The Pension Schemes' Act 2021 introduced new tougher powers for The Pensions Regulator ('TPR') which, for sponsors of Defined Benefit pension schemes, potentially bring into scope a wide range of business activities, such as refinancing, Group restructuring and distributions (both within the Group and external).
In particular, sponsors need to be able to demonstrate they have considered the potential impact on the DB pension scheme in key business decisions, and potentially provide additional support to the scheme if there is a risk of the activity negatively impacting on the scheme's covenant (or set out clearly the rationale for why such support would not be needed).
Now more than ever, sponsors need to be proactive to develop and drive an overall pensions strategy and work with trustees to ensure alignment with the wider corporate strategy of the business in order to avoid unintended consequences of key business decisions.
For example, we are seeing in practice that the new TPR powers are giving trustees more leverage in discussions around M&A activity but also in ordinary commercial activity such as payment of dividends.
This can lead to potential roadblocks for the sponsor if such activities are not identified upfront and analysed to determine the potential associated level of regulatory risk. Where this risk is high, the company may consider there is a need to mitigate this by reaching an agreement with the Trustees to provide further support to the scheme (eg cash or security), or will want to clearly document the reasons why mitigation is not being considered (eg on account of wider covenant support / pre-existing agreements with the trustees). It is important there is a clear process in place to address this ahead of the proposed activity to avoid falling foul of TPR’s expanded powers.
For some sponsors these requirements may prove onerous and so they may conclude this additional regulatory risk drives a business case for seeking to buy-out the Scheme in the short term (and so provide greater flexibility in future).
For example, this may be the case where the buy-out deficit is relatively small in context of the business, or where the overall business is so complex that there is an extensive need for covenant monitoring and for management to be on the look-out for potential activities falling foul of the new TPR powers across the Group.
However, for many sponsors the current financial position of the scheme means that the cash required to buy-out in the short-term would not represent value for money. (Some of these sponsors may still wish to target a buy-out in the longer term, while for others the preference will be to run the scheme on rather than transfer to a 3rd party).
Irrespective of whether buy-out or run off is the longer-term target, the sponsor will need to have a robust governance process in place for managing regulatory risks over the years to the benefits being settled, to guard against negative or unexpected effects on the corporate strategy of the business.
Assessing the impact of key business decisions on the Scheme
It's worth noting the Scheme’s buy-out deficit is increasingly prominent under TPR's new powers (irrespective of whether this is the scheme’s longer-term funding target). In particular, the percentage recovery of the Scheme’s buy-out deficit is now a core metric used by the Regulator to assess whether to use its Contribution Notice powers as a result of many activities which are conducted as part of normal business.
As such, schemes targeting a run off approach will still need to consider this measure and trustees will focus on this measure in discussions with the sponsor around the impact of corporate events.
How can the regulatory risk be managed in practice?
The sponsor will need to be able to identify in advance any business activities which could potentially be drawn into the net of the new TPR powers. This could include some activities which it traditionally considered ‘ordinary commercial activity’, for example moving cash funds around its group or a parent company paying a dividend.
Once an activity is identified, there is a need to assess the potential impact on the scheme (through the lens of the two new contribution notice tests) and to establish if there is a need to engage with the trustees (or with TPR) and/or to provide mitigation to the scheme. Clear contemporaneous records of decision-making will be key, as noted in TPR’s guidance.
For most sponsors, understanding the practical implications of the new TPR powers (rather than the full technical detail) will be key – we set out below 5 crucial steps to help company directors avoid unwanted TPR scrutiny and to manage reputational risk:
1. Company Board training on the new powers
Ensure the Company Board is aware of the new TPR powers and requirements – especially the additional corporate and personal risks of the new criminal offences, financial penalties and contribution notice tests.
2) Review corporate governance procedures around key business decisions
Put in place checks around key ‘normal’ (eg cash pooling arrangements, refinancing, dividends); and more ‘ad-hoc’ (eg group restructuring/M&A) business decisions which may impact on the covenant support to the pension scheme.
This may involve seeking external specialist pension covenant support, to ensure that management is in a position to assess the impact of key business decisions on the pension scheme in advance.
3) Consider how documentation and record keeping will work
Consider how the outcome of the impact assessment of the business decision on the scheme will be documented and communicated to key decision makers within the business and to the trustees.
The recently issued guidance from TPR is clear that contemporaneous records of how the scheme has been considered in decision-making will be critical in the context of any regulatory investigation.
4) Review any information sharing agreements with trustees
Review the information sharing agreement with the trustees (or introduce one if not already in place) to ensure that the company is providing the right information to trustees at the right time.
The agreements should cover notification of upcoming ‘at risk’ events with timescales for sharing the information, as well as the provision of ongoing covenant metrics (balance sheet, P&L info, cash forecasts etc).
5) Ensure you have processes in place to meet Regulatory reporting requirements
Be aware of the new Notifiable Event and Statement of Intent requirements – and ensure that company directors understand the thresholds for notification to TPR and the required timescales.
The impact of the new powers are already starting to be felt in terms of the discussions between trustees and sponsors on ‘normal business activity’ and in M&A activity. Managing regulatory risks needs to be a component of the sponsor’s thinking in the context of the timescales for reaching the ‘end game’.
You can read more on details behind the new regulations and guidance on the ‘TPR powers’ section of our Pension Schemes Act hub
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