Last week, the Pensions Regulator ("TPR") published guidance (the "Guidance") aimed at helping trustees of defined benefit pension schemes protect their schemes from sponsoring employer distress. The Guidance comes at a time where the economic strain caused by COVID-19 continues to build for many employers, with no clear answer as to when things will return to 'normal'. As a result, many trustees will be considering what they can do to protect their pension scheme if the sponsoring employer begins to struggle.
Although TPR recommends a holistic approach to reading the Guidance, three different scenarios are outlined, each with potential strategies which trustees can adopt to reduce the risk posed to the scheme by sponsor distress:
Best practice IRM approach:
The Guidance makes it clear that all trustees should adopt an integrated risk management approach to their scheme, as this will highlight problems early on and improve the prospects of protecting the scheme's position by allowing action to be taken before a sponsor shows signs of distress.
The Guidance sets out the following as the main actions that trustees should be taking under this approach:
- understand the employer's legal obligations to the scheme, the funding position of the scheme and the possible outcome for the scheme in a hypothetical insolvency;
- ensure effective risk management processes are in place;
- undertake a scheme governance review; and
- monitor the covenant to identify and mitigate sponsor risk.
Actions when sponsor showing signs of financial distress:
Knowing your sponsor's industry challenges and staying vigilant to early warning signs can ensure that trustees are in the best possible position to take action and reduce their scheme's exposure to any financial distress.
Where signs of financial distress are apparent, the Guidance encourages:
- early engagement with the sponsor;
- sound understanding of the role of other stakeholders;
- increased frequency of covenant monitoring;
- a review of the scheme's position and investment strategy; and
- mitigating action to be taken as soon as appropriate.
Where scheme easements are sought by sponsoring employers, such as a reduction in deficit repair contributions, trustees should ensure they fully understand the scheme's legal position, the obligations of the sponsoring employer and the effect that agreeing to the request will have on the scheme's position.
Trustees should continue to communicate effectively with members throughout periods of sponsor financial distress, consider whether additional communications are required and remain alert to the risk of scams and unusual transfer activity.
Actions when insolvency is likely:
Where sponsor insolvency appears likely, the following practical steps are recommended to trustees:
- seek professional advice from a specialist restructuring adviser before taking specific action, to ensure all options to protect the scheme's position have been explored and to help understand the potential impact of any employer restructuring plans on the scheme;
- consider enforcement options where the scheme has security structures in place;
- notify the Pension Protection Fund (the "PPF") under the notifiable events regime where obliged to do so;
- be familiar with the PPF's contingency planning guidance and engage with them to understand the practical steps to be taken to prepare the scheme for PPF assessment.
TPR recommends a holistic reading of the Guidance, taking into account all aspects which may be relevant to each scheme. In addition to the three approaches above, the guidance provides case examples illustrating how a scheme's position can decline in situations of employer distress and a list of warning signs for trustees to look out for.
Practical steps for trustees
Even where a scheme's sponsoring employer shows no sign of financial distress, the Guidance makes it clear that trustees should be adopting best practice principles to protect their scheme from potential downside risk in the future. Trustees should seek appropriate advice where required, particularly where specialist knowledge is needed to fully understand the funding position of the scheme, the sponsoring employer's obligations to the scheme, the funding arrangements and the options available to them. Additionally, trustees should continue to ensure good practice in relation to record keeping and fully document all decisions they take.
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