Guidance on monitoring employer support: Sackers’ comments

Background

The draft “Guidance on monitoring employer support: covenant, contingent assets and other security”, published on 15 June 2010, draws together a number of strands from TPR’s existing publications with a specific focus on monitoring employer support.  This will be useful as a trustee knowledge and understanding (TKU) tool, to help new trustees understand their goals in connection with covenant monitoring and as a reference point for more experienced trustees.

However, in our view, the draft guidance only provides a basic introduction and broad overview of the subject.  It does not assist trustees with finding answers to some of the more difficult, practical questions that trustees frequently face.  Overall, we feel that the guidance is helpful in identifying the issues and pointing trustees to potential solutions but ultimately, it does little to help resolve the many cases where trustees are in practice unable and/or powerless to agree any of the suggested solutions with the employer.

In this response:

• Schemes in crisis
• Improved cash flow
  
• Regulatory action
• Proportionality
• Subordination of other creditors
• Monitoring and taking action
  
• Relationship of the covenant to other areas of scheme management
  
• Appendix A: Assessing the financial strength of employer covenant

Schemes in crisis

For schemes where all possible steps have been taken to reduce costs, and the scheme sponsor is unable to make good the scheme’s deficit in the foreseeable future, there may be no further steps that trustees can take.  The draft guidance fails to recognise this and provides no assistance for trustees in these circumstances.

While there are signposts in the draft guidance for trustees facing a gradual decline in the covenant of their scheme’s sponsoring employer, it does not deal with the situation of a covenant which deteriorates very rapidly – a situation which has unfortunately become more common as a result of the global economic crisis.

Improved cash flow

Paragraph 14 of the draft guidance notes that “Where employer covenant is weak and not anticipated to improve with market recovery, the trustees should be very cautious about accepting a long or back-end loaded recovery plan”.  However, this contrasts with the comments made in TPR’s June 2009 statement on scheme funding and the employer covenant, which states that “trustees should look at the widest range of flexibility in recovery plans, mindful of their duties to secure member benefits; these can include lengthening recovery plans, step-up payments, back-end loading of recovery plans…”.  If TPR is distinguishing between companies which have no prospect of recovery and others, this should be made clear in the guidance.

Regulatory action

Paragraph 68 invites trustees with serious concerns to contact TPR at an early stage to raise their concerns, and states that TPR “will consider whether regulatory assistance may help resolve the situation”.  It would be useful if examples were included here of the type of assistance that TPR is able to provide in these circumstances, together with examples (on a no names basis) of what it has done in practice to help schemes.  Trustees do need to know how TPR can be of practical help when they do not have sufficient power to influence the decision making of the employer.

In some cases, trustees may be faced with a situation where the best result for the scheme would be for it to wind-up, for example, where they have exhausted all the options available to them to secure funding for the scheme.  However, the trustees may not themselves have the power to do this and may therefore wish to have recourse to TPR for assistance.  If TPR is prepared to exercise its power, (under s.11, Pensions Act 1995), to order a winding-up in these circumstances, it would be useful to state this in the guidance so that trustees are aware of the possibility.

Proportionality

In a number of places, the guidance notes TPR’s expectation that trustees and employers should act proportionately, particularly when incurring cost.  However, both the guidance generally and the illustrative examples point trustees towards engaging the services of a professional covenant reviewer.  As this will not be necessary in all cases (for example, where there is sufficient appropriate expertise on the trustee board – as noted in paragraphs 36-37) references to the appointment of professional covenant reviewers should be subject to the need for proportionality.

Subordination of other creditors

Paragraph 41 of the draft guidance refers to the possible subordination of other creditors, to improve the outcome for the scheme on insolvency.  While it would clearly be helpful for schemes to be given higher priority in these circumstances, without a change in the law to enable this as a matter of course, it is in most cases an unrealistic expectation.

Monitoring and taking action

In terms of ensuring a full covenant review is carried out at regular intervals, the draft guidance suggests that trustees put in place a monitoring plan specifying the process by which an employer’s covenant will be monitored, (see section 4 of the consultation). According to the draft guidance, the monitoring plan should have trigger points which require certain action to be taken if performance measures or other metrics are breached.

Is it intended that failure to put in place such a plan will be treated as a failure to maintain adequate internal controls?  If this is the case, it would be useful to note that such a failure can attract TPR’s statutory enforcement powers.

Relationship of the covenant to other areas of scheme management

An employer’s covenant is inextricably linked to other areas such as scheme funding and investment strategy.  While the draft guidance touches on the use of contingent assets, it does not explore in-depth the interrelationship between these factors.  It would therefore be helpful if the guidance addressed this, to give trustees a broader picture of their responsibilities in terms of managing their scheme.

Appendix A: Assessing the financial strength of employer covenant

Paragraph 8 of Appendix A states that “Employers should recognise that it is in the best interests of all concerned to have properly informed, knowledgeable and competent trustees.  To achieve this, they should share information relating to the employer covenant and plans for the scheme and any event that may affect the pension scheme security with the trustees at the earliest opportunity”.

It is clearly in the interests of the trustees that this communication takes place, but in some cases it will not be in the employer’s interests to do so.  In many circumstances it will be possible for the trustees and scheme sponsors to deal with potentially sensitive issues by putting in place a confidentiality or non-disclosure agreement.  However, there will be times when, perhaps due to the speed at which events unfold, or the nature of a particular transaction, this will not be practicable.  While the guidance should promote best practice, it should also recognise the difficulties which trustees and employers may face in practice.