Distressed employer guidance from TPR

Overview

Recent guidance from The Pensions Regulator (TPR) urges trustees of defined benefit (DB) pension schemes to prepare now in case their sponsoring employer faces financial difficulties. It encourages trustees to monitor the covenant and adopt an integrated risk management (IRM) approach, even if the employer is not currently in trouble. As we emerge from the COVID 19 pandemic and government support begins to be withdrawn and associated deferred debts fall due, this is all the more important.

Key points from the guidance

• All trustees should adopt a fully documented IRM approach to their scheme, with workable contingency plans and suitable triggers in place.
• Practising IRM will highlight problems early on, and the sooner trustees act, the greater the prospects of protecting the scheme’s position. Trustees should regularly review these risk management and governance procedures to make sure they are fit for purpose.
• Engaging regularly with the sponsor and with other creditors (where applicable) to identify and manage key risks early on.
• If trustees delay putting robust scheme protections in place, other stakeholders, such as lenders, will be in a better position to exert control over, and extract value from, a distressed sponsor, potentially to the detriment of the scheme.
• Trustees should remain alert to pensions scams or unusual transfer activity and prepare a communications strategy to support members when they are facing uncertainty.
• If a sponsor is facing the prospect of insolvency, trustees should refer to the Pension Protection Fund (PPF)’s contingency planning guidance.

The guide is aimed at trustees and, very usefully, includes practical recommendations, case examples and a checklist to use during periods of sponsor distress.

The concept of a corporate stress curve is used to illustrate a hypothetical employer’s downturn towards insolvency. It picks out strategies that trustees should focus on, depending on where their employer sits along the curve and highlights the steady decrease in options for trustees as a sponsor becomes more distressed.

So far so good.

My experience entirely supports the contention that, the earlier monitoring regimes are set up and key information about a sponsor’s performance and the positions being taken by key financial stakeholders is obtained, the better equipped trustees are to respond to an employer’s overtures for support or to defend a scheme’s position from the unintended consequences of any new or additional requirements being sought from other financial stakeholders.

The guidance identifies that, at times of distress, actions taken by employers, often under pressure from other financial stakeholders, can adversely affect the scheme’s position as a creditor or even cause scheme losses.

I would agree with this. Quite often the price for continued banking support, possibly at lower levels than previously provided, is incremental pricing and security that has an adverse impact on the scheme’s position. All too often, these requests, or a trustees’ knowledge of them, comes at the last minute where at first flush there might appear to be few options but to accept the proposition and take the medicine.

It is my experience that quite often such adverse consequences for the scheme are not intentional and proposals can be structured, or reworked such that the scheme, as a major creditor, can take part, or have its position protected. Or at least have the adverse impact minimised with options for being rewarded later on for lending support in the event of a successful restructuring or a return to profitability.

Preparation and protection

The guidance is very timely given the impact of COVID 19 and the prospect of a material increase in distressed sponsors and insolvencies when government support schemes (such as furlough) end at some point this year.

A key message is that trustees should act now to ensure they are prepared for the risk of employer distress and have more protections or triggers in place to protect their schemes from any negative impact in the event the worst-case scenario materialises.

In my view, it is in the best interests of the employer and the scheme for trustees to understand when underperformance is turning into stress, stress to distress and distress to the risk of insolvency.

Ideally, as a minimum, trustees should seek to ensure they are provided with early information that explains the declining performance of their sponsor, preferably before it turns into stress. It is also essential to understand the position of the sponsor’s other financial stakeholders and their capacity to alter the terms upon which they provide support to a sponsor. Matters to consider include lender covenant compliance, facility repayment and renewal dates and the implications of their interaction with audit sign off. Credit insurance arrangements or major contract renewal dates, production levels and order book sizes and lead times are also worth knowing about.

Quite often, and as a starting point, the key metrics used by management to understand the performance of the sponsor, and which are regularly reported upon at Board meetings, can form a major part of the information provided to the trustees.

Pro-active engagement

Finally, whilst it is ideal for triggers and consequent actions for breach to be agreed with employers, I recognise that in practise this is often easier said than done. If this is not possible, then it should not stop a trustee from having their own triggers to promote a conversation or pro-active engagement with an employer, or indeed consider whether they need to revisit the appropriateness or otherwise of say, valuation assumptions, investment strategy or transfer policies or to commence active contingency and additional communication planning.