Employer Covenant: Final Guidance

Introduction

TPR’s guidance on “Monitoring employer support: Covenant, contingent assets and other security” (the Guidance) was finalised on 30 November 2010. The tenor of the guidance has not changed significantly since the draft was published for consultation in June,1 but TPR has listened to the consultation responses and made a number of helpful changes.

In this Alert:

• Key points
• What is the employer covenant?
• Can trustees monitor covenant themselves?
• Appointing external covenant assessors
• Contingent Assets

Key points

• The final guidance includes, for the first time, a general definition of “covenant” – with TPR clarifying that “willingness” does not constitute part of covenant.
• The guidance is a useful tool for trustees and employers to use when monitoring employer covenant. In particular, we welcome TPR’s comments regarding what is a proportionate level of monitoring for schemes.
• The guidance also covers the topical issue of contingent assets.

What is the employer covenant?

TPR has defined covenant as:

“the employer’s legal obligation and its ability to fund the scheme now and in the future. The strength of it depends upon the robustness of the legal agreements in place and the likelihood that the employer can meet them. As scheme sponsor the employer underwrites the risks to which the scheme is exposed, including underfunding, longevity, investment and inflation.”

Earlier TPR guidance included the concept of willingness as a crucial element of covenant along with ability to pay. Willingness has now been dropped from the definition, with TPR recognising that “recent experience has shown that willingness can evaporate just when it is needed most”.

But that does not mean that trustees can ignore willingness altogether. A failure to demonstrate willingness to fund the scheme “should alert trustees to the inappropriateness of taking an optimistic view of employer covenant”.

Can trustees monitor covenant themselves?

Following comments on consultation, TPR has revisited elements of the guidance to ensure that a proper balance is struck between specifying a process for monitoring employer covenant and not imposing unnecessary costs on trustees and employers.

In order to manage costs, the revised guidance places a greater emphasis on trustees taking a proportionate approach to covenant assessment, by using the resources already available to them. For example, the guidance notes that a “positive working relationship” between the employer and trustees is important. But to promote openness, the trustees should be prepared to commit to confidentiality in respect of price sensitive information.

Appointing external covenant assessors

The guidance also makes it clear that trustees may only require external support for those items for which they do not have the required skills on the trustee board. TPR emphasises that it does not require standardised reports “that do not add value”, and so trustees may only need to request input on certain issues.

If advice is sought from a professional covenant assessor, TPR indicates that the appointment should be subject to a “robust selection process” bearing in mind the trustees’ budget.

Contingent Assets

This guidance also focuses on contingent assets – an issue which has been in the spotlight since TPR’s recent statement on employer-related investments.2

Contingent assets are becoming more sophisticated and the changes made to the section on contingent assets reflects these developments. Greater prominence has been given to other forms of non-cash funding, such as insolvency priority or negative pledges. The guidance reminds trustees to consider how these assets are valued, in particular, that “some assets which are closely related to the employer may decline in value at the same time the employer covenant deteriorates”. As a result, professional advice may be needed to value such an asset.

1 For more information, see our Alert: “Employer covenant – first set of guidance issued” dated 18 June 2010
2 For more information, see our Alert: “Employer related investments: TPR’s statement” dated 10 November 2010