Potential crosswinds and undercurrents

There is light at the end of the tunnel, but look out for potential crosswinds and dangerous undercurrents.

The emergence of the ‘new normal’ is on everyone’s minds, as the vaccine programme is rolled out, COVID-19 cases start to fall and the Government intends to kickstart the UK’s economic recovery with the 2021 Budget. If all goes to plan, we will all soon be back to social gatherings and doing all the things we have so long missed.

So what does this mean for DB Pension Schemes and the supporting covenants? Well, it must be good news as businesses ‘bounce back’ with a surge in demand for their goods and services –  shouldn’t it?

Some words of caution:

  1. The emergence from the trough of this pandemic will be very similar to a recovery from a recession, where the economy will inevitably drive greater demand and the order books will grow substantially. However, where staff and inventory costs have been cut back, then big investment will be needed to pick up operations and invest in the capex, that has, inevitably, been deferred.
  2. More importantly, and bizarrely, the one benefit of a collapse in demand during 2020 was the unwinding of the working capital position as debtors pay up and the payables shrink, resulting in significant short-term cash inflows. Also, longer term creditors will likely have been supportive during this period by deferring debt and providing standstill agreements, which will have artificially improved available cash flow.
    The problem that a lot of businesses overlook is when the demand bounces back, so does the working capital strain.  And it could be even worse as previously, timely paying, customers may take more credit than they should, especially as there is a general market ‘COVID’ approach to be supportive of one another.
  3. Finally, don’t forget about the short-term Government support.  Whilst essential, it has been mainly used to support staff costs over periods of lock down and to help cover other critical costs to keep businesses afloat. These costs will need to be paid back at the same time as there will be a need for cash to support a surge in demand.

So what does this mean for DB schemes?

As much as a ‘bounce back’ for any business is a great relief, these can be challenging times as good cash flow management is critical for sponsoring employers, and their cash hungry DB schemes. There is often a time lag between investing and being paid back to reinvest in future growth. Therefore, good cash flow planning is critical to understand whether there are funding needs and how best to manage this. This will play into short term cash flow management forecasts to optimise cash management.

This phase will be challenging for a lot of businesses out there and whilst sponsors should be thinking ahead, trustees should be closely monitoring and engaging regularly with their sponsoring employers to understand how the sponsor is approaching these challenges and what support (if any) is required from their scheme.

It would be a real shame in the euphoria of the bounce back that DB schemes are part of the crosswinds and undercurrents that dampen recovery.

Nick Agius, Associate Director

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