The Pensions Regulator

Clearance

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Employer-related type A events

Assessing an employer-related event

31. To assess whether an employer-related event is a type A event, employers and trustees should:
    • compare and contrast the pre- and post-event employer covenant;
    • assess whether any weakening of the employer covenant is to such a degree that the event could be considered to be materially detrimental to the ability of the scheme to meet its liabilities; and then
    • identify whether the scheme has a relevant deficit.
32. In general, it is important to carry out these three steps in the above order because the outcome of the first two steps may determine what basis should be used for the relevant deficit. However, depending on the circumstances, it may be possible to form an initial view of the appropriate basis for the relevant deficit at the outset.
    
    

    The employer covenant

33. The employer plays a vital role as the scheme sponsor. It effectively underwrites the risks that the scheme is exposed to, including existing underfunding, longevity, investment and inflation.
34. The employer covenant and its strength is determined by: 
    • the employer’s legal obligations to the scheme; and
    • its financial position (both current and prospective).
35. Appendix A discusses how to assess employer covenant.
    
    

    Assessing whether there has been a weakening of the employer covenant

36. When assessing the pre- and post-event employer covenant, employers and trustees should analyse both the employer’s legal obligations to the scheme (to ascertain any change that might occur to the employer’s legal obligation to support the scheme) and the employer’s financial position (to ascertain any change in the financial strength of the employer and the wider employer group).
37. Appendix A discusses how to do this in more detail. 
38. Employers and trustees should consider whether the event has any of the effects listed in paragraph 26.
39. In order to assess whether a particular event weakens the employer covenant, it is often necessary to consider where the pension creditor sits in the allocation of proceeds in the event of the insolvency of the employer, and then consider the impact of that event on the potential allocation.
40. The scheme is usually an unsecured creditor of the employer. The priority of an unsecured creditor, with regard to the realisation of the assets of a company in the event of insolvency and when compared to other creditors, is broadly summarised below:
    1. creditors with fixed charges;
    2. preferential creditors;
    3. creditors with floating charges;
    4. unsecured creditors (usually including the pension creditor);
    5. subordinated creditors;
    6. equity.
41. When considering potentially detrimental events, it is therefore helpful to assess the effect on creditors, including the pension creditor.
42. Trustees and employers should also keep in mind the long-term nature of the employer’s pension obligation, and should therefore consider the employer’s long-term future.
43. An event may also be detrimental because of its impact on the ability of the employer to meet its ongoing funding commitments to the scheme. This could be because of an event’s effect on the employer’s cash flow or balance sheet, for example, because of an employer’s dividend policy, intra-group arrangements or debt repayments.
44. Assessing the impact of a possible type A event may be a complex process. Where trustees feel they may not have the necessary financial or legal skills to allow them to assess an event, they should consider obtaining independent professional advice. If trustees decide not to take independent professional advice, they should document the reasons for this decision (for example, because the cost of advice would be disproportionate to the possible detriment), as well as their views on the particular event.  
45. If a type A event is due to occur, the regulator expects that responsible employers will wish to pay for the trustees to obtain independent financial advice in relation to the event where appropriate.  Where trustees obtain such advice, applications are likely to progress more efficiently. 
    
    

    Assessing whether a weakening of the employer covenant is material

46. Where a weakening of the employer covenant has been identified by comparing the employer covenant pre- and post-event, the trustees and employers need to assess whether that weakening is materially detrimental to the ability of the scheme to meet its liabilities. The judgement as to whether an event is materially detrimental can be made by reference to and comparison of a number of factors, which may include:
    • the amount by which the employer covenant is weakened;
    • the size of the employer after the event; for example, the net assets of the employer or wider employer group;
    • the size of the scheme; for example, the value of the assets or number of members;
    • the amount of the scheme’s relevant deficit.
47. This judgement will often be a complex matter, for which both employers and trustees may need independent professional advice. 
    
    

    Identifying the relevant deficit

48. An employer-related event will not be a type A event unless the scheme has a relevant deficit.
49. The regulator's duty to protect pension benefits must be balanced with the choice of a sensible deficit trigger for operating a risk-based approach to clearance.
    
    
    Relevant deficit for employer-related events
    
    The general rule
    
    The relevant deficit for an employer-related event will usually be the highest of the scheme’s deficits according to the following bases:

    • FRS17/IAS19 (current accounting standards);
    • s179 (PPF levy basis);
    • technical provisions (scheme funding basis, where available);
    • ongoing (following scheme valuation, where technical provisions are not yet available).

    Exceptions

    • The relevant deficit will sometimes be measured by a higher basis, reflecting the impact of an event identified by trustees and employers where the employer-related event is significantly materially detrimental to the scheme’s ability to meet its liabilities (including where there is a significant weakening of the employer covenant).
    • The relevant deficit will be measured by the S75 basis where there are ‘going concern’ issues, the scheme is in wind-up, or there is scheme abandonment.
    
    

    The general rule

50. In most cases the appropriate relevant deficit will be measured on the higher of FRS17/IAS19, s179, technical provisions or ongoing bases.
    
    

    Exceptions

51. There are certain circumstances where the appropriate measure for the relevant deficit will differ from the higher of the FRS17/IAS19, s179, technical provisions or ongoing deficits.
52. Where the event is significantly detrimental to the scheme’s ability to meet its liabilities, including where there is a significant weakening of the employer covenant, then trustees and employers may judge that using the highest of FRS17/IAS19, s179, technical provisions or ongoing deficits as the basis for the relevant deficit does not properly reflect the impact of the event. In such cases, a higher basis would be appropriate.
53. Where there are reasonable doubts that the employer will continue as a going concern, where the scheme is in wind-up, or the event may result in scheme abandonment, then the s75 basis applies.
54. In addition, where the FRS17 deficit for the employer group cannot be allocated on a company-by-company basis, and technical provisions are not yet available, the trustees may consider that some other basis would be appropriate.
55. The relevant deficit is a trigger for clearance and is not an indication that employers and trustees should only fund schemes to this level.  If there is no relevant deficit, this is not an indication that the employer-related event is not detrimental to the scheme only that it is not a type A event.  Any identified relevant deficit does not restrict the trustees’, the employer’s or the regulator’s duties, powers and obligations, including in relation to scheme funding under Part 3 of the Act. The relevant deficit is designed to give clarity to the market as to when an employer-related event might be a type A event.
    
    

    Examples of employer-related events

56. Some examples of employer-related events that could be type A events include:
    
    • a change in priority – a change in the level of security given to creditors; for example, the granting or extending of a fixed charge or floating charge over assets of the employer or the wider employer group;
    • a return of capital – a reduction in the overall assets of the employer or the wider employer group; for example:
      • dividend payments (such as special dividends);
      • share buy backs;
      • repayment of subordinated debt; and
      • distributions in specie, including de-mergers;
    • a change to group structure, including a change of control; for example, a change or partial change to the control structure of an employer or a change to the parties who could be subject to a financial support direction, which reduces the overall employer covenant. This could include, for example, a change to the parent company or the ultimate holding company of the employer. Note that a change of control may be accompanied by new or increased debt, which may be secured. A change of control may be a notifiable event;
    • a change to the employer in relation to the scheme, including replacement of a participating employer or the merger of two or more employers;
    • sale and leaseback transactions in so far as these lead to a reduction of assets or adversely affect net cash available to support the scheme;
    • the granting or repayment of inter-company loans, particularly where the loan is not on 'arm’s-length' terms, where it is not properly documented or where there is credit risk;
    • 'phoenix events' – an arrangement resulting in the employer re-emerging as substantially the same entity following an insolvency event;
    • business and asset sales from the employer or the wider employer group, particularly where the transaction is not at arm’s length for fair value, where the sale proceeds are not retained, or where the whole or a substantial part of the operating business is sold; or
    • a corporate event that would reduce sustainable cash flow cover for the wider employer group’s funding commitment to the scheme; for example, an increase in debt or a reallocation of debt.
57. These are only examples, and this is not a complete list of employer-related events that could be type A events.
58. To establish whether there is a type A event in a particular case, a comparison of the pre- and post-event employer covenant is needed and the scheme must have a relevant deficit. In some circumstances events listed above will not be a type A event. 
59. For example, a change in priority is more likely to result in a material weakening of the employer covenant if it does not relate specifically and solely to new money.
60. Similarly, a return of capital may be more likely to be a type A event if any of the following apply to it:
    
    • it is made by an employer to the wider employer group;
    • it is made to an entity outside the EU;
    • it is made to a party who could not be subject to a financial support direction; or
    • it is a large or unusual return.
61. Measuring the effect of a change in control structure is difficult, but some guidance can be found in existing market practice, and in particular by looking at commonly applied financial ratios or banking covenants.
62. There are some employer-related events that may weaken the employer covenant but that result from normal commercial activity and may not be within the employer’s control, such as losing a key supplier or customer contract.  By themselves these are not generally type A events but trustees and employers should still consider the impact on the scheme, and the regulator may wish to monitor or investigate if there is possible employer insolvency or the scheme appears to be at risk. 
    

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