Chancellor pushes RPI reform out to 2030

26 November 2020

The Government and the UK Statistics Authority (UKSA) have confirmed that the Retail Prices Index (RPI) will be aligned with the Consumer Prices Index including owner occupiers’ housing costs (CPIH) in February 2030. The announcement takes the form of a response to the joint public consultation by the Government and UKSA earlier this year, on reform to the RPI. The change would see RPI continue to be published as an index but bring the methods and data of CPIH into RPI.
What is the timing?
A critical aspect of the response relates to the timing of the switch. The Chancellor’s consent is required for any change to RPI that would be “materially detrimental”, as determined by the Bank of England, to holders of certain index-linked gilts referencing RPI (“relevant gilts”) until the last of these gilts reaches maturity, which is in 2030. The Chancellor has declined to consent to an earlier switch, in order to minimise the impact of the change on holders of index-linked gilts generally. 
However, the UKSA has confirmed with the Bank of England that it need not wait until redemption of the last “relevant gilts” in July 2030 before making the change, as the last RPI data used in calculating the coupon for those gilts will refer to November 2029. On this basis, the UKSA will implement the changes in February 2030.
Will there be any compensation for index-linked gilt holders?
CPIH is historically lower than RPI by, on average, one percentage point per annum1.

Whilst many respondents called for the Government to mitigate the impact of the reform through compensation, the Government has confirmed that it will not offer compensation to the holders of index-linked gilts. The response notes that the contractual terms of index-linked gilts state that RPI is to be used to calculate interest and redemption payments, and that will not change. There will, however, be an adverse economic impact on holders of index-linked gilts. This is a factor in not introducing the change before 2030, in order to minimise the impact as compared with an earlier date.

The Government’s response recognises the impact of the reform of RPI on defined benefit (DB) pension schemes and members’ benefits, as members with RPI-linked DB pensions will face a reduction in their benefits over their lifetime. On this point, the Government response is, however, limited to stating that it “keeps the occupational pensions system under review and will continue to do so”.
How will the reform be implemented?
The UKSA aspects of the consultation focused on the statistical robustness of the proposed approach to bringing CPIH methods and data sources into RPI. Following the consultation, the UKSA has concluded that its preferred statistical method to achieve this, as set out in the consultation, is appropriate. 
It has also confirmed that it will discontinue supplementary and lower level indices of RPI, including RPIX, at the point of implementation of the proposal, i.e. in February 2030, and sets out guidance identifying CPIH measures that could be used in place of lower level or supplementary RPI measures.
What to do now?

A broad range of contracts in the financial markets, as well as the property and infrastructure sectors, reference RPI. In the pensions sector, a number of pensions schemes have, as part of their liability driven investment strategies, entered into long-dated RPI swaps. With the road to reform now clear, it is time to take stock of RPI-linked assets and liabilities.

In the financial markets context, consideration should be given to whether any applicable terms in bond issues, derivatives or other financial instruments may be triggered either by the announcement of the change, or when it actually takes place in 2030, and the impact on any associated hedging transactions. This will include, in the derivatives context, consideration of the ISDA Inflation Derivatives Definitions where applicable, as well as any bespoke contractual terms that may apply.

As RPI will continue to be published, any terms that relate to cessation of publication of the index do not appear applicable (unless the financial instrument relates to one of the supplementary or lower level indices of RPI). As regards material modification of the index, terms may provide for the index to be adjusted for the purposes of the financial instrument in the same way as a reference gilt or bond is adjusted. However, it appears that the Government does not intend to make any such adjustments to existing index-linked gilt issues in light of the changes to RPI.

So it will be important to analyse applicable terms in financial instruments maturing later than February 2030, to see whether they will apply to the change in RPI. Consideration also needs to be given to the terms of any new financial instruments that will reference RPI, and that will have a maturity beyond that point in time.
1A Consultation on the Reform to Retail Prices Index Methodology, paragraph 46.