DB Schemes Abolition of LIBOR and (possibly) RPI

24 / 02 / 2020

New Rules – Introduction

There is no shortage of challenges for trustees of defined benefit schemes and their sponsoring employers. In this article we consider two game changers, namely (1) the replacement of the London Interbank Offered Rate (“LIBOR“), and (2) the Government’s proposal to alter the calculation basis for the Retail Prices Index (“RPI“).

(1)     LIBOR

LIBOR is used in many different types of financial contracts and for many decades has been the leading benchmark for short-term interest rates. It serves as the primary indicator for the average interest rate at which leading banks may obtain short-term loans in the London interbank market, and is quoted in five major currencies – US dollar, euro, pound sterling, Japanese yen and Swiss franc.

In the world of pensions, LIBOR-linked contracts such as trustees’ derivative instruments, liability driven investment arrangements, buy-in/buy-out and longevity contracts often feature.

Why is LIBOR being discontinued?

Following the LIBOR ‘rigging’ sandal, and a consistent decline in the wholesale interbank lending market, there has been increasing pressure from international regulators to move away from LIBOR, with accelerated milestones in place for 2020.

Move to risk-free rates in place of LIBOR

As LIBOR is phased out across financial products it is being replaced predominantly by so-called “risk-free rates”, which are based on actual, underlying overnight money market transactions as opposed to forward-looking “forecast” term rates which underpin LIBOR. For sterling, the preferred risk-free rate is the Sterling Overnight Index Average, otherwise known as “SONIA”. Typically, SONIA rates will be lower than LIBOR rates as SONIA does not have built-in future risk or term premiums. Transitioning from LIBOR to SONIA means finding a methodology to equalise the economic effect between the parties – otherwise the switch is likely to involve winners and losers.

What should Trustee boards do?

Trustees should ensure that their appropriate professional advisers report on which of the trustees’ contracts are linked to LIBOR. Advisers should make recommendations to the trustees about how the transition from LIBOR to SONIA should be managed. In the case of commoditised derivatives governed by terms set by the International Swaps and Derivatives Association (“ISDA“), ISDA standard amending protocols can be used but for other contracts, bespoke contractual amendments will be required.

Investment consultants and/or actuaries may be adept at identifying LIBOR-linked contracts. Trustee boards should, however, seek specialist legal advice on new bespoke contract wording to accommodate the transition from LIBOR to SONIA. Wedlake Bell’s Banking Team are actively advising in this area, and participate in the Bank of England’s task force focusing on the replacement of LIBOR. Please see the Wedlake Bell’s Banking Team’s recent article “THE END OF LIBOR: CALL TO ACTION” (available as part of the Pensions Compass February 2020).  Please contact us if you need any advice in this area.

(2)   Is it RIP for RPI?


The Government’s Consultation on its proposed change to the Retail Prices Index (“RPI“) is due to be published on Budget Day, Wednesday 11 March 2020. RPI has been severely criticised and ceased to be an official National Statistic in 2013. Nonetheless, the Government continues to publish RPI as an index and there are a considerable number of RPI-linked gilts in issue.

Government proposal

The Government proposes to change the RPI calculation method so that, in effect, RPI will become more like CPIH (CPI with a housing component). This change would not be made until 2025 at the earliest.

The terms for gilts maturing after 2030 are set by the UK Statistics Authority and not by the Government. It seems likely that the UK Statistics Authority will in 2030 change the index for RPI-linked gilts maturing post-2030 to the new basis.

The Government has indicated that once it has considered the Consultation responses, it will take a final decision on its proposal later this year.

What is the impact on Schemes?

Actuaries are the experts here.

Broadly, asset values would decrease for schemes holding RPI-linked assets such as RPI-linked gilts. Conversely the value of member RPI-linked liabilities would decrease. However, the decrease in value of RPI-linked liabilities would not necessarily balance out the decrease in value of RPI-linked assets. Schemes with pension increases linked to CPI may still be holding RPI-linked gilts as there are so few bonds linked to CPI.

Trustees’ legal responsibilities

The Government’s proposals create major uncertainty. Trustee boards should take extra care where RPI is a component of their decision making, for example with regard to the valuation of member liabilities, management liability exercises and buy-in/buy-out contracts.

When making decisions trustees must ensure that they comply with the relevant legal requirements, including the requirement to obtain legal advice.

Switching from RPI to CPI

Some schemes with pension increases currently linked to RPI have been unable to link their pension increases to CPI instead, due to the wording of their scheme rules. If the changes to RPI proposed by the Government (from 2025 at the earliest) or by the UKSA (from 2030) come into force, this would remove the impetus for changes to the index from RPI to CPI, but at present there is no certainty about these changes or their timing.

The uncertainty may complicate current Court applications regarding RPI/CPI. Employers and Trustees considering changing from RPI to CPI should ensure that they obtain updated legal advice – the Wedlake Bell Pensions team has considerable practical experience in this area.

Latest RPI/CPI case

The proposed shift away from RPI may be somewhat galling for the trustees of the Britvic scheme. The case report in Britvic, heard in the High Court in January 2020, has recently been published. The Trustees persuaded the Court that the index for increases should continue to be capped RPI and that the Employer’s discretion under the Rules was limited to setting higher, and not lower rates of increase – the discretion being “or any other rate decided by the Principal Employer”, a surprising decision in our view.

So RIP for RPI it may be in the coming years, but not just yet. Meanwhile, it is still to be seen whether the courts will uphold arguments for amending scheme rules to replace RPI with CPI.