March 03
Covenant confusion hidden in the new pensions debt regulations

On 26th February 2018 the Department for Work and Pensions published its response to the consultation on their draft amendments to the employer debt regulations.  My blog “Deferring your pensions debt” detailed the proposals set out in the consultation.

Under the proposals a new option was to be introduced allowing employers participating in a multi-employer scheme to defer the requirement to pay an employer debt (the Section 75 debt or buy-out deficit) following an employment-cessation event.  (Broadly, an employment-cessation event occurs when an employer in a multi-employer scheme ceases to employ any active members whilst at least one other employer participating in the scheme continues to employ an active member.)   

In order for a deferred debt arrangement to be implemented it was proposed that the ‘funding test’ must be satisfied.  This test is already used within some of the existing apportionment and withdrawal arrangements and requires the trustees to be satisfied that the remaining employers are reasonably likely to be able to fund the scheme so that it will have sufficient and appropriate assets to meet its technical provisions and that the arrangement will not adversely affect the security of members’ benefits.  However, as a result of the consultation, the requirement to satisfy the funding test has been replaced with the requirement that the trustees are satisfied that:

“the deferred employer’s covenant with the scheme is not likely to weaken materially within the period of 12 months beginning with the date on which the trustees or managers expect the deferred debt arrangement to take effect”.

This wording creates a number of issues.  Firstly, when carrying out a covenant assessment we already make allowance for expectations over the next 12 months.  Consideration of the ”employer’s perspective financial performance “ is required under the Pensions Regulator’s guidance “Assessing and monitoring the employer covenant”.   Therefore, any covenant assessment at the date on which the deferred debt arrangement takes effect will already allow for the likely future financial performance of the sponsor and it would only weaken materially if there was an unexpected event that significantly impacted on the employer (such as the unexpected loss of a significant contract).

Secondly “not likely to” is a vague term that is difficult to interpret and it is not clear what threshold applies.  It could be interpreted that this requires a greater than 50% chance of the covenant not weakening or it could be a significantly higher hurdle such as 90% or even higher.

In addition, the use of the words “weaken materially” whilst reflecting the current wording in the Pensions Regulator’s clearance guidance require a significant degree of judgement and are easier to interpret when considering a standalone event such as a corporate transaction rather than a period of possible future decline.

Under the new deferred debt arrangements the debt becomes payable when the trustees and deferred employer agree to end the arrangement.  However, the debt is also triggered in a number of other scenarios including those outside the deferred employer’s control.  This includes the scenarios whereby all the employers in the scheme become deferred employers, if the scheme becomes frozen (i.e. all remaining employers simultaneously cease future accrual) and, crucially. if the Trustees believe that the covenant will materially weaken in the next 12 months.  As a result the Trustees will be expected to continually review the deferred employer’s covenant to ensure the arrangement remains appropriate creating significant uncertainty for the deferred employer.  This uncertainty may be too great for some employers given the Trustees are most likely to use this power (notwithstanding the ambiguity in the wording outlined above) at a point in time when the employer’s business is showing signs of distress and the implications of meeting the required debt payment may be very significant.

Whilst the intention behind these easements is that they will only be used in limited situations (in particular, by non-associated multi-employer schemes) It is disappointing that these amendments were not consulted on before being laid before Parliament on 26th February 2018.  These new, somewhat ambiguous regulations come into force on 6th April 2018.


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