The Regulator has softened its stance a little but trustees will have to be careful to take the guidance into account and be prepared to justify any different approach when monitoring and taking action on employer covenant.
The Regulator began consulting on this issue in June 2010. In the August edition of the Trustee Quarterly Review we reported on the draft guidance. The Regulator has now published its final guidance together with a consultation response, which addresses some of the issues raised in the consultation.
The Regulator’s key message is that it places a high level of importance on the assessment of employer covenant and expects trustees to have monitoring plans in place so that they are in a strong position to anticipate future events and take timely action if the covenant weakens. Trustees should think about the practical steps that would be taken if the need for employer support crystallised. A variety of mechanisms can be used to strengthen covenant and increase scheme security (this may include, but is not limited to, the use of contingent assets).
A few changes have been made to the detail of the guidance as a result of the consultation responses. In particular, the Regulator has concluded that employer “willingness” is not part of the objective assessment of employer covenant, on the basis that “recent experience has shown that willingness can evaporate just when it is needed most”.
The final guidance also emphasises that it does not intend to impose unnecessary costs on schemes; the costs of measuring and monitoring the covenant should be proportionate to the size of the scheme and the employer. It is recognised that there may be instances where carrying out a lesser degree of monitoring than that envisaged by the guidance could be appropriate. This is a matter for the trustees to decide (and their reasons should be recorded), but the Regulator has set out some considerations that might be relevant when deciding to adopt a less exhaustive approach.
The Appendices give further practical guidance to trustees on assessing the employer’s financial strength. Where trustees do not have relevant expertise on the trustee board, they should consider appointing a covenant assessor, having regard to Appendix B, which recommends factors that should be taken into account when commissioning a covenant report.
The Regulator’s main message in relation to employer covenant remains the same, with an emphasis on forward looking assessments and the establishment of a monitoring framework within which trustees can react to changing economic circumstances. However, there is a greater recognition in the finalised guidance that in certain instances an alternative approach could be adopted. Any departure from the guidance should be carefully considered and trustees should ensure they record their reasons for doing so in writing.