The Pensions Regulator has issued new guidance on assessing employer covenants aimed at preventing smaller or highly funded schemes from wasting time and money on costly advice.
Schemes have been increasingly encouraged by the regulator to take into account the effect of investment or funding plans on the sponsor’s financial position, as a strong employer is better equipped to help the scheme if needed.
If there’s a restricted flow of information [between scheme and sponsor] they should consider a weaker covenant
Simon Kew, Deloitte
The guidance states: “Assessing and monitoring the covenant should be proportionate to the circumstances of the scheme and employer, including the degree of reliance of the scheme on the employer now and in the future and the complexity of the employer’s operations.”
The need for a proportionate approach was seen as a key aspect by industry experts.
Lightening the cost burden
Ben Roach, partner at consultancy Barnett Waddingham, said it would reduce the need for “schemes that are particularly well funded, or… small relative to the free cash flow of the company” to seek regular external covenant reviews.
“Costs can be very high,” he added. “For large schemes, it’s a smaller proportion of assets, but for smaller schemes it’s more significant.”
“Where this is really useful is for trustees who think they have a reasonable covenant and think they know the business and pension quite well. it points out a few pitfalls for them.”
James Berkley, director in consultancy PwC’s pensions credit advisory team, said the guidance largely reflected the best practice of the market, codifying what is being done rather than proposing new approaches.
“There’s been greater focus on linking investing and actuarial with covenant, which is what the market’s been doing,” he said. “This is pretty close to the accepted best practice.”
Last summer, the regulator published a revised version of its Code of Practice 3 for funding defined benefit schemes, putting a greater focus on covenant and the employer’s potential for sustainable growth when formulating funding and investment plans.
“Trustees need to look at what knowledge and experience they have on the board,” Berkley said. “They need to have a good handle of the ability of the sponsor to underwrite the scheme risk.”
Simon Kew, assistant director of pensions advisory at consultancy Deloitte, said the guidance highlighted the need for communication and transparency between the company and scheme.
“If there’s a restricted flow of information [between scheme and sponsor] they should consider a weaker covenant,” adding the decision to do so could come from a position of caution but could also serve as a tool to highlight the benefits of sharing information.
The need for transparency is highlighted in the guidance, which says: “Trustees and employers should work openly and collaboratively together. A proportionate covenant assessment, aided by good information sharing, is in the employer’s best interests so the scheme does not pose an unnecessary risk to its future sustainability.”
Kew added that any monitoring of scheme or sponsor had to be proportional, to ensure resources were not wasted.
“It needs to be appropriate, and doing it for its own sake is not going to help things,” he said.
