UK: Protecting Defined Benefit Pension Schemes – proposals for a stronger Pensions Regulator

Last Updated: 20 August 2018
Article by Mark Howard
Most Read Contributor in UK, November 2018

Following on from the March 2018 White Paper - Protecting Defined Benefit Pension Schemes - the Government has issued the first of its promised further consultation papers considering in more detail the proposed changes to the Pension Regulator's powers.

The proposals in the consultation are designed to improve the Pensions Regulator's powers so that the Regulator:

  • can be more proactive and get involved earlier where employers make changes which could affect the pension scheme;
  • can obtain the right information about a scheme from its sponsoring employer; and
  • are able to gain redress when things go wrong.

Our commentary on the March 2018 White Paper is available here.

Notifiable Events

The notifiable events framework requires trustees and employers to inform the Pensions Regulator of certain events to give advance warning of circumstances which could lead to insolvency and a claim on the PPF. The White Paper had identified this as an area for reform, both in terms of the events to be notified and when the notification should be given.

The proposal is for a broader range of employer-related events which require notification. To balance improved transparency for the Pensions Regulator with the additional burden on businesses, it is envisaged that only transactions exceeding a certain risk threshold should be notified. This threshold would be determined by the Pensions Regulator.

The new notifiable events being proposed are:

  • Sale of a material proportion of the business or assets of a scheme employer which has funding responsibility for at least 20% of the scheme's liabilities. It is not clear what measure of scheme liabilities will be adopted for this purpose.
  • Granting security on a debt to give it priority over debt to the scheme.
  • Significant restructuring of the employer's board of directors. This would encompass an appointment of a "chief restructuring officer" or "chief transformation officer" (or similar) and changes to two out of three of the chairman, chief executive office (or equivalent) or chief finance officer (or equivalent) in a six month period.
  • Sponsoring employer taking independent pre-appointment insolvency / restructuring advice. The current notifiable event of "wrongful trading of the sponsoring employer" will be removed as experience has shown that an employer wrongfully trading is unlikely to admit it by reporting to the Pensions Regulator.
  • The current notifiable event of "breach of a banking covenant" will be widened to include covenant deferral, amendment or waiver. This could have a significant impact as covenant deferral, amendments or waivers are not uncommon. It is also unclear how the widened notifiable event will interact with loan agreements which allow a borrower to cure a default by injecting more cash into the business or where a breach of a financial covenant only gives rise to an event of default if it is breached on consecutive testing days.

Declaration of Intent

A declaration of intent will be required at a later point in a corporate transaction than a notifiable event, where there is greater certainty as to whether the transaction is going ahead. This will be after due diligence and transaction financing has been finalised, but before the sale and purchase contract has been signed.

The declaration of intent will oblige companies to think about the effect of corporate decisions on pension schemes and at an appropriately early point in the transaction. It is intended to form part of an enhanced "early warning system" as all parties will be aware of concerns and proposed mitigations earlier than is currently the case.

Declarations of intent will apply to:

  • sale of controlling interest in a scheme employer;
  • sale of the business or assets of a scheme employer; and
  • granting of security in priority to scheme debt.

The declaration of intent would be addressed to the trustees from the transaction's corporate planners (usually the Board of the company) and would be shared with the Pensions Regulator. It would:

  • explain the nature of the planned transaction;
  • confirm that the trustees have been consulted with and confirm the trustees' agreement (or otherwise) to the planned transaction; and
  • explain any detriment to the scheme and how this is to be mitigated.

Contribution Notices, Financial Support Directions and Clearance

Contribution Notices can be imposed where employers or connected parties act in a way which is materially detrimental to the scheme. A number of changes are proposed:

  • Amending the "reasonableness test" so that there is a stronger focus on the loss or risk caused to the scheme.
  • Changing the date on which the cap on the level of the contribution notice (the section 75 debt) is determined, so it is closer to the date of the final determination than the date on which the "act" attracting the contribution notice occurs. This is aimed at mitigating the risk that the deficit increases during the time it takes the Regulator to take enforcement action. A mechanism will be introduced so that the contribution notice sum can reflect the impact of a delay in payment.
  • Amending the material detriment test so that is can be assessed by reference to the weakening of the employer strength.

Financial Support Directions (FSDs) can require a company associated with a sponsoring employer to provide financial support for a scheme. Proposed changes to the FSD powers are:

  • Creating a single stage process under which the FSD is imposed with a specific and enforceable obligation on the target.At present the FSD is imposed and the target must then agree the support with the Pensions Regulator, failing which a contribution notice is imposed. The aim is to make the process of obtaining the financial support quicker once the FSD is imposed.
  • Financial support is to be provided in the form of either cash or a statutory guarantee.
  • Reviewing the "insufficiently resourced" criteria for whether an FSD should be imposed.
  • Allowing FSDs to be imposed on a broader range of individuals.
  • Allowing the actions of a target in creating or increasing risk for the scheme to be taken into account when assessing whether an FSD should be imposed.
  • Providing the Regulator with the power to impose a contribution notice on any person connected or associated with an FSD recipient.
  • Increasing the "lookback" period for imposing an FSD beyond the current two years.
  • Allowing an FSD to be imposed after a scheme has transferred to the PPF.

Employers can apply to the Pensions Regulator for clearance for a particular transaction. This is a voluntary process and, if granted, is a formal confirmation from the Pensions Regulator that it will not use its Contribution Notice and /or Financial Support Direction powers in relation to that transaction. The Pensions Regulator will be reviewing its clearance guidance in light of the proposed changes, but no changes to the legislation governing clearance are envisaged.

Improved Regulator Powers

Primary legislation will be introduced to widen the circumstances in which fines and criminal proceedings can be used, so that the Pensions Regulator has a comprehensive suite of powers to use in varying circumstances:

  • The existing civil penalties of up to £5,000 for an individual or £50,000 for a company for low-level non-compliance will be maintained.
  • A new civil penalty – of up to £1 million – will be introduced to deter behaviours which are more serious and which result in actual harm to a pension scheme (or have the potential to do so if left unchallenged). This could be applied for non-compliance with the updated Code of Practice for defined benefit funding.
  • New criminal offences for "wilful or grossly reckless behaviour in relation to a defined benefit pension scheme", non-compliance with a contribution notice and a failure to comply with the notifiable events framework.

Clyde & Co Comment

The changes to the notifiable events framework – backed up by the new civil penalty or criminal sanctions – and the declaration of intent will have a significant effect on corporate activity where there is a defined benefit pension scheme. It will force companies to engage with trustees at an early stage in a transaction (something which surprisingly still does not always happen). It is also unclear whether members will be able to see the declaration of intent. Whilst a transaction is on-going there would be an understandable reluctance due to commercial sensitivity. But if it proceeds, members might argue that they have a right to see how the security of their pension was taken into account.

The application of the new larger civil penalty– and the prospect that it could be applied to sponsoring employers for failing to comply with the defined benefit funding Code of Practice - is also a significant change to the Regulator's powers and ability to take action against sponsoring employers over scheme funding.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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