The Pensions Regulator

Clearance

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Appendix A: Assessing the employer covenant

161. When assessing the strength of the employer covenant it is necessary to assess both:
     
     • the employer’s legal obligations to the scheme; and
     • its financial position (both current and prospective).
162. Also relevant in the context of type A events and an application is the covenant of the wider employer group. This is always relevant but will be of particular importance where:
     
     • the financial position of the identified employers is not of sufficient strength to support the scheme;
     • the event affects the financial position of the wider employer group, for example by removing entities from the group or transferring assets (whether within or outside) the group;
     • the employers have indicated that the trustees should take the financial position of the wider employer group into account when assessing the employer’s financial position;
     • there is existing support for the scheme from the wider employer group, for example in the form of a parental guarantee; or
     • there is interdependency between entities in the wider employer group and the employer.
163. Employees and trustees should remember, though, that only certain members of the wider employer group (employers or those with contractual obligations) may be legally liable to contribute to the scheme. Therefore, whilst the wider employer group is always relevant, trustees should be cautious about over-reliance on the wider employer group. 
164. When assessing the employer covenant, trustees may also consider the employer’s willingness to fund the scheme. However, they should be aware that assurances from the employer that are not legally binding may not protect the position of the scheme.
     
     

     Assessing the employer’s legal obligation to the scheme

165. To carry out a covenant assessment it is always necessary to identify the legal employers in relation to a scheme. This is important, because the scope of legal obligations to the scheme will define the extent of support for the scheme that trustees can legally enforce. The financial position of the employer and other relevant parties will determine the extent to which any legal obligations can be met.
166. Identifying the employers, and analysing and assessing their legal obligations to the scheme, can be a complex process and will normally require legal advice. Employers and trustees should identify:
     
     • those employers who could be liable, now or in the future, to pay a s75 debt, and ascertain the likely amount of the s75 debt that may become due from each employer in a multi-employer scheme (which may depend upon the circumstances in which the s75 debt arises and the trust deed and rules as well as legislation and any scheme apportionment arrangement, regulated apportionment arrangement, withdrawal arrangement or approved withdrawal arrangement);
     • those employers required by a statutory schedule of contributions to pay contributions to the scheme and, in a multi-employer scheme, assess the proportion of the total contribution that is payable by each employer; and
     • those employers participating in the scheme and who are bound by the scheme’s trust deed and rules, and identify the employer’s powers and obligations under the deed and rules.
167. Depending on the circumstances, it may also be appropriate to identify: those employers whose insolvency could result in the scheme entering an assessment period.
168. In some cases, former employers will be included in the above categories because of the relevant statutory definitions.
169. It is important to remember that some employers may not fall into all of the above categories.
170. Where a review of the wider employer group is appropriate, it will also be relevant to identify which parties are within the wider employer group.
171. Other legal obligations of either the employer or another entity in the wider employer group to the scheme will also be relevant, for example, in any guarantee, ancillary deed or agreement.
172. The legal relationships between the employer and the rest of the wider employer group are also relevant because these could have an impact on the employers.
173. The legal domicile of the employers and the wider employer group should also be considered.
     
     

     Assessing the employer’s financial position

174. Assessing an employer’s financial position can often be a very complex process, and may require independent professional advice where there is likely to be a materially detrimental event. The level of detail necessary for such a financial review will usually be proportionate to the level and materiality of the potential detriment.  The relevant factors to consider in assessing the current and prospective financial position of the employer (and, where relevant, the wider employer group) may vary depending on the nature and effect of the detrimental event, and may include:
     
     • the nature and prospects of the industry in which it operates;
     • its competitive position and its relative size within that industry;
     • its management ability and track record;
     • its financial policies;
     • its profitability, capital structure (including balance sheet and financial leveraging), cash flow and financial flexibility; and
     • its credit rating (if any), which may have some bearing on these considerations. However, the credit rating on its own should not be seen as a substitute for an independent review, unless the detail of the analysis behind the rating is made available and is acceptable to the trustees.
175. For many detrimental events, the nature and structure of the wider employer group will also be relevant, including the ultimate owners of the employer or the wider employer group. The extent of a review of the wider employer group will depend upon the nature and materiality of the event. Relevant considerations may include:
     
     • the legal domicile of the entities within the wider employer group, including the ultimate owners;
     • any restrictions or limits on capital and cash flows within the wider employer group;
     • whether there is interdependency between the wider employer group and the employer, for example:
       
       • whether the employer is providing services to the rest of the group;
       • whether the employer services debt that sits elsewhere in the group;
       • whether there is security over the employer’s assets in respect of any debt; or
       • what additional funds, if any, exist within the wider employer group that the scheme may have recourse to, either through a financial guarantee or other legal right;
     • what additional covenant, if any, is provided by the wider employer group, and whether the structure of the wider employer group adds strength to the covenant of the employer;
     • any investment timeframe of the ultimate owners, covering the manner in which they extract returns on any capital invested and whether the ultimate owners have any legal obligations to support the scheme;
     • the potential for the scheme to have access to additional funds from the wider employer group; and
     • the nature and enforceability of any contingent security provided to the scheme by the wider employer group.
176. Employers and trustees should be careful to review the financial position of the employers and the wider employer group in the context of each entity’s legal relationship with the scheme and the extent of its enforceable obligations.
     
     

     Information from the employer

177. Information that may assist with the assessment of employer covenant may include the types listed below. The level and type of information that is appropriate will depend upon the nature and materiality of the event. Types of information may include:
     
     • updates on the group’s financial position, including key performance data and future business plans;
     • statutory company accounts (and management accounts if appropriate) to ascertain its profitability, capital structure, cash flow and financial flexibility;
     • independent business reports;
     • confirmation of compliance with banking and other creditor covenants;
     • information relating to security that has been or will be granted;
     • any reviews of the scheme, or any plans or proposals in relation to the scheme;
     • information from rating agencies or credit scoring institutions;
     • information from credit specialist advisers;
     • information that relates to the risk-based element of the PPF’s levy;
     • any new developments in the credit advisory services market aimed at assisting the trustees to evaluate the employer’s financial position; or
     • publicly available information such as press reports and the employer’s website.
178. 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 type A event that may occur with the trustees at the earliest opportunity. This should also help the application process proceed more quickly and efficiently. The confidentiality of information is discussed at paragraphs 105 to 107. 
179. Much of the information provided to the regulator is restricted information, which means that the regulator is restricted by law from disclosing the information without consent, although some statutory exemptions apply.
180. Under the scheme administration regulations, the employer and its auditor or actuary is obliged, on request, to provide trustees with such information as the trustees or their professional advisers reasonably require for the performance of their duties. This includes information reasonably required to assess the employer covenant.
181. The employer is also required under the scheme administration regulations to make the trustees aware, within one month of its occurrence, of any event that could reasonably be considered of material significance to the trustees or their professional advisers in the exercise of their functions. This includes type A events and any events that may impact on the benefits of scheme members. In practice, the regulator would expect employers to notify trustees of type A events much earlier. 
     

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