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The opdu Report - Issue 23, November 2007 Why would trustees be interested in clearance? After all, it is a procedure used voluntarily by an employer to obtain assurance from the Pensions Regulator that the Regulator will not issue a financial support direction or a contribution notice in respect of a particular event (such as a corporate transaction). However, the Regulator has issued, in draft, revised clearance guidance which is much more trustee focussed. If the guidance is finalised in its current (or similar) form (consultation ended on 2 November, and finalised guidance is expected before Christmas), trustees will be expected to play an increased role. This will relate not just to the clearance process itself, but also to regularly monitoring the employer covenant and the trustees are encouraged to approach the Regulator if inadequate mitigation of damage caused by the event is offered. Some of the key proposed changes are listed below. Type A events The definition of a type A event, being an event which has a materially detrimental impact on the pension scheme and about which the Regulator should be made aware, has not changed. However, type A events are separated into employer related and scheme related events, and further examples of type A events are provided. Type B and C events, for which clearance applications were not appropriate, have been removed altogether. Employer related events In addition to the current examples of a change in priority, a return of capital, and a change in control structure, the Regulator has added a further six examples (not exhaustive) of these events:
Is the event type A? As with the existing guidance, an event falling into one of the above categories does not, in itself, mean that an application for clearance ought to be made. The parties will need to consider whether the event is likely to materially impact on the pension scheme. However, the existing guidance is very prescriptive, with almost a checklist approach to whether an event is type A. In the proposed guidance there is a move away from this ‘one size fits all’ approach to a more principles based approach, with the emphasis on the overall impact of the event on the pension scheme. With regard to employer related events, there are three considerations that need to be taken into account in determining whether the event is type A. Trustees and employers need to:
Compare and contrast the pre- and post-event employer covenant Trustees will need to assess the employer’s legal obligation to the scheme. The guidance says this can be a complex issue and will normally require legal advice. Trustees will also need to assess the employer’s financial position, both current and prospective. The list of criteria to be taken into account in making these assessments runs to some 4 pages in the revised guidance. By contrast, in the current guidance, there is one line saying trustees must understand the employer’s financial situation and its commitment to the pension scheme. Further, this is in the context of negotiating with the employer once an event has been classified as type A. No assistance is given as to how trustees obtain this under-standing. The revised guidance is helpful in giving trustees a steer on this point. However, there is little doubt that it vastly increases the trustees’ role both in determining whether an event is type A (thus requiring them to be more heavily involved at an earlier stage) and also in ensuring they have a sufficient under- standing of the employer covenant. Assessing whether there is a material weakening of the employer covenant The guidance indicates that whether a weakening of the employer covenant is material will often be a complex matter on which trustees may need independent professional advice. The guidance states that “if trustees decide not to take independent professional advice, they should document the reasons for this decision, as well as their views on the particular event”. In practice, it will be increasingly difficult for trustees not to take advice and there is also the issue of who pays for the advice. Identifying relevant deficit An employer related event will not be a type A event unless the scheme has a relevant deficit. In most cases, this will be the higher of a scheme’s ongoing funding level, its technical provisions, FRS17/IAS19 or the section 179 (PPF) basis (the latter being a new addition). Scheme related events In addition to compromise agreements, there are three further examples of scheme-related events:
A scheme does not have to be in deficit for a scheme related event to be a type A event. It is still the case that any attempt to compromise the pension debt is always a type A event. Helpfully, considerable guidance is given on assessing whether apportionment of a scheme’s deficit is a type A event. What happens once an event is identified as type A? The hard work for trustees is not over. In fact, it is just beginning. Perhaps the biggest change for trustees is the emphasis on mitigation and negotiation where a type A event has been identified. Unfortunately, although the revised guidance lists different types of mitigation, there is little direction on how to determine the appropriate type of mitigation in various circumstances. Again, trustees are told they should seek appropriate independent professional advice to ascertain what they should seek in negotiations (and also to assist them in the negotiations if they do not have the neessary negotiation skills). Trustees will be expected to enter into negotiations whether or not the employer wishes to apply for clearance. Significantly, the guidance states “where a application for clearance is not being considered and the trustees are concerned that no mitigation is being offered, or that mitigation is inadequate, they should consider contacting the regulator”. This places a heavier burden on trustees to whistleblow where they consider (usually with the benefit of professional advice) that the employer is not behaving appropriately. Trustees are expected, as at present, to be involved in any application for clearance. The Regulator states “as part of a clearance application, the trustees will be asked to comment on whether or not they support the application”. Monitoring the employer covenant As well as being involved whenever a potentially detrimental event is planned, trustees need to keep the employer covenant under regular review. Trustees are expected to form a view of the employer covenant, effectively as a benchmark, with the help of (you guessed it) independent professional advice. Employers and trustees are expected to put in place procedures (including confidentiality agreements) allowing information to be shared so that shifts from the benchmark may be reviewed. One example of information that “may be routinely supplied” by the employer to the trustees is ‘an early indication of any event that may potentially impact on the employer or the scheme; such events would include, but not be limited to, type A events and notifiable events’. The level of detailed scrutiny required by the Regulator of trustees in monitoring the employer covenant seems to be much higher than the level likely to be implemented by an unsecured creditor on the employer. It may be that this scrutiny will unduly hamper business transactions and re-structuring. Conclusions The revised guidance places an additional burden on trustees to obtain professional advice in five different situations. The current guidance only specifically refers to obtaining professional advice in cases of conflict. If they do not obtain advice, the onus will be on trustees to explain why not. It is likely that the guidance will increase the situations where trustees feel they ought to take advice, simply to protect their position, and even if they are clear on the way forward. This raises the issues of cost and delay before advice is given and, more fundamentally, whether the Regulator’s touch has become heavy-handed. There is also little doubt that trustees will need a greater understanding of the employer covenant (on an ongoing basis as well as when an event arises). Trustees ought not to hold back in ensuring they are supplied with the information which the Regulator expects employers to provide. Trustees will be active at an earlier stage, and may potentially come under pressure from the employer to agree to an event not being type A, or to agreeing a lower level of mitigation than they would like. Whilst trustees will need to be mindful of the commercial importance of any event to the employer, it is also very important that trustees do not feel pressured into agreeing something which leaves them feeling uncomfortable. They are likely to regret doing so should the Regulator or the scheme beneficiaries query their actions at a later date. Harold Lewis
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