Key provisions of the Pension Schemes Act 2021 (the Act) which impact corporate activity for groups with UK defined benefit pension schemes came into force on 1 October 2021.
Now that those provisions have been in force for six months, this blog highlights some of our thoughts on how the new regime is playing out in practice and how that might develop further in the future.
A reminder of the key provisions
The key provisions of the Pension Schemes Act 2021 for these purposes are those which increased the potential for criminal and civil liability where corporate actions impact on the covenant support for a UK defined benefit pension scheme. In particular, with effect from 1 October 2021, the Act:
- introduced two wide new criminal offences of “avoidance of employer debt” and “risking accrued scheme benefits” which can be committed by any person and are punishable by up to seven years in prison and/or unlimited fines;
- widened the circumstances in which the UK Pensions Regulator (TPR) can issue a “contribution notice” to make third parties who are connected to a scheme employer liable to contribute to the scheme. This was done by adding two new gateway tests: the “employer insolvency test” and the “employer resources test”, both of which focus on the immediate before and after impact of the particular corporate activity on that particular aspect of employer covenant; and
- widened TPR’s investigatory powers and introduced new penalties for providing misleading information to pension scheme trustees and TPR.
More detail on these provisions is available in our briefing.
How are the new provisions playing out in practice?
When the Act was progressing through Parliament, significant concerns were raised by the pensions industry about the breadth of the new provisions, with particular focus on the potential for the new criminal powers to damage, rather than protect, the financial covenant supporting pension schemes. We previously discussed these concerns in various blog posts, which can be found here, here, here and here.
Now that the Act has been in force for six months, there is a reasonable track record developing of corporates and trustees needing to grapple with the new provisions both on significant transactions and in more day-to-day corporate activity such as dividends. Some key highlights of our experience over this period are as follows.
- Overall, the M&A market seems to have adapted quickly to the new powers, with purchasers and other third parties not being deterred from engaging in corporate activity. The changes are generally viewed as another incremental step to the changes over the last 10-15 years as pension protection laws have been progressively tightened and TPR has taken an increasingly proactive stance. There is recognition that the pension scheme needs to be high on the agenda, but also that pensions risks can be appropriately addressed.
- The new powers have, for many corporate groups, acted as a catalyst for better corporate governance around pensions so that the pension scheme is more commonly being considered at an earlier stage in a wider range of corporate activity and the steps taken being more carefully documented to provide evidence in case of future scrutiny. That can only be good for pension schemes as it makes it more likely that there will be appropriate engagement with the trustees at an early stage, and should be considered as a positive from a corporate perspective too as there are less likely to be nasty surprises at a later stage.
- There hasn’t yet been any significant increase in applications for TPR clearance in response to the new powers. Although there will always be exceptions, generally purchasers, corporate groups and their directors continue to get comfortable that they will be adequately protected by taking steps to assess the impact of corporate activity on the pension scheme and (where appropriate) engaging with the trustees to negotiate and reach agreement on mitigation.
- Whilst it inevitably has its limitations, TPR’s policy in relation to the criminal offences provides genuinely helpful comfort around the expected application of the wide criminal offences. Provided they have the benefit of appropriate professional advice, corporate groups and trustees are generally able to get comfortable with the criminal risks, including when managing section 75 debts using mechanisms such as flexible apportionment arrangements, which on their face fall within the potential scope of the “avoidance of employer debt” criminal offence meaning that parties need to rely on having “reasonable excuse”.
- The new contribution notice tests are being thought about carefully in assessing the impact of corporate activity on the pension scheme. Trustees and corporates are testing the impact of the proposed corporate activity against the new employer insolvency test and employer resources test, often with the benefit of independent covenant advice, in addition to considering whether there is overall material detriment. However, whilst this is then (quite rightly) used to inform discussions on mitigation, we are still seeing sensible conversations around mitigation which recognise that it isn’t always necessary or appropriate to fully and immediately mitigate any detriment assessed by reference to the new technical tests – the overall context remains relevant and important. TPR’s revised clearance guidance helpfully supports this by continuing to focus on material detriment.
- Better governance and processes leads to better paper trails. The increased risks make it more important than ever for there to be clear contemporaneous documentation which demonstrates the process followed and conclusions reached in relation to pensions. We are seeing more care being taken when drafting board papers/minutes and other documentation, which also helps build statutory defences and a record of the arguments around reasonableness.
Are there any particular areas for concern?
The experience of the last six months suggests that the concerns of the industry when the Act was progressing through Parliament might have been unfounded and that the new protections are having their desired effect of protecting pension schemes. However we would raise a significant note of caution about jumping to such a conclusion, for two key reasons.
- Firstly, many of the concerns expressed when the Act was progressing through Parliament centred around the impact that the new powers and criminal offences would have where corporate groups are in distress, which we discussed in our blog posts here and here, and our briefing here. It is much easier to get comfortable about the new criminal offences and widened contribution notice powers in circumstances in a non-distress scenario where there are resources available to agree mitigation with the trustees and/or transactions can be restructured or reconsidered if there is detriment which cannot be mitigated. The position is different in distress scenarios where all options are likely to risk some detriment to the pension scheme, even if some mitigation is possible. Over the last six months, there has been less restructuring activity and so the majority of transactions where the Act has needed to be considered do not involve corporate groups that are in distress. This may be giving a false sense of security around how easy it is to get comfortable with the new risks. As the last pandemic related protections for corporates wind down (discussed further in a separate blog post here), there may be an increase in restructuring activity which will prove a greater challenge.
- Secondly, we haven’t yet seen TPR start to build a track record of using its new powers by investigating and bringing prosecutions or civil action. When it does so, it will need to tread carefully to strike the right balance between using and testing its powers and ensuring that it doesn’t undermine confidence in the comfort that the industry is taking from TPR’s guidance and policies. For example, it would be hugely damaging if TPR started to depart from its stated expectation that the new powers won’t change the types of behaviour that TPR will target and that the criminal offences are only intended to capture the worst behaviour. Industry confidence would be rapidly underlined if, when it comes to enforcement, TPR is either too quick to investigate and pursue prosecutions when things go wrong and/or too ready to depart from their policies if they simply disagree with commercially negotiated mitigation outcomes or conclusions reached in good faith on whether there is detrimental impact. Given the breadth of the powers, there is clearly scope for that to happen, particularly in high profile cases where there is significant political and media scrutiny.
What’s coming next?
We are still waiting for the final provisions of the Act which are relevant to corporate activity to come into force, namely the extension of the circumstances in which mandatory notifications to TPR are required. Whilst those were expected to come into force in April 2022, they have been delayed and revised timing is not yet clear. Hopefully the DWP is taking time to reflect on concerns raised in the consultation on the draft regulations so that the final regulations and subsequent TPR directions and guidance provide a clear and workable set of new requirements. For more information about the progress of the new requirements.