On 16 June, the Pensions Regulator updated its DB scheme funding and investment: COVID-19 guidance for trustees to reflect the Regulator’s evolving approach to issues such as requests to defer deficit contributions and monitoring employer covenants and in response to developments since the guidance was first published.
Since the original guidance issued in April, the Regulator has been monitoring how trustees and employers have reacted to the Covid-crisis and the uncertain economic climate. The guidance therefore provides an update of the impact of Covid-19, and how the Regulator is adapting its approach in light of this.
Suspending or reducing contributions
The evidence suggests that around 10% of schemes have agreed a temporary suspension or reduction of deficit repair contributions (DRCs) so far. However, the Regulator is aware that some schemes are still in discussions about possible deferrals and future requests are likely as more employers experience trading and liquidity issues. Extensions to existing suspensions may also be required.
In particular, the guidance notes that given the timing of the start of business restrictions and closures due to the pandemic, employer loan and banking covenant tests at 31 March 2020 are unlikely to have been adversely affected. However, 30 June 2020 and future covenant tests may be significantly impacted. This could result in funders seeking increased protections from employers and lead to further requests of trustees.
Therefore, the Regulator’s approach to DRCs remains largely the same with the Regulator continuing to recognise that “DRC suspensions or reductions may continue to [be] appropriate”. However, the Regulator expects that discussions with lenders and other creditors will have progressed since its original guidance was published and employers are now likely to have more meaningful financial projections as part of an updated business plan, albeit that this will need to take account of various scenarios that might play out. As such, there is a greater emphasis on trustees undertaking due diligence on the employer’s financial position and the sponsor covenant before agreeing to a new suspension or reduction and the Regulator “does not expect trustees to unquestioningly extend their original suspension arrangements on a three-month rolling basis based on limited information”.
Due diligence and the employer covenant
When assessing their employer covenant, trustees need to decide whether there is a short term impact from the crisis or if there has been a material deterioration in the employer covenant which is unlikely to be remedied in the short term. If the latter is the case, trustees should consider whether to update their scheme’s funding arrangements.
Protecting members’ interests
Whilst a request to defer may be reasonable and trustees should be open to such requests, the Regulator emphasises that trustees should make an informed assessment of whether the request is in the members’ best interests, even if a request is part of a larger co-ordinated request across other stakeholders that may appear equitable.
The guidance provides examples of protections that trustees may want to consider when deciding whether to agree to a request including:
- requiring all dividends and other forms of shareholder distribution to stop throughout the period of suspension
- agreeing triggers for contributions to start again or increase
- putting in place legally enforceable protections to ensure equitable treatment of the pension scheme alongside other creditors
- ensuring access to security/valuable assets, particularly where a suspension or reduction of contributions is agreed as part of a refinancing or other amendment process (as well as fully understanding the terms and conditions, costs and enhancements of any finance agreement),
- ensuring an ongoing provision of information from the sponsor and undertaking enhanced monitoring of the employer’s and (if applicable) wider corporate group’s trading and liquidity position, and
- ensuring that reduced or suspended contributions will be repaid within the current recovery plan timeframe and that the recovery plan is not lengthened unless there is sufficiently reliable covenant visibility available to justify this.
The Regulator expects that the less confidence trustees have of getting access to timely and relevant financial information, the shorter any reduction or suspension should be. Similarly, when there is little or no information available regarding the strength of the employer covenant trustees should only agree to a short-term suspension of contributions. In addition, trustees should consider carefully how appropriate a suspension is if the contributions due during the proposed suspension period are substantial or if a one-off payment or annual contributions is due during that time.
Whilst the Regulator’s guidance does not explicitly address this, it is also important that trustees take account of the proposed changes to UK insolvency law contained in the Corporate Insolvency and Governance Bill which are due to come into force within a matter of weeks before they agree to a suspension or reduction. These changes may materially impact the amount that a DB scheme may expect to recover where a sponsor experiences financial difficulties. They may also reduce the protection afforded by existing security or contingent assets that a scheme may have the benefit of. Read our recent blog on the Corporate Insolvency and Governance Bill to find out more about the potential impact of the Bill on DB schemes and the Pension Protection Fund.
COVID-19 questions for covenant monitoring and contingency planning
The initial guidance listed a number of questions that the Regulator expects trustees to be asking their sponsor regarding COVID-19. Further questions have been added including:
- In what ways has the sponsor considered how the impact of the virus and the measures to contain it may affect its debt burden?
- What are the assumptions and scenarios that have been used to prepare forecasts or projections?
- What financial information is being provided to other key stakeholders?
- For how long are current borrowing facilities expected to be sufficient?
- Is the employer discussing further funding facilities?
- Are funders seeking new security and, if so, what impact will this have on the scheme?
- What is the position of trade credit insurers?
The Regulator has reinstated the requirement for trustees to report any agreement to suspend or reduce contributions and, depending on how a suspension is implemented, it expects trustees to either submit a revised recovery plan or a report of missed contribution with an accompanying explanation.
Requests to release security
The guidance advises trustees to think carefully before considering a request from an employer to release security, as there is the possibility that if the employer fails to recover, the scheme will have lost access to a potentially valuable asset and it is very unlikely that security release is in members’ best interests.
Trustees should be provided with a business plan and forecasts explaining why the request is being made. Schemes should be treated equitably with other creditors and requests should not be limited to them.
Valuations due to be finalised
The guidance remains largely the same for schemes regarding actuarial valuations.
Where trustees are close to completing their valuation and they have agreed the assumptions with their scheme sponsor, the Regulator does not require them to allow for any higher deficit that would exist if they took account of post-valuation experience in their recovery plan. However, it does expect trustees to take account of relevant post-valuation experience in considering the rate and timing of contributions that an employer can reasonably afford to pay under any recovery plan.
Where trustees have passed or are approaching the 15 month deadline for submitting a valuation but they need more time to complete it as a result of the current economic uncertainty, the Regulator has said it will continue to take a reasonable approach to late submissions caused by Covid-19 issues. In particular, some trustees may consider it to be in the best interest of their members to take more time to consider the impact of the current situation on the scheme and the sponsor rather than submit a valuation and associated documents which may need to be re-negotiated soon.
Trustees are required to resume reporting any breaches of their transfer obligations from 1 July 2020. The Regulator reminds trustees of the need to continue to send members the new template warning letter and to monitor requests and patterns. Where trustees encounter delays in processing a transfer request for Covid-related reasons they may want to consider applying for an extension of up to three months to issue CETV quotations, which can be granted where a delay is caused by reasons out of the trustees’ control.
The updated guidance remains largely the same on scheme investments.
The Regulator continues to expect trustees to:
- review their scheme’s cash flow requirements and how they expect those obligations to be met. They should allow for issues such as additional ‘cash strain’ arising from increased member movement, potential reduction in or suspension of DRCs, lower levels of investment income and investment ‘cash calls’
- review and manage specific risks which may now exist within their portfolios or within their sponsoring employer’s business, such as concentrations of risk and/or exposures to deteriorating sectors/credits
- review any previously agreed investment and risk management decisions due to be implemented in the future to ensure they remain appropriate, efficient and do not introduce risks or crystallise losses
- review their investment governance structures and delegations to ensure they can continue to function and make decisions in the event of trustee incapacity or absence, and
- assess, following the recent performance of their scheme, whether they should make any changes to their investment and risk management governance framework.
A new paragraph has been included to say that evidence suggests that there has been a broad range of impacts on scheme funding positions, depending on the scheme’s pre-COVID asset allocation, the degree of hedging and trustee risk management and contingency planning. Over the last few months, the Regulator has seen high-levels of volatility in investment markets and funding positions.
Dealing with difficult decisions
The guidance now includes a new section on dealing with difficult decisions, which outlines the need for trustees to take professional advice (where appropriate), the importance of information sharing, the need for trustees to manage conflicts of interest and the need to keep full records of decision-making processes.
Trustees should consider the need to take professional advice when they have difficult decisions to make and the decision is material to the scheme or employer. This includes taking advice on the strength of the employer covenant, to understand the scheme’s position in refinancing, restructuring and insolvency scenarios and to understand the options in any negotiations with the scheme’s sponsors.
Regarding the costs of advice, trustees may want to check whether their trust deed and rules allows for expenses to be paid from scheme assets, even if the employer usually pays. If the governing documents do not provide for expenses to be paid from scheme assets, the employer and trustees may wish to consider whether it would be appropriate to amend the trust deed to permit this.
The guidance emphasises the need for employers to provide trustees with the information they need to make informed decisions and the importance of trustees keeping full records of their decision making and how they reached their conclusions, in case they need to justify those decisions in future down.
Guidance for employers
The Regulator’s has also updated its Covid-19 guidance for employers on DB scheme funding to ensure it is consistent with the update guidance for trustees. With the increased emphasis on due diligence by trustees, the guidance for employers focuses on the need for employers to provide trustees with the information they need and in a timely manner.
The Regulator confirms that employers can expect it to be reasonable where trustees are being asked to agree to previously unforeseen arrangement (such as reductions or suspensions in DRCs, or additional debt being secured over employer assets) provided that:
- the need for this can be justified
- a plan is made for deferred scheme payments to be caught up
- a plan is agreed for mitigating any detriment caused to the scheme, and
- the scheme is being treated equitably compared with other stakeholders: in particular, payments to shareholders (as well as other forms of value leaving the employer) to have stopped.
The Regulator also strongly recommends that employers document their position regarding the treatment of their schemes, particularly as this may assist in any future engagement with us.
The updated guidance indicates that the Regulator is continuing to adopt a pragmatic approach to requests from employers to defer or reduce deficit reduction contributions or for trustees to agree to other arrangements (such as corporate re-financing) where the reasons for this are related to Covid-19 and the request can be justified and where the scheme is being treated fairly and equitably. However, the Regulator expects trustees to carry out more due detailed due diligence now that more information is likely to be available on how the current economic crisis has and will continue to impact the sponsor’s business and how its lenders and other creditors are responding.
That process and the decision for trustees to agree to a contribution reduction or suspension may become more complicated if the proposed changes to the UK insolvency regime are implemented as planned in the coming weeks.
If you have any queries about the updated guidance or any of the points covered in this blog, please contact your usual HSF adviser.