Trustees of UK defined benefit (DB) schemes are being urged to look beyond short-term “gyrations” in pension deficits in the wake of the country’s vote to leave the EU and to focus on the latter’s impact on scheme sponsors.
UK government bond yields, which have an inverse relationship with bond prices, have plummeted due to high demand for Gilts in the days since the UK Brexit vote on Thursday caught financial markets, and many others, off guard.
In the immediate aftermath of the vote, a rush into Gilts on Friday morning caused the collective UK DB scheme deficit to balloon by £80bn (€96.3bn), to £900bn.
On Monday, according to consultancy Hymans Robertson, a further fall in Gilt yields – to record lows – pushed scheme liabilities to an all-time high of £2.3trn and the aggregate funding deficit to around £935bn.
This is the worst it has ever been, although deficits had already been plummeting before the referendum resulted in a Leave vote, noted the consultancy.
Yields on 10-year UK government bonds fell below 1% (to 0.93%) on Monday, 27 June, having dropped by 44 basis points following the referendum, according to Fitch Ratings.
Martin Jenkins, pensions partner at law firm Irwin Mitchell, said growing deficits would put more pressure on UK DB schemes and cause more to “seek help” from the Pension Protection Fund (PPF), the lifeboat vehicle for UK schemes.
However, trustees of UK DB schemes are being advised to avoid knee-jerk reactions to what is being seen as short-term volatility and to instead, as in the words of Adrian Kennett at Dalriada Trustees, “calmly assess [their] funding strategy”.
This will involve working with sponsors to assess the risks facing schemes, with an emphasis on the longer-term outlook for the real economy.
In a similar vein, Patrick Bloomfield, partner at Hymans Robertson, said that, although “the gyrations in UK pension deficits are eye-watering”, the primary consideration for funding decisions for UK DB schemes should be “the health of the sponsoring company post-Brexit”.
Trustees need to reassess the employer covenant for its strength or weakness, he said.
“Post-Brexit, some parts of the economy will look healthier than others,” said Bloomfield.
“Some sectors have taken a battering in stock markets, including financials, housebuilders and airlines. The outlook for companies with a UK market focus – in other words, those that won’t benefit from sterling weakness, and those that are reliant on importing raw materials – will have changed.”
The three major rating agencies – Moody’s, Standard & Poor’s and Fitch – have each taken negative actions on the UK’s credit rating for reasons including an expected weaker economy following the vote to leave the EU.
Moody’s changed the outlook on its rating of the UK to negative on Friday.
S&P downgraded its rating by two notches to AA from triple-A, while Fitch has cut its UK rating by one notch to AA.
The day after the referendum, Fitch Ratings said the vote to leave was “credit negative” for most sectors in the UK “due to weaker medium-term growth and investment prospects and uncertainty about future trade arrangements”.
The impact of the Brexit vote is likely to vary by sector, however, with the ratings agency noting that it would be “broadly negative” for UK banks and “mildly negative” for UK-focused corporates.
UK exporters could benefit, however.
“Transport, property and leisure companies will suffer to some degree, along with smaller non-food retailers,” it said.