Corporate events and PSA2021: Practical actions for trustees
Much has already been made of the possible implications of the new Pension Schemes Act 2021 (“Act”) following its long-awaited royal assent. Initial attention has rightly centred around The Pension Regulator (TPR) and its new powers, with focus on the introduction of new criminal offences and the risk of prison sentences or significant fines for individuals, and how both corporates and trustees should be reacting to these.
In this blog I turn attentions to the practical implications for trustees thinking about the myriad corporate transactions which could impact their employer covenant support.
Trustee position in transactions
Arguably, the Act simply solidifies the powers and potential leverage position trustees already have in transactions from the material detriment (“Type A”) test. However, the requirement to provide a “declaration of intent” to trustees should hopefully see them brought to the table earlier than has previously been the case, while the introduction of two new tests which apply for imposing a contribution notice – “employer insolvency” and “employer resources” test – provide a useful framework for formalising how detriment might be assessed.
Interestingly, while detrimental events under the Pensions Act 2004 events provisions are viewed through the lens of whether they impact on the “ability of the scheme to meet its pension liabilities” the new tests in the Act appear to focus more clearly on the impact of events on the present-day covenant support provided to a scheme.
The new tests
The employer insolvency test is likely to see the re-emergence of the regular use of estimated outcome statement (“EOS”) analysis in the covenant world. Whilst the use of solvent balance sheets to simulate insolvency outcome can arguably make it a spurious exercise, EOS’s have remained an important tool for covenant advisors to assess insolvency outcomes in certain scenarios, and there could now be a case for running EOS analysis for any material transaction (even if insolvency risk doesn’t increase on day one of the transaction).
Employer “resources” feels like a broader concept which will likely to be open to interpretation; the Department for Work and Pensions (DWP) is seeking views on rationale and suggested approach to the test through its current consultation and subsequent guidance due from the regulator later this year will be important in this regard and it will be particularly interesting to see how prescriptive it is around how “resources” should be objectively assessed.
Impact on trustees and sponsors
Nevertheless, trustees and sponsors, with the support of their advisors, will likely need to consider some or all of the follow implications from a transaction:
- Impact on the underlying earnings capacity of the sponsor (and therefore affordability)
- Impact on the quality of balance sheet assets and financial flexibility. For example, will meaningful assets, including cash, be replaced by intercompany balances (which may be less liquid/recoverable)?
- Whether a scheme’s creditor position has been diluted
With the bar very high for criminal prosecution (“beyond reasonable doubt”) one suspects TPR is more likely to pursue civil cases. This brings to the table the concept of what TPR considers “reasonable”. While TPR will have its own views on reasonableness, for the two new tests careful thought and consideration will need to be given to how to think about and set materiality thresholds, with a logical argument that it might be appropriate for a prudent set of trustees to set the materiality bar that is lower than the view taken by sponsor directors.
While trustees already had some protection against certain, less headline-grabbing, activities – such as internal dividends and reorganisations – through the existing Type A test, such events are now likely to come under much closer scrutiny from stakeholders. Initially it will be important for directors to themselves understand the new contribution notice tests coming into play, not least to avoid tripping one unknowingly. We would then expect (and hope) to see more proactive engagement from sponsor directors in advance of transactions, with this coming well before the need for formally providing a “declaration of intent” to trustees.
While we know a change in behaviour is coming, the extent of this change remains unclear, particularly on the corporate side. For example, will we see increased director focus (and company analysis) on whether their plans might create detriment to the pension scheme and a subsequent uptick in sponsors proactively offering mitigation for schemes? Lack of engagement (or wilful blindness?) regarding the impact of corporate events on the covenant could see directors exposing themselves to personal liability if things go badly wrong for their business before the 6-year contribution notice lookback period expires.
Much will hinge on guidance which is due to follow from TPR later this year and I remain intrigued as to whether we will see a flurry of Clearance applications from directors who are unclear about how reasonableness will be assessed by TPR and nervous about individual exposure.
Some takeaways to consider:
- Trustee directors should look to understand the implications of events on the sponsor covenant at the earliest possible opportunity
- Ensure transactions that are less obviously detrimental to covenant, often undertaken as part of good corporate “housekeeping”/BAU (e.g. tidying up of intercompany balances), are fully considered
- If trustees and sponsors don’t already have an information sharing protocol in place, now would be a good time to formalise one. Here, trustees may need to play a role in educating sponsor directors around their new responsibilities – it’s in everyone’s best interest!
Hamish Reeves, Director
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