Grand Committee
Arrangement of Business
The Deputy Chairman of Committees (Viscount Colville of Culross) (CB)
My Lords, in the unlikely event that there is a Division in the Chamber while we are sitting, the Committee will adjourn as soon as the Division Bells are rung and resume after 10 minutes.
Pensions Regulator Defined Benefit Funding Code of Practice 2024
(1 month ago)
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Lord Davies of Brixton
That the Grand Committee takes note of the draft Pensions Regulator’s Defined Benefit Funding Code of Practice 2024, laid before the House on 29 July.
Relevant document: 2nd Report from the Secondary Legislation Scrutiny Committee
Lord Davies of Brixton (Lab)
I always appreciate a challenge, and I was quite interested to note that our Whips have got the idea that this debate will last half an hour, but I will not take up the whole 30 minutes.
First, I have to declare an interest: I am a fellow of the Institute and Faculty of Actuaries, or IFoA as it is now. Many members of the institute provide advice on funding of defined benefit or DB schemes, and they will be significantly affected by the code that is before us. However, I add with some emphasis that I no longer practise as an actuary, hence nothing of what I say must be regarded as constituting actuarial advice. It might sound like actuarial advice, but I assure those here that it is not; noble Lords have to get their own advice rather than take it from me. Nevertheless, I speak from experience as a scheme actuary who has undertaken scheme valuations including, in the past, under the Pensions Regulator or previous iterations.
We are talking about the regulator’s defined benefit code of practice—the code—issued under Part 3 of the Pensions Act 2004. I very much welcome the opportunity to make a few remarks about the code and to ask my noble friend the Minister some questions.
TPR has been producing codes of practice on funding going back to 2006, but it is worth pointing out that it first consulted on this iteration of the funding code more than four years ago, in March 2020, with a second attempt in December 2022. This version was published for consultation in March this year, so its final form comes after years of waiting and four Prime Ministers; the whole Covid epidemic; a significant shift in the financial position of many defined benefit schemes, with increased investment returns in particular; considerable discussion about how these funds should be invested in the light of the Mansion House reforms under the last Government; the pension review under this Government; and, not least, an increased appreciation of the risks to defined benefit schemes from climate change. So much has happened and the code has, in effect, had to hit a moving target. Unfortunately, I would argue that even this version has not really caught up with developments and events.
The new code, together with the Occupational Pension Schemes (Funding and Investment Strategy and Amendment) Regulations 2024, which we discussed in this Room last March and which came into force in April, gives trustees and advisers most of the tools and processes to follow for DB funding valuations with a valuation date on or after 22 September 2024. There has been a bit of time-shifting going on here, but it is not a concern. It is clear that there will be specific areas of the code where further clarification is required, which will be found out only in practice.
I will not repeat everything I said in March, but I want to emphasise my main point. I was talking about the regulations, but it applies to the code as well:
“The regulations are patently too prescriptive. The details that they require are not directed at the objective of protecting members’ benefits but are about establishing a system where box-ticking will take priority over the longer term and broader interests of scheme members”.—[Official Report, 26/3/24; col. GC 165.]
This version may well be better than earlier drafts but, given that the code is already in effect in practice, it should be understood that it is only one stage of the longer-term reassessment that is required, given the continued pace of developments in this sphere. We should not be under the delusion that this constitutes a job done.
There are positives that I want to recognise. The DWP tells us that the draft code has been revised to strike a balance between setting clear funding standards and maintaining flexibility for scheme-specific approaches. The move to a more principle-based rather than prescriptive approach to areas such as the low dependency investment allocation and assessment of the covenant is helpful and gives the trustees some flexibility. Other commentators have welcomed the redefinition of what constitutes significant maturity; clarification of what happens when the valuation is based on notional investment rather than actual investment; greater clarity on how to assess the employer covenant; and—this is particularly important—what applies when there are surplus assets. It is to be welcomed that the final version includes a section for open schemes, collating the guidance that is relevant to them across the code.
Nevertheless, the code remains a work in progress. The IFoA has said:
“The totality of the changes being introduced by the new code remain complex”,
and that there are still a few more steps on the journey to take. It says that it hopes
“the regulator will adopt a pragmatic approach when considering the first valuations under the new regime, due to the short implementation period for the final rules”,
emphasising the point that this is a work in progress.
My major concern remains that here we have 100 pages of detailed instructions and rules, albeit with quite a lot of repetition, not just on how to undertake a valuation under the terms of the legislation for a defined benefit scheme but about how such a fund should operate, particularly in the field of investment. It passed through my mind to go through the document quoting the minutiae that is dealt with—for example, telling us that we have to use a Macaulay duration calculation. I have resisted that temptation—I do not wish to delay people too much—but I have no doubt that the requirements, while well intentioned, are excessive. Although there are references to proportionality, what will happen in practice is that the code will suffer from what is described as procedural drift, where individuals become overreliant on routine processes, potentially leading to reduced understanding of the overall decision: failure to see the wood for the trees.
The underlying belief, as far as I can tell, is that detailed prescriptions and requirements are better than general principles. I do not know what evidence there is for such a belief. Is it true that detailed prescriptions and reporting requirements along the lines set out in the code make it any more likely that members will receive their benefits? I doubt it. As an overriding principle, given the inherent uncertainty about any attempt to forecast the future, there is no reason to believe that making an algorithm more complex improves the outcome.
One problem that concerns me, which I raised in the debate in March, is how the code reacts with Technical Actuarial Standard 300: Pensions. TAS is set by the Financial Reporting Council and lays down how any actuary in the UK should undertake technical actuarial work required by legislation to support decisions on funding, contribution requirements and benefit levels. I have the latest version here; it came into effect in April. The point is that the actuary who undertakes the valuation at the request of the trustees must comply with the professional standard. However, we are in the peculiar position where the code makes no reference to TAS, and TAS refers only by implication to the requirements of the code in an appendix.
It is a matter of concern that the 18 pages of TAS, only four of which refer to scheme funding, make more sense than the 100 pages in the code. What exactly in the code achieves anything that is not already achieved by those four pages in TAS 300? We are told that in its review of TAS 300, the Financial Reporting Council has deferred consideration of the provisions on funding and financing until the new legislation on funding and TPR’s revised code of practice are in place. I am not convinced that this will work. There must be a real question about who is responsible for setting technical standards on funding DB schemes—the Financial Reporting Council or the Pensions Regulator. Judging by the record, my vote goes to the Financial Reporting Council.
Having made that general point, to which I will no doubt return in future, I have three specific questions about how the code will deal with continuing developments in DB pensions. First, there must be a question of whether the code deals with whatever comes out of the first stage of the pensions review. We have been told that the first stage is due to report in the next few months and will consider further measures to support the pensions Bill. It will take account of the need to prioritise gilt market stability, liquidity and diversity. The objective, we are told, is to boost investment, increase saver returns and tackle waste in the pensions system. The problem is that this objective is not reflected adequately in the code. How and when will these issues be reconciled? How will what comes out of the pensions review be reconciled with what has been established in the code?
The second question arises from the improved state of DB funding, which has led to more schemes being run on—continuing rather than moving quickly to buyout. Because schemes will be running on and must, under the code, have the objective of being fully funded, this raises a question: when schemes move into surplus, what rules apply to that surplus? In discussions that people have initiated since we have seen the improvement in scheme funding, it has been suggested that schemes with a material surplus may invest in a greater allocation to growth assets. This aligns with the policies I have just referred to—of both the previous and the new Governments—which emphasise investing for UK growth. That objective is not adequately reflected in the code. In addition to the issue of investing surplus, there are other possible results of improved financial conditions for DB schemes. Not least of them is the possibility of improvements in members’ benefits, either through trustees exercising the discretionary powers that many of them have or through rule changes.
In the same way, some people are talking about the possibility of powers being used to refund sponsoring employers or to use the surplus in the scheme to cover the cost of accruing benefits. Unfortunately, the Pensions Regulator appears to have given insufficient thinking to such developments and to how its powers will be exercised when confronted with such issues. The code does touch on the issue, talking about covenant leakage but in a way that is clearly inadequate when faced with the challenges that will arise from these moves. Will the Government press the Pensions Regulator to give the issues that arise from the potential existence of scheme surplus further thought and more adequate thinking? I have already complained that the code is too complex. I am not suggesting that this should be in the code, which is complex enough, but it is an area to which the Pensions Regulator has to give considerably more thought, so that we know where it is coming from when confronted with these issues.
The third issue, which I will cover swiftly as we will debate it again on Thursday, is the impact of climate change. The code touches briefly on the issue, in paragraph 23 of the application module, but it is an issue on which the Pensions Regulator has to take much more of a lead. Will the Government encourage the regulator to pursue what needs to be done to enable schemes to confront the challenge of the greater risks that face the financial system, including defined benefits schemes, as a result of global warming?
Baroness Drake (Lab)
My Lords, I declare my interest as a DB pension scheme trustee as recorded in the register. I thank my noble friend Lord Davies for securing this debate. This is an important code, and it should not pass without comment.
As the Explanatory Memorandum and my noble friend observe, while aggregate DB funding levels have improved in recent years, financial markets and economic conditions are changeable and funding positions can quickly deteriorate. There is a dynamic in the pensions world related to economic circumstances, whether fiscal policies, investment returns, gilt yields or the impact of technologies on markets, to name but a few.
An intended purpose of the code is to allow TPR to be more proactive in identifying and mitigating emerging risks in a targeted way. There have been significant instances over the past 30 years of regulatory failure to identify or respond quickly to emerging risks in DB pension provision, some with dreadful consequences. What do the Government believe are the most compelling levers in this code that will materially improve mitigating such emerging risks?
The new code sets two key requirements: planning for the length of the scheme’s journey plan to get to full funding at an appropriate pace of de-risking and assessing current funding positions when carrying out valuations. As part of that planning, the code trustees must set a funding and investment strategy—that is, the journey to getting to the planned endgame for the scheme. The strategy must set out how the trustees will transition from the scheme’s current funding position to low employer dependency funding when the scheme is mature. In making that transition, how risk can be supported by the employer and the strength of the scheme has to be made clear.
During the consultation a lot of concern was expressed that the new code could weaken an important fiduciary power of trustees to make the investment allocation decisions by requiring trustees to invest in line with the investments set out in the funding and investment strategy that must be agreed with the sponsoring employers. In response to those concerns, although changes have been made to the code to clarify that decisions in relation to the scheme’s investment allocation are not constrained by the notional investment allocations in the funding and investment strategy, an inference remains that, in most instances, TPR expects trustees to align their investment strategy with the funding and investment strategy. Will the Minister confirm unequivocally that the code will not remove the power of existing trustees to decide on the scheme’s investment allocation? It is an important power in addressing moral hazard.
The code places a welcome greater emphasis on the strength of the sponsoring employer covenant, which is of fundamental importance but is often lost in debate, when considering funding and investment risk. The level of cash generated by a sponsoring employer and its future prospects will be key determinants of how much investment risk a scheme should take. The strength of an employer covenant can change very quickly following mergers, acquisitions, restructurings et cetera. Such changes may result in changes to the level of debt in a company, dividend policy, free cash flow, covenant and longevity. The code requires any funding deficits to be repaid as quickly as the sponsor can reasonably afford, but trustees will have to consider the impact on the employer’s sustainable growth. Trustees will need to assess such affordability annually; they will also have to provide evidence for their view of what is reasonably affordable and their opinion on the maximum supportable risk that a sponsor employer can bear.
These are potentially significant areas for disagreement between sponsoring employers and trustees, with one seeking to discharge a fiduciary duty to protect its members and another wanting maximum freedom from the liability of funding a pension scheme, but TPR has still to provide its covenant guidance on the main areas that trustees must consider when assessing the employer covenant. In that sense, there is a significant area of this code where an important point of detail is missing. Can the Minister advise when such covenant guidance will be issued?
The code emphasises a flexible and scheme-specific approach to regulation, taking into account the variety of DB schemes. It contains provisions for schemes that remain open to new members and may not be maturing, such as schemes that are now closed. Again, that is quite a controversial issue in the initial iteration and consultation on the development of this code. The considerations around investment strategy and the ability of trustees to choose how to invest now recognise the different characteristics of open schemes compared to closed schemes; the importance to open schemes of long-term planning; and a more flexible approach to assessing investment risk, which is supportable by the covenant and the scheme.
Finally, the Explanatory Memorandum—I shall pick up with brevity a point that my noble friend elaborated on in more detail—states:
“The approach to monitoring this legislation is that there is no requirement to carry out a statutory review of the draft Code”.
However, as we all know, the previous Government were—and, more so, the current Government are—focused on the issue of wider funded pension scheme consolidation and scheme investment strategies. Although I recognise that the Minister cannot comment on the outcome of such considerations or what may flow from the first pension review, if those outcomes had an impact on the provisions of the DB code, what would be the mechanism and consultation for revising the code as a consequence?
Baroness Altmann (Non-Afl)
My Lords, I congratulate the noble Lord, Lord Davies, on securing this important debate. I agree with the noble Baroness, Lady Drake: the code is an important document that certainly deserves the attention of this Committee. I apologise to the Minister because this debate may well end up lasting more than the half an hour that was apparently expected; I will try to be as succinct as I can.
The overall aim of the defined benefit code is to protect member benefits. The whole point of the code was that, in the past, there had been a kind of free-for-all where employers and trustees could invest and take as much investment risk as they wished. Given other circumstances in the market, hundreds of thousands of members either lost their benefits or were at significant risk of doing so. I welcome the fact that there is now a stronger regulator, the Pension Protection Fund and this kind of code, which is constantly being revised and updated.
However, I stress that I agree wholeheartedly with the comments of the noble Lord, Lord Davies, that this particular document, like previous documents, is rather too prescriptive, with excessive requirements placed on trustees, who may or may not need them. It seems to attribute spurious accuracy to an inherently uncertain outcome of events. The kind of box-ticking and groupthink approach that needs to be revised within 15 months of each new valuation will be costly to the schemes, and it is not clear what value will be added if the long-term strategy is unchanged or not likely to change.
Some of the issues we are grappling with, in this code and in the defined benefit universe as a whole, are dependent on and the result of the exceptional period of quantitative easing introduced in 2009. It was deliberately designed to drive down government bond yields and, concomitantly, to clearly put a much greater inflation risk on liabilities. That is indeed what happened. Initially, assets did not keep up with liabilities, but the fears of ongoing falls in gilt yields over that subsequent period, as quantitative easing, gilt printing and the driving down of long-term bond yields continued, have made anyone involved in the defined benefit space rather nervous of what are called “non-matching assets”.
We had a reversal of conventional thinking about defined benefit pension schemes. They were supposed to invest to take risk and welcome risk placed judiciously. This thinking became: do not take risk or try to beat the gilt market, because the gilt market may beat you and increase your deficit. So a whole groupthink built up around the idea that defined benefit pension schemes should have as much as possible in so-called matching assets, because you want to match your liabilities. The fact is that, if you want good funding, you need to outperform your liabilities—just matching them is not sufficient—but I am not sure that that is reflected very much in the code for schemes that are not in healthy surplus.
I welcome the Minister’s comments on the fact that we are talking about estimated liabilities based on expected future values, relative to current mark-to-market actual values for the assets, and on whether the risks of attributing that spurious accuracy to the long-term liabilities have been sufficiently considered. In this regard I declare my interests: I work with some defined benefit pension schemes, and have done so in the past, to advise on investment strategy.
It seems to me that part of the thinking going through this defined benefit code is that it is better for all schemes to fail conventionally than for too many schemes to try to do unconventional things that might succeed but incur greater risk. I feel we need more scheme-specific flexibility there, and we need to consider the impact of quantitative tightening and how that will be different for the pension liabilities associated with these schemes.
I welcome the differentiation mentioned by the noble Baroness, Lady Drake, and the noble Lord, Lord Davies, between open and closed schemes. I urge the Government to consider going further in allowing and enabling open schemes to take advantage of investment opportunities from a diversified array of risk assets, even in circumstances where there is, perhaps, some nervousness about the sustainability of the employer.
There is concern about the stability of the gilt market, but there is also an inherent conflict between that desire for stability and the need for outperformance of liabilities that these schemes could be delivering. If capitalism is not at an end—one might argue that it is—then investing in assets of higher risk than government bonds or the supposedly safer assets should, on aggregate and in the long run, deliver better returns. On top of that, we have a Government who rightly want to use more pension assets to boost the economy. There are assets such as infrastructure, small growth companies and equities as a whole, both domestically and internationally, that could deliver that objective, but they entail risk. That is where I hope the funding code may be further refined.
Baroness McIntosh of Pickering (Con)
My Lords, I was not intending to speak because this is way out of my comfort zone, but I congratulate the noble Lord, Lord Davies of Brixton, on securing this debate. I spent a year in opposition as a shadow Minister trying to encourage women in particular to enter into a pension scheme. This is a classic example of how fiendishly complicated UK pensions are.
I have a number of questions for the Minister, who is quite an expert in this field having shadowed it for a number of years. I welcome her to her place in this Administration. The Secondary Legislation Scrutiny Committee says in its second report that it remains concerned about the cumulative burden of so much regulation on the schemes. While the Explanatory Memorandum states that there were two waves of consultation, it is still not entirely clear how much support for and understanding of the scheme there is.
However, my main concerns relate to paragraphs 9.3 and 9.4 of the Explanatory Memorandum, which cover the impact assessment and the schemes’ mind-boggling costs. Paragraph 9.3 states:
“Initial implementation costs, including familiarisation, could total around £36.8 million in the first year”
alone; I am not surprised, given how complicated it is. It goes on to say:
“Schemes may then face ongoing administration costs of £5.4 million per annum”.
However, paragraph 9.4 states that there will be
“an estimated increase of around £7.1 billion to around 1200 schemes over the 10-year period”.
Will there be any sort of watch to see whether those figures are final—or, indeed, whether there may be some liquidity in them? They might not represent the final cost going forward but they are eye-watering. It is right to update the code but, in view of the figures, have the Government reached a verdict on what the cumulative burden on the schemes will actually be?
Lord Palmer of Childs Hill (LD)
My Lords, I thank the noble Lord, Lord Davies. Indeed, I thank all the speakers for the expertise gathered in this Room on what is an unlikely subject for many people.
On the DB funding code, first, with all the expertise that has been expressed—and for those reading Hansard who have no expertise—perhaps I ought to say something basic. For the record, what is a defined benefit pension? It is a type of workplace pension that guarantees you a specific income for life throughout retirement. The amount that it pays out depends on things such as your final salary, your average salary and how long you have been a member of your employer’s scheme. I know that everyone in the Room knows that, but people outside it may not.
The DB code has been many years in the making, as the noble Lord, Lord Davies, said. It sets out in detail how defined benefit pension schemes will have to approach funding in future, including things such as how quickly they must deal with any deficit that may arise. The code was arguably written in an era of deficits, whereas the majority of DB schemes are now in surplus, but I agree that you still need a set of rules for those schemes that are short of funds.
Despite all the worthy speeches, most of the code is uncontroversial, in my view, and has my general support. The response from the industry has been broadly positive; it appears to give trustees and scheme sponsors flexibility while ensuring that they carry out proper risk management as it relates to their pension products. Numerous articles have been written on it; given the length of this debate, I will not go into them in any great detail, but I highlight an article entitled “PwC Comments on The Pensions Regulator’s New Defined Benefit Funding Code of Practice” and an article in Pensions Age Magazine headed “Industry expresses ‘relief’ as TPR confirms final DB Funding Code”. So the industry and commentators have been complimentary in general terms.
However, I wish to raise some issues on which I would appreciate the Minister’s views. First, how far does the code truly accommodate the needs of remaining open DB schemes? This was a big topic of debate in the Lords during the passage of the Pension Schemes Act 2021. Does it allow them to take an appropriate level of investment risk for the long term, rather than having to go for lower-risk assets prematurely? This simply means that they cost more to run, as the noble Baroness, Lady Altmann, said in another way.
Secondly, how far does the code recognise the particular position of charities and other not-for-profit sponsors of pension schemes? Is there a risk of charities being forced to close deficits too quickly and, therefore, having to divert a loss of revenue income into the pension scheme? There would then be a risk of it appearing to donors to those charities that their money is not being used for front-line charitable purposes, thereby weakening the charities’ futures. I would appreciate the Minister’s comments on that.
Finally, I am sure the Minister has read the blog by David Fairs, who worked at the Pensions Regulator. It was headed: “At long last, new regulations fire the starting gun for the new funding regime”. He stresses the challenges and opportunities missed. He queries—and he is an expert—whether the new funding code will make a significant difference. I ask the Minister the same question.
Viscount Younger of Leckie (Con)
My Lords, I thank the noble Lord, Lord Davies, for giving us the opportunity to have the first pensions debate in this House since the general election. This Committee is my first experience of swapping sides with the Minister, and it gives me the opportunity to wish her well in her role with all its responsibilities, with which I am all too familiar.
This debate on the defined benefit code of practice is interesting in that, as has been said, it is not an SI but arises out of one in the form of delegated powers from the Occupational Pension Schemes (Funding and Investment Strategy and Amendment) Regulations 2024. It seems that every decade or so there is a requirement for a code update: there was one in 2006, leading to the current version in 2014, and now in 2024 we are debating another code of practice—number four, I believe. Updates are based on the premise that the pensions landscape changes, and of course it does, as now with the need for scrutiny of liabilities in DB schemes, the plethora of closed and maturing schemes and the need to ensure risk management, greater robustness over the longer term and optimum management of open schemes, which have been alluded to in this debate.
Ensuring that pension schemes are well managed is essential in safeguarding the incomes and welfare of pensioners. This is especially important at a time when the cost of living is high and the Government are restricting the financial support available to pensioners—more of which later. I welcome the publication of this code and its stated aim of helping trustees comply with their responsibilities under the defined benefit pension funding requirements. The focus is necessarily on supportable risk and ensuring that trustees and sponsoring employers are not caught unawares and plan well ahead, in particular where schemes are nearing maturity.
The work on the code was undertaken by the regulator under the previous Government, and I am pleased that the consultation on the code—there have actually been several, as the noble Lord, Lord Davies, and others alluded to—has been widely accepted by a broad range of stakeholders. I note that where there were concerns, such as on the need for flexible risk-taking at low dependency and not a one-size-catch-all approach, they were largely addressed and accepted in discussions with the industry.
I have listened with interest to the technical points raised by a number of noble Lords, in particular the noble Lord, Lord Davies, and I know that these points will be addressed—I say this with some relief—by the Minister. By his own admission, the noble Lord, Lord Davies, repeated some of the points made in the debate in March, such as about so-called box-ticking and the code being too prescriptive. In March he also mentioned his concern about the regulator misunderstanding its role, although I am not sure he alluded to that today.
My first question to the Minister leads on from this. It is simply: is the job done? Is the code an iterative process because we do not want another 10-year wait, or do we just accept that this is bringing it up to date and that, in effect, we wait for eight or 10 years? It does not particularly matter, I suppose.
I have some questions of my own on the code. The best-practice management of pension schemes is dependent on the effectiveness of trustees. How does the Minister regard the current landscape for recruiting trustees? There is a danger that too much guidance and steer towards adherence to codes, with the greater responsibilities attached, could act as a chilling factor.
What is her assessment about the training of trustees? This question plays into other questions, not least those of the noble Lord, Lord Davies, and the noble Baroness, Lady Drake, who quite rightly alluded to the important relationship between employers and their covenants, as well as the trustees. Who undertakes this training? This is important in assisting the chairs of trustees and, of course, the supporting employers.
The Parliamentary Under-Secretary of State, Department for Work and Pensions (Baroness Sherlock) (Lab)
My Lords, I thank my noble friend Lord Davies for securing and opening this debate and all noble Lords for their thoughtful and constructive contributions. I say to my opposite number, the noble Viscount, that it is easier asking questions than answering them in this space, so I hope that noble Lords will bear with me. More questions were asked today than I can conceivably answer in the time I have, but I will do my best to get through them. I assure noble Lords that we will carefully scrutinise Hansard and write to them with the answers to any questions that I cannot pick up.
First, by way of background, as my noble friend noted, earlier this year the House approved the Occupational Pension Schemes (Funding and Investment Strategy and Amendment) Regulations 2024. It is worth remembering that, alongside those regulations, the code of practice we are discussing is a key component of the new arrangements for the funding of DB occupational pension schemes. I am grateful to the noble Lord, Lord Palmer, for explaining what a DB scheme is to those watching at home. I hope that those watching at home who have never heard of a DB pension scheme are enjoying themselves, and I encourage them to read Hansard afterwards.
The code is designed to provide practical guidance for trustees and employers to meet their legal obligations, and it includes key metrics needed to implement the requirements. We moved very quickly to lay the code in the new Parliament to give schemes and industry the certainty they have been calling for. It may not be noticed from reading the debate that in fact the code has been well received. A lot of consultation has gone on.
The new scheme is designed to ensure the security and sustainability of DB pensions. Let us not forget the reason we needed to act at all: the damage done by schemes that were not appropriately run and the ensuing loss of benefits to members. Not taking action was not an option. These reforms strengthen the funding regime by providing clearer, more enforceable funding standards with a greater focus on long-term planning.
My noble friend Lord Davies noted that we have published two consultations on the code. The first, in 2020, considered the key principles to underpin the new regime and the proposed regulatory approach. The second was a consultation on the first draft of the code that we are debating today. DWP and the regulator worked collaboratively with and listened to a wide range of stakeholders. As a result, changes have been made to the code to provide more flexibility. For example, the regulator developed a chapter specifically for open schemes. When the code was published in July, it was welcomed for providing clarity and achieving a flexible approach. There is broad consensus that the code strikes the right balance between member security and employer affordability. Crucially, it provides sufficient scheme-specific flexibility to take account of the very wide range of scheme circumstances. I thank the noble Lord, Lord Palmer, for his support and the noble Viscount, Lord Younger, for the acknowledgment. Broadly speaking, we are looking at detail, but we think we are doing the right thing in the right way.
The new framework, including the code, has been revised following extensive engagement with industry to ensure that it provides flexibility for schemes to invest in a wide range of asset classes, including growth assets, both before and after significant maturity. Open schemes, like others, will have significant flexibility to invest in riskier investments with potentially higher returns, if the risk can be supported, so member benefits are protected. It also makes clear that the open schemes will not be made to derisk as long as they remain open to new members, are not maturing and the risk they are taking is supported by the employer covenant.
I will try to go through as many of noble Lords’ questions as I can. First, the phrase box-ticking has been used once or twice. I reassure noble Lords that this regime is absolutely not a box-ticking exercise. The regulator is taking the opportunity provided by the introduction of the new regime to evolve the way it regulates DB funding. This includes proportionate measures with flexibility for different schemes. The regime will be based on clear metrics designed to protect members’ benefits as well as to take account of employer affordability.
The Pensions Regulator operates on a risk-based and outcome-focused approach. We think that that proportionality is in the right space. The regulator is introducing a twin-track approach: fast-track and bespoke. This aims to help target its engagements with the sector effectively. Where a scheme meets a series of fast-track parameters, the regulator will ask for less information and is less likely to engage with trustees. On the other hand, the bespoke route allows schemes to take a different approach and to provide evidence of why this is appropriate. Many of them are unlikely to require further engagement between the regulator and trustees.
My noble friend Lord Davies asked about the use of scheme surplus. I remind the Committee that, in February, the options for defined benefit schemes consultation sought views on the potential benefits of introducing additional flexibilities for the use of surplus funding on DB pensions schemes. The Government will continue to consider the potential of such flexibilities to benefit scheme members and sponsoring employers while supporting economic growth.
The noble Viscount, Lord Younger, asked about low dependency investment allocation. The flexibility of the UK’s funding regime is one of its greatest assets and one that we have been careful not to undermine in the new arrangements. Pension schemes are many and varied and each has its own circumstances, so they are best managed through scheme-specific arrangements. That is why we try to balance clear metrics on how liabilities have to be calculated with scheme-specific flexibilities that allow trustees the discretion to react to changing circumstances and act in the best interests of their members while strengthening the ability of the regulator to intervene and act if things go wrong. Noble Lords may have other views. We believe that this balance is right and in the interests of members of schemes.
There was a question about whether trustees have the flexibility to take decisions in the light of the circumstances of their individual schemes. Flexibility is a key strength of the regime, but it is balanced with those funding standards and the key metrics of the new arrangements. The bottom line is that it is fine to take supportable risk. Taking investment risk to benefit from potentially higher returns is fine if there is enough time for asset values to recover or a sponsor with enough resources to pay more in the future. That is why the new regime focuses on the key metrics of maturity and covenant strength.
The noble Baronesses, Lady McIntosh and Lady Altmann, raised costs to scheme members. It is worth putting those absolute costs in the context of the scale of our pensions world. The impact assessment for the code indicates that costs will amount to around £7,000 per scheme on average, with ongoing administrative costs of approximately £1,100 on average per scheme. That excludes costs associated with changes in deficit repair contribution payments, of course. Those are small costs compared to the overall liabilities of a scheme. They are unlikely to have a significant impact, and certainly not on members. Most schemes are closed, and members of those schemes will not be paying contributions. Modestly increased costs are unlikely to have any impact on the probability of members’ benefits being paid in full. There are some members in schemes which share costs and are still open for accrual, but they are the minority. Only 4% of schemes are fully open; 20% are closed to new members. As the costs per scheme are estimated to be low, we do not anticipate any significant material impact on members overall. This must be seen in the context of the impact of clearer funding arrangements with more emphasis on long-term planning, which should make members more confident that their benefits will be paid in full.
We were asked what will be done to monitor the costs. We will continue to monitor the costs. Although there is some uncertainty about trustee behaviour and response, as we cannot know that, the impact assessment used data from March 2022 and modelled, on average, an overall net saving of around £20 million per year. I can write with more detail if Members would like that.
It is worth understanding that the regulations and code are principle-based. The code is practical guidance for implementing the regulations.
The noble Lord, Lord Davies, asked about different valuation methods. I will not get into TAS but will write to him on how TAS interacts. However, I have a word for the broader audience watching from home about the different valuation methods. There are two main ones. The technical provisions are, rightly, used to assess contributions and deficit recovery contributions because they are calibrated to balance member security with employer affordability. On the other hand, the solvency measure is much more generic and less scheme-specific. It is used to assess funding against the cost of insurance buyout. That is a much stronger measure. Schemes are not required to be funded to that level because that would make DB much more expensive, if not unsustainable. The use of these technical measures does not push schemes into inappropriate de-risking or into a risk-adverse approach. Schemes can choose a variety of approaches to setting their liabilities, including by reference to the investments that they intend to hold. They will be affected by a whole range of considerations, not least the route to compliance with TPR that they choose to use.
The new regime is extremely scheme-specific and flexible. Even at significant maturity, schemes can invest in a proportion of return-seeking assets provided that the risk can be supported. Most schemes are currently investing more prudently than the new regime requires. Indeed, the regime suggests that there is headroom for some schemes to take more investment risk than they are taking currently, of which I am sure the noble Baroness, Lady Altmann, will be very conscious. The requirement in this to derisk will, as intended, mostly impact outliers which have been pushing the scheme-specific flexibilities further than they were ever expected to stretch and, in doing so, putting members’ benefits at risk. It is right that those outliers should be required to derisk to protect members’ benefits through the clearer and more enforceable metrics of the revised regime.
Lord Davies of Brixton (Lab)
I thank the Minister for her long and detailed response. I think I need to use the formula used by Ministers: “I will read the entry in Hansard”. There was so much information in it, for which I thank her. I also thank noble Lords who came for the debate on Russian sanctions; I hope they found it informative to hear about pensions.
The phrase that had particular resonance with me was that used by the noble Baroness, Lady Altmann: “spurious accuracy”. When I was a trainee actuary, we were told specifically that making calculations more complex and difficult did not make them any better. Trying to forecast the future is difficult enough. Making complex calculations does not improve the outcome for members.
My major point is that current developments in pensions will require the code to be kept under review in any event, whether they are an increasing appreciation of the risks of climate change or the development of pension scheme surpluses. I welcome the remark about that. These changes accumulate and I hope that the Minister will enjoy further debates and discussions. I look forward, in particular, to the pensions Bill. Not many people say that, but I think we will have some interesting debates.
Motion agreed.
Russia (Sanctions) (EU Exit) (Amendment) (No. 4) Regulations 2024
(1 month ago)
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Baroness Chapman of Darlington
That the Grand Committee do consider the Russia (Sanctions) (EU Exit) (Amendment) (No. 4) Regulations 2024.
Relevant document: 3rd Report from the Secondary Legislation Scrutiny Committee
The Parliamentary Under-Secretary of State, Foreign, Commonwealth and Development Office (Baroness Chapman of Darlington) (Lab)
My Lords, these regulations amend the Russia (Sanctions) (EU Exit) Regulations 2019. This instrument was laid on 5 September under powers in the Sanctions and Anti-Money Laundering Act 2018, and the measures in it entered into force on 6 September as “made affirmative” measures.
In recent years, the UK has transformed its use of sanctions. We have deployed them in innovative and impactful ways, including in our response to Russia’s invasion of Ukraine. This includes our prohibitions on the legal sector. We take a rigorous approach that is carefully targeted to deter and disrupt malign behaviour, as well as to demonstrate our defence of international norms.
In June 2023, a prohibition on legal advisory services, Regulation 54D, was introduced to prevent UK lawyers providing their services to those seeking to continue trading with Russia in goods or services that the UK had sanctioned. This was a unique prohibition that sought to prevent access to our world-renowned legal services market while retaining and upholding the UK values of access to justice and representational advice. Once introduced, it became clear that the sanction had the unintended effect of preventing the legitimate provision of advice on non-UK sanctions compliance, for instance in advising companies on compliance with US or EU sanctions on Russia. A general licence was therefore rapidly implemented in August 2023 as a temporary fix to enable UK lawyers to continue to provide this advice.
This instrument provides the permanent solution and clarifies in legislation the kinds of legal advice that the Government intend UK lawyers to be able to continue to provide. For example, it ensures that advice can be given on compliance with non-UK sanctions, on Russian counter-sanctions and on global criminal law. Receiving this advice is paramount to the functioning of an effective international sanctions response to Russia.
In amending this legislation, a full and thorough review was undertaken, including engaging with esteemed stakeholders in the legal and financial sectors. This engagement has assured us that this amendment will ensure greater clarity for the sector and continue to support our robust and unwavering commitment to cutting off access to our world-leading legal sector from those wishing to advance the interests of Russia.
The review also highlighted a number of other areas for improvement, which have been reflected in this instrument. They include amending Regulation 54D to align more closely with the way the existing circumvention regulations work, creating greater parity between legal advisory services that can be provided to a UK person and a non-UK person. The amendment clarifies expressly that Regulation 54D covers activity outside the UK, meaning that it more clearly operates alongside the existing circumvention regulations and avoids overlapping offences.
We have worked with the sector to ensure that the language in the instrument is as clear as possible regarding the provision of its services. By ensuring that legal advice can continue to be provided for the purposes of non-UK sanctions compliance, we enhance the effectiveness of the sanctions that the UK and our allies have placed on Russia and intensify the pressure on Putin. As well as ensuring that advice can be given on compliance with non-UK sanctions and on Russian countersanctions, we have ensured that advice can continue to be provided on compliance with global criminal law. By protecting the fundamental right to legal representation, we continue to distinguish ourselves from Putin’s oppressive regime.
Lord Purvis of Tweed (LD)
I am grateful for the Minister outlining in clear terms the Government’s position on the wider aspects of the sanctions enforcements. I support this measure. I spoke on the previous regulations on 19 July 2023, when I raised the issue that the Law Society had brought to our attention. It has subsequently had follow-up communications saying that this permanent solution is preferable, and I therefore support it.
I will raise a separate issue that the noble Lord, Lord Alton, spoke to me about—I think he spoke to the Minister prior to the Committee—concerning shipping insurance. I checked Hansard and, on 1 February 2022, I raised a question about this in a debate on one of our early Russia sanctions. The Minister’s colleague, the noble Lord, Lord Collins, heard us raise the continuing concerns in Grand Committee last week. I understand that this has also been raised in a letter today from the right honourable Sir Iain Duncan Smith, the chair of the all-party group on Magnitsky sanctions and reparation, regarding the concerns of 12 vessels that it alleges are continuing to receive insurance via the UK. I hope the Minister might reply on this, although I do not necessarily expect her to give the Government’s response to a letter that was sent to the Foreign Secretary today. But we have an important debate in the Chamber on Friday, so an update from the Government, if possible—written to Members of the Committee and also placed in the Library—would be of assistance to us in our debate on Friday. With that, I support the Government’s moves on these sanctions.
Lord Callanan (Con)
My Lords, I too can be brief. These are of course updates and clarifications of sanctions introduced by the previous Government. We were grateful for the support of the Opposition then and, on behalf of the Opposition now, I offer my full support for the changes that the Minister announced. It is important that we maintain the principle of unity across the parties in support of these sanctions and of Ukraine, taking action wherever possible to restrict Russia and its activities across the world. We need to be mindful of the big role that the City of London plays across the world in legal, financial and professional services. Some UK companies are undoubtedly involved in helping the Russians to circumvent these sanctions. We fully support the strictest clampdown on these activities. We should be very proud of these industries, but they should be used for right, not for helping Russia in this regard.
Following the noble Lord, Lord Purvis, I offer my support for the letter from Sir Iain Duncan Smith to the Foreign Secretary. We support these sanctions but ask the Government to look again at what more can be done to clamp down on the shadow fleet of tankers that Russia is using to spread its oil and gas around the world. As the noble Lord said, I do not expect the Minister to reply now to a letter that was sent only today and probably has not been received yet, but I hope that the Government can bear this in mind and can possibly give us an answer on Friday. We fully support these sanctions.
Baroness Chapman of Darlington (Lab)
My Lords, I am grateful for the support of the noble Lords, Lord Purvis and Lord Callanan. I thank the noble Lord, Lord Purvis, in particular, for his ongoing—I will put it that way—interest in this issue. I very much welcome the comments of the noble Lord, Lord Callanan, on how vital it is that we keep our unity on these issues intact as we move forward. I am grateful and pleased that this is what we have seen today.
On the specific issue about the natural gas tankers, I am grateful to both noble Lords for their forbearance, as I do not have a full response on this today. The insurance is a complex issue. I will endeavour to get a fuller response by Friday. That is not a guarantee but, if I cannot get it by Friday, we will make sure that there is a response to the letter from Mr Duncan Smith.
I will do what I believe is called a pivot, to liquified natural gas more generally. I point out—because it is quite interesting and helpful, although it does not address the issue of insurance head-on—that Novatek, Russia’s largest producer of LNG, suspended production at its flagship Arctic project in April 2024 because of sanctions and a shortage of specialist tankers. This project is critical to Russia’s ambition to triple LNG production by the end of the decade, so we are taking measures that are having some effect on LNG. However, I will come back to noble Lords on the wider issue of insurance.
Iran (Sanctions) (Amendment) Regulations 2024
(1 month ago)
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Baroness Chapman of Darlington
That the Grand Committee do consider the Iran (Sanctions) (Amendment) Regulations 2024.
The Parliamentary Under-Secretary of State, Foreign, Commonwealth and Development Office (Baroness Chapman of Darlington) (Lab)
My Lords, these regulations amend the Iran (Sanctions) Regulations 2023. The instrument was laid before Parliament on 12 September under powers contained in the Sanctions and Anti-Money Laundering Act 2018. The measures entered into force the following day.
The UK has transformed its use of sanctions. We have deployed sanctions in innovative and impactful ways, including in our response to the threat from the Iranian regime. This instrument contains measures to deter the Government of Iran from causing regional and international instability by disrupting their unmanned aerial vehicles—UAVs—and missile industries, and their access to items critical to military development.
The Iranian regime’s development and proliferation of large volumes of advanced conventional weapons, including UAVs and missiles, continues to destabilise the Middle East and prolong Russia’s illegal war in Ukraine. Iran’s use of an unprecedented number of UAVs and missiles during its attack on Israel on 13 April 2024 demonstrated how Iranian weapons development and proliferation is fuelling conflict in the Middle East. The Iranian regime also used hundreds of these arms in its attack on Israel on 1 October, which we condemn in the strongest terms. This attack once more endangered the lives of innocent civilians and escalated an already incredibly dangerous situation. It cannot be tolerated.
In response to Iran’s attack on Israel on 1 October, the UK has designated nine individuals and entities involved in facilitating Iran’s destabilising activity. These include senior military figures and the Iranian Space Agency, which develops technologies that have applications in ballistic missile development. We are deeply concerned about the prospect of further escalation. All efforts must now be on breaking the cycle of violence. At this moment, when tensions are at a peak, calmer heads must prevail. All sides must take immediate steps to de-escalate. A regional war is in no one’s interest.
This is the latest in a long history of Iran destabilising the region, including through its political, financial and military support for its proxies and partners, such as Hezbollah, Hamas, the Houthis and aligned militia groups in Iraq and Syria. We have been clear that Iran must cease this support.
Iran is now one of Russia’s top military backers; it has supplied Russia with hundreds of UAVs since 2022. Russia has used these to target Ukraine’s critical infrastructure and kill innocent civilians, prolonging the suffering of the Ukrainian people. In September, Iran also supplied Russia with hundreds of close-range ballistic missiles. This is a further escalation of Iran’s military support to Russia’s war of aggression against Ukraine and will further enable Russia’s invasion. In return, Iran is receiving Russian military and technological support, enabling it to further develop its military capabilities and enhancing the risk that it poses to the region and beyond.
This legislation expands the UK’s trade sanctions against Iran with the aim of disrupting its UAV and missile industry, as well as its access to items critical to military development. It includes sanctions in relation to items on the Russia common high-priority list. This list was jointly agreed by the UK, the EU, the US and Japan in the context of Russia’s war against Ukraine. It identifies items that Russia is using in its weapons systems, ranging from semiconductors to machine tools.
These items are also significant in Iran’s production of advanced conventional weapons. As the Committee will know, there have been many public reports about Iran’s supply of weapons to Russia. We are therefore prohibiting the export, supply, delivery and making available of these items to Iran through the measures in this instrument. We are also prohibiting the provision of ancillary services associated with the goods, such as brokering services, technical assistance, financial services and funds.
All of the items prohibited by the EU in May have been prohibited by this instrument. In addition, prohibitions will also be applied to some items identified by the Ministry of Defence as significant to Iran’s UAV and missile industries. These trade restrictions complement our existing export controls and sanctions, ensuring that no UK business or person, wherever they are in the world, can facilitate the export, transfer, supply, delivery or making available of these items to Iran without the appropriate licence.
Finally, this Government are committed to enforcement. It is right that we ensure that we have the necessary powers, tools and capacity to implement and enforce our sanctions regimes effectively. That is why, on 10 October, we launched the Office of Trade Sanctions Implementation, with enhanced civil enforcement powers, in order to maximise the impact of the UK’s trade sanctions against Russia. These powers include the abilities to issue civil monetary penalties for breaches and to make details of breaches public. There are also new reporting requirements on sectors well positioned to find evidence of trade sanctions breaches.
To conclude, these new regulations will increase the pressure on Iran’s defence industry. They will disrupt Iran’s production of UAVs and missiles that could be supplied to its proxies in the Middle East or to Russia. We will continue to work with like-minded partners to disrupt, deter and respond to threats from the Iranian regime and to co-ordinate sanctions action. These regulations send a clear message to the Government of Iran and those seeking to harm the UK’s security, as well as that of our partners: we will not stand idle in the face of this aggression. I beg to move.
Lord Polak (Con)
My Lords, I totally support these regulations and agree with every word that the Minister has just spoken. The Iran regime is the problem, not the Iranian people. I remind the Committee that two Members of your Lordships’ House are proscribed by the Iranians: me and the noble Lord, Lord Alton, to whom the Minister referred.
Lord Purvis of Tweed (LD)
My Lords, I thank the Minister for outlining these measures, which I support. I will make an appeal and ask two specific questions, on which I would be very happy if she writes to me rather than responding today.
I agree with everything the Minister said about the role of Iran in the Middle East and its relationship with Russia. My appeal is that we broaden our interests to include Sudan. We know that many of the drones in Sudan have been sourced from Iran. It is the world’s biggest humanitarian crisis at the moment. External actors are providing munitions despite there being no justification at all for any external munitions to be used on civilians in Sudan. I would be grateful if the Minister could write to me with the Government’s assessment of what is currently being used in the conflict in Sudan from external sources, specifically with regard to Iran.
I turn to my questions. First, I absolutely support the prohibition on equipment, but I noticed—if I read the measures correctly—an exemption for the personal property of someone travelling. Does that include designs? Do His Majesty’s Government have any concerns about UK interest in the design of these munitions, not just the provision of equipment to manufacture them? Again, I do not necessarily expect the Minister to outline that today.
Secondly, on the provision or export of goods to third countries that relay trade to Iran, I hope the Government have a response to what could be a particularly easy circumvention of these measures if our trade is with a broker country. We know that much of the equipment being used has multiple components from many sources; I would be grateful if the Government have a response on that. Notwithstanding those questions, I support these measures.
Lord Callanan (Con)
I thank the Minister for her kind introduction to this subject. We also fully support these regulations on drones, broader drone technology, financial services, funds and brokering services related to other items of strategic concern; of course, they are one piece of a much larger jigsaw. The Minister commented on the impact of Iran in our previous debate on Russian aggression in Ukraine.
Both the other noble Lords who have spoken outlined graphically how actively and malevolently Iran is undermining the international order through its support for Hamas, Hezbollah and the Houthis. While it is tempting to think that these are faraway conflicts, any action by the Houthis in the Gulf has the potential to undermine international shipments of oil, gas and other important commodities, which can affect the economy and well-being of this country. Therefore, it is right that we are targeting further the Iranian regime. We fully support these sanctions.
I lend my support to the point made by my noble friend on the proscription of the IRGC. It is strange that so many Conservative Ministers and MPs were in favour of proscription but never managed to get it through the Foreign Office bureaucracy and now so many Labour Ministers and MP who were previously in favour of proscriptions also do not manage to get it through the FCDO bureaucracy. It makes you wonder whether “Yes Minister” was a commentary or a documentary indicating the true state of affairs with the standing bureaucracy in this country. I know that this is difficult, but political will must win over bureaucratic will. I hope that the Minister can influence the Foreign Secretary to return to his previous views and hers and those of her ministerial colleagues and finally proscribe the IRGC. That would meet with widespread support across both Houses of Parliament and from me and many of my noble friends.
We support the sanctions and hope that the Government have success in implementing them.
Baroness Chapman of Darlington (Lab)
My Lords, I again thank noble Lords for their contributions and support for these measures.
On the IRGC, I note the comments of the noble Lord, Lord Callanan, about the frustrations of political life and government. That is all I will say on that line of inquiry. We have already sanctioned the IRGC in its entirety. The separate list of terrorist organisation proscriptions is, as noble Lords know, kept actively under review. We do not routinely comment on whether an organisation is or is not under consideration for proscription. I will leave that there for today.
The noble Lord, Lord Purvis, makes an important point on Sudan. I will write to him about Sudan, but I point out that when sanctions are applied to Iran, they will affect Iran’s ability to supply Sudan as much as it would Russia. That will be the intention. On the issue of personal property, we have in minds such things as laptops, phones and other personal items. It would be restricted to that. It is right to flag this issue, and we are aware of it, but we felt it was important to include it.
This will apply to UK entities and individuals overseas and anyone who is in the UK. It will not apply any more widely than that. This is how the UK organises its sanctions, as the noble Lord knows. I know that he has long had a very keen interest in the issue of secondary sanctions and how we might engage with them. That is the situation as embodied in these regulations and with regard to the UK’s policy towards sanctions more generally. If I have missed a point there, which I think I may have done, the noble Lord must feel free to come back and help me out.
Lord Purvis of Tweed (LD)
It might be my ignorance about how this operates, as it may well be covered elsewhere. I understand that there will be a prohibition on exporting this equipment, but I am not sure that any of it has end-use certificate requirements. Therefore, how will we know if we are sending it to another country which then immediately ships it to Iran? How is that covered?
Baroness Chapman of Darlington (Lab)
I will hopefully improve my note-taking as we go on with this. Brokers would be specifically in breach of sanctions were they to facilitate or knowingly support in any way something ending up with Iran. I hope that helps the noble Lord. If he needs any further information, I would be happy to speak to him about it.
These measures represent a step forward in our capability to restrict Iran’s proliferation of advanced conventional weapons, which continue to fuel conflict in the Middle East and support Russia in its illegal war in Ukraine. The UK Government are firmly committed to using sanctions to hold the Iranian regime to account for its malign activities in the UK and elsewhere. I beg to move.