Against an economic backdrop which continues to be extremely challenging for many businesses, the Pensions Regulator has issued new guidance for trustees of DB schemes on how to protect their scheme from employer distress (Guidance). The types of employer distress covered by the Guidance is wide and the Guidance will be relevant not only to trustees whose employer is facing the prospect of entering a formal insolvency process, but also at an earlier stage, including where the business may be seeking to restructure or refinance. A key message is that the range of options which trustees have to protect the pension scheme reduce as the levels of financial distress increase and so trustees should be proactive in preparing themselves for possible distress scenarios and should engage with employers as early as possible - ideally before any signs of financial distress materialise. The Guidance is, accordingly, also relevant to trustees whose employer is currently in good financial health.
- In depth
Employers should be aware that the Pensions Regulator is encouraging trustees to plan for potential future employer distress and be prepared to engage with trustees as they conduct pre-emptive contingency planning in this area. Employers who are already suffering some level of financial distress should be aware of the Regulator's expectation that trustees should be given a seat at the table and that they should be treated fairly compared to other creditors.
Much of the Guidance draws on existing regulatory materials and will be familiar to trustees, for example the importance of integrated risk management. The Guidance is, however, helpful in drawing these various strands together and highlighting particular action points which trustees should be focussing on in the context of actual and potential employer distress scenarios.
From a legal perspective, specific actions which trustees should be considering, in conjunction with their legal advisers, before their employer starts showing signs of financial distress include:
- refreshing their understanding of the legal position and obligations of the employer sponsoring the scheme (including in a hypothetical insolvency) - trustees should ensure they understand what, if any, additional support can be called on from the employer and when
- ensuring that scheme governance arrangements are up to date and fit for purposes (including reviewing conflict policies and information sharing agreements).
The Guidance suggests a range of actions which trustees may consider, depending on where their particular employer is on the "corporate stress curve". This starts where the employer shows no signs of financial distress (e.g. meeting all its liabilities), moves through an intermediate stage where the employer is showing some signs of distress (e.g. it might be in default under financing documents), and finishes where the employer is facing insolvency (e.g. its financial position is such that a formal insolvency process such as administration or liquidation is likely). The key message for trustees, whatever the level of financial distress, is that the Regulator expects trustees to be prepared and to act fast, and early, to mitigate potential risks. The Regulator wishes trustees to ensure that they are being treated equally compared to other financial stakeholders.
The Guidance contains a helpful checklist encapsulating the suggested actions at each stage in Annex 4.
Employer showing no signs of distress
There is a strong emphasis in the Guidance on the steps trustees should take to monitor the covenant on an ongoing basis, even when there is no immediate concern about an employer's financial position. As part of the monitoring framework, the Regulator recommends trustees adopt a fully documented integrated risk management approach to their scheme, with workable contingency plans and suitable triggers in place, and that trustees should regularly review risk management and governance procedures to make sure they are fit for purpose.
The following are some of the key steps identified by the Regulator as part of this pre-emptive risk management approach.
Understand the legal position and obligations of the employer
Trustees should fully understand the scheme's legal position and obligations of the employer, including in a hypothetical insolvency scenario. Relevant obligations could be the employer's statutory obligations, or obligations under the Rules. The Regulator recommends that trustees familiarise themselves with:
- the employer's group structure
- the scheme's current funding position and details of the funding arrangements of the scheme
- the “balance of powers” under the scheme's trust deed and rules
- obligations on the employer to share information with the scheme, under statute, the scheme rules or any information sharing protocol agreed with the trustees and
- the scheme’s eligibility of the scheme to enter the Pension Protection Fund (PPF), particularly if the employer is incorporated outside of the UK
Review trustee governance
Trustees should undertake a review of scheme governance matters, to confirm the trustee board has the right mix of experience, structures and processes in place to protect the scheme. In particular, the Regulator highlights the need to have clear records of decision making and agreed conflict of interest policies and information sharing protocols. Another notable theme is regular engagement with the employer and other key stakeholders in order to identify issues and actions early. The Regulator recommends trustees and employer put in place a legally enforceable information sharing agreement to ensure trustees are given sufficient visibility of events affecting the scheme in periods of employer distress, when an employer’s attention may understandably be focussed on its business.
Employer showing some signs of distress
Whilst recognising that the specific warning signs of employer distress are likely to vary according to the nature of the employer's business and the industry in which it operates, the Guidance identifies the following as key warning signs which may point to financial distress:
- cash flow constraints;
- credit downgrades;
- removal of trade credit insurance;
- disposal of profitable business units and
- loss of a key customer contract
A more detailed overview of the potential distress warning signs are included in Annex 2 of the Guidance.
The Guidance identifies a number of actions which trustees should consider taking to manage risk at this stage, focussed on the following areas:
- increasing the frequency of covenant monitoring;
- performing a more detailed review of the scheme's position;
- reviewing investment strategy;
- understanding the role of other stakeholders;
- trustee considerations where an employer requests an easement in relation to funding;
- information sharing between employers and trustees;
- transaction activity;
- communicating with members and
- being alert to scams and unusual transfer activity
Employer facing insolvency
Where an employer is facing the prospect of entering some kind of formal insolvency process (e.g. administration or liquidation), trustees should take professional advice from specialist restructuring advisers to ensure that all options to protect the scheme's position have been explored. Other trustee actions recommended at this stage include:
- reviewing enforcement options if the scheme has security structures in place, to make sure trustees are aware how to enforce such security if they have explored all other options and insolvency is imminent and
- reviewing the PPF's contingency planning guidance and, where appropriate, starting to engage with the PPF to understand what practical steps will need to be taken to prepare the scheme for PPF assessment
New procedures for distressed companies - Corporate Insolvency and Governance Act 2020 (CIGA)
CIGA, which came into force on 26 June 2020, introduced new procedures for distressed companies, including a "restructuring plan" to be proposed by companies in or facing financial difficulty and a new process for companies to receive short-term breathing space by obtaining a statutory "payment holiday" from certain creditors (known as a "moratorium"). The Guidance notes that these new procedures may be good for pension schemes that are reliant on the long-term employer covenant, but there are potentially new risks that will need to be addressed. The Guidance recommends that where the new procedures are being used, trustees should request a copy of the turnaround plan and review this alongside specialist restructuring advisers to understand the potential impact of plans on the scheme.