asset and liability risks, including exploring member options. 

Create your contingency plan

In reality, the shape of Brexit outcomes will continue to evolve. Future risks that may or may not arise require frequent monitoring. But alongside that monitoring needs to be a considered process for responding to situations.

This contingency plan could detail trigger actions to rebalance risks, using available covenant, scheme funding and available investment tools. The plan should ideally involve prescribed action, but – being brutally honest – such actions are unlikely to be palatable to sponsors unless they can be brought into the wider debate about future management of scheme risks and financing.

A summarised framework for managing the risks to pension schemes in the light of the imminent triggering of Article 50 would be to: complete an IRM framework and assess known risks and future scenarios; collaborate with sponsors to understand their Brexit plans and forecasts; monitor development of risks and have available workable contingency plans.

Given the potential for future uncertainty, pension schemes and sponsors should not be afraid to consider material changes to funding and investment strategy aligned with any concerns regarding the future strength of the sponsor covenant.

Darren Masters is a partner and head of the covenant consulting group at Mercer