The results of a referendum on EU membership would have serious implications for UK pension schemes, Natasha Browne hears
- A UK exit from the EU would have implications for investments and regulation
- Questions would arise over whether or not to repeal EU legislation
- The Bank of England may have prop up the UK gilt market
The result of the UK general election soothed concerns about political instability after the Conservatives took an unexpected majority. But it brought about another big unknown for the UK economy.
The Conservatives pledged to have an in/out referendum on EU membership by 2017 and the party is set to stick to its promise. The potential consequences of a UK exit - or Brexit - are twofold for domestic pension schemes.
A break from the block would affect the UK gilt and equity markets. There are worries that it would drive foreign direct investment (FDI) out of the country. Figures from Columbia Threadneedle Investments show defined benefit (DB) schemes have an average 18% weighting to UK equities and 36% weighting to fixed income.
But there are also major legal implications to consider. Since it joined the EU in 1973, the UK's domestic pensions legislation has been steered heavily by laws approved by the European Parliament. A Brexit could see the UK repeal laws initiated by Europe.
Herbert Smith Freehills (HSF) professional support lawyer Naveed Soomro highlights the significance of the Equality Act 2010. This aims to enshrine measures in EU law that prohibit discrimination on grounds including sex, race, age and sexual orientation.
He adds: "If the UK were to exit the EU we would no longer be subject to this EU legislation and that then begs the question, how is the UK going to react? Is it going to amend UK legislation retrospectively, which is very unlikely because it's so entrenched in UK law now. Pension schemes have taken action to comply with it.
"But also, would they change the legislation prospectively? That could have all kinds of implications."
The EU accounts for 46% of British exports and 53% of imports. Hermes Fund Managers chief economist Neil Williams says the UK is unlikely to want to distance itself from its main trading partner and that a Brexit risks weakening the relationship with the US. Uncertainty around the outcome of an election would also weaken the pound.
Williams says: "Initially the inference that the UK's growth would be hit because of the loss of trade would probably suit long conventional gilts because it would also stall the Bank of England's attempt to raise interest rates.
"But when the dust settled, the question would be ‘who is going to mop up the gilts?' More than a third of UK gilts are held internationally by investors who will care about currency risk and who will care about credit ratings."
Williams thinks the Bank of England would have to step in. like it did after the 2008 financial crisis. He adds: "If there's anything like close to a buyer strike from international investors on gilts, then it's really looking to the Bank of England to again become the biggest single sponsor. But then how can the bank raise interest rates if at the same time, it's beginning to buy back gilts by offering cash?"
Columbia Threadneedle Investments head of pensions and investment education Chris Wagstaff highlights fears that Brexit would cause overseas financial institutions headquartered in the UK to relocate.
He says: "Many of these institutions act as the counterparty to UK scheme interest rate and inflation rate hedging swap trades. Whilst they would remain counterparties, the legal documentation would probably require renegotiation unless schemes start to move their swaps and other over-the-counter/bilateral derivatives positions away from the big banks, to derivative exchanges (i.e. central clearing)."
Still, those in favour of Brexit point out the UK would save a net contribution to the EU budget of £12bn per annum. They also see potential for Britain to renegotiate its trading relationship with the area.
Cicero Group executive director John Rowland says a Brexit would prompt a review of all the regulatory arrangements that have been set by Europe. And anything that changes regulation entails time and money. But there are also those who would welcome the removal of red tape they found burdensome.
But Rowland says: "For other financial products which are sold across borders - I'm not talking so much about pensions that don't operate across borders - UK companies would probably have to apply some equivalent form of regulation in order to be able to access the European market.
"Just because we were out of the EU doesn't mean we could ignore European regulation because it may be a condition that our regime would have to be equivalent to the European's in order to access that market."
A major area of contention for cross-border schemes is the full-funding requirement laid out by the draft Institutions for Occupational Retirement Provisions II Directive (IORP II). Critics previously suggested the rules could "kill off" DB schemes.
There are also questions about whether the compensation cap of approximately £32,000 the Pension Protection Fund (PPF) applies to most deferred members complies with a separate EU directive. It covers the protection of employees in the event of insolvency.
According to HSF's Soomro, there are a number of cases interpreting that requirement in terms of PPF compensation. He says: "If we were no longer subject to the EU directive, the UK would have a freer hand in what compensation to award members under the PPF."
Questions linger over whether or not court judgments led by EU decisions would continue as precedent in the UK. Still, Soomro says it would be very disruptive to make changes retrospectively.
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