Background

The term employer covenant refers to the legal obligation, ability and willingness of a pension scheme's sponsoring employer (or a number of employers) to provide the requisite funds in order to meet the scheme's liabilities both at present and in the future. Whether an employer is able to support and fund an often costly DB pension scheme is often a matter of concern to trustees of such schemes.

The new guidance from the Regulator is intended to identify good practice for trustees in:

  • assessing the strength of the employer covenant in relation to a DB scheme;
  • deciding what a proportionate approach to the assessment should look like (giving consideration to the context of the scheme); and
  • deciding how to monitor the covenant on an ongoing basis and prepare contingency plans to react appropriately so as to improve scheme security.

One of the key messages contained within the guidance is the need for trustees to adopt an integrated approach to risk management. The Regulator stresses that having a sound understanding of the strength of an employer covenant acts as an effective underpin for scheme risk management.

What is new?

In response to feedback on a previous version of the guidance published back in November 2014, the Regulator has tailored this latest version by providing a more digestible series of user-friendly examples, checklists and scenarios to go alongside the full, detailed guidance document. In contrast to many similar Regulator documents published in the past, this guidance offers more than 20 lengthy examples of what sorts of issues trustees should be considering and analysing when dealing with covenants, as well as providing guidance as to what may constitute suitable actions in varying circumstances. A list of considerations for trustees drawing up a brief for the appointment of a covenant adviser is also provided.

The example scenarios deal with a broad range of issues associated with employer covenants, which include, amongst others:

  • the impact the capital structure of an employer may have on its covenant;
  • the possible impact of intra-group trading on covenant employer assessment;
  • additional contingent support that may need to be sought from an employer if a higher-risk investment strategy is adopted by a scheme; and
  • the implementation of a trustee monitoring framework.

The latest refresh of the guidance has also been prompted by the replacement of the Regulator's code of practice on DB funding in June 2014.

The Regulator will be promoting the guidance among DB scheme trustees and their professional advisers via its ongoing communications campaign work including direct emails, social media posts and stakeholder engagement, so many within the industry are likely to come across the guidance in the weeks and months to come.

Later this year, the Regulator intends to produce further guidance in the series to help trustees navigate the DB code, including guides on integrated risk management and investment strategy. We will provide a further update on these as and when they are published.

Dentons' comment

The assessment of the employer covenant strength is an essential consideration for trustees regardless of the size and complexity of the scheme in question. However, each scheme, trustee board and employer will be different, having their own priorities, issues and nuances. Nevertheless, the refreshed guidance provides useful information as to the Regulator's expectations and illustrations of what trustees could be doing set out in the example scenarios, as well as providing trustees with a steer if and when different scenarios arise.