Introduction
Background
The government’s policy intent in introducing the two new alternative ‘act’ tests to the existing CN power is to focus on the effect of an act on an employer, which in turn affects its capacity to support the scheme. These ‘snapshot’ employer-impact assessments contrast with the existing ‘material detriment’ test (which looks at the effect of an act on the prospect of scheme benefits being paid many years into the future) and offer an alternative route to engaging our CN powers.
The new tests measure the impact that an act, or failure to act, has had on the employer relative to the scheme on a snapshot basis, comparing the situation with and without the act. The employer insolvency test considers the impact of the ‘act’ on the hypothetical insolvency outcome for the scheme, and the employer resources test considers its impact on the value of the employer’s resources, relative to the scheme’s deficit.
The Pensions Act 2004, as amended by the Pension Schemes Act 2021, sets out a legal requirement for us to publish a code setting out the circumstances in which we expect to issue a CN if we consider that either of the new tests have been met. This is an addition to the previously existing requirement to produce a code on the circumstances in which we expect to issue a CN if consider that the material detriment test is met.
We have approached this requirement by updating Code of Practice 12 to include the new tests. This new draft code now includes examples of circumstances that could meet some, or all, of the three tests. We have also taken the opportunity to update and clarify the circumstances in the code, and corresponding examples in our guidance, based on our experience to date.
Consultation responses
We received a total of 17 responses from stakeholders, including advisers, industry associations and employers, among others. We would like to thank all those that participated as their feedback has been significant in addressing some aspects of the code and the code related guidance.
Key themes raised
Respondents noted that some of the changes introduced to the code and the code related guidance are helpful. However, they highlighted a number of suggested improvements, including whether more practical guidance could be provided on how we will go about using the new tests. Some also questioned whether we could explain better the materiality threshold for each of the two new tests. While respondents appreciated the updated examples that illustrate the circumstances in which the tests could or could not be met, they asked whether the examples could be improved by changing specific wording and adding more examples in which the tests would not be met.
A minority of respondents made comments about the specific technical drafting of the tests, although they generally appreciated this is a matter of the legislation as drafted by DWP (the Department for Work and Pensions).
The final version of the code and the code-related guidance has been changed in response to some of the feedback we received. In the next section we explain how we have responded to some of that feedback.
Comments received and our response
We asked:
Is our overall approach in the draft code and code-related guidance consistent with the policy intent behind the changes introducing the two new alternative ‘act’ tests to the CN power?
You said:
The feedback to this question was mixed - some respondents said our approach was right, while others disagreed. In general, most highlighted that we could provide more guidance on how we will go about using the new tests. Some suggested this could be achieved by improving the information provided by the examples, while others asked for specific practical guidance on how we will use the tests. Some respondents highlighted that the two new tests are subject to a materiality assessment and wanted to know more about how we will approach that.
Some respondents also highlighted the possible interaction with the new civil penalties and the new criminal offences for avoiding pension scheme debt and conduct risking accrued members benefits. Finally, many asked about our timings for the update of the Clearance guidance, as that would be helpful given the introduction of the new tests.
Our response:
The update to this code and code-related guidance follows the legislative requirement, as set out in the Pension Schemes Act 2021, to provide an updated list of circumstances in which the tests could be met. We are confident that this update fulfils such requirement. We note some respondents call for more practical guidance on the use of our CN power, but we believe it would be more helpful to do this as part of a separate piece of guidance and will consider publishing such guidance in the future. What is material will depend on the circumstance of the case, so it would not be practical for us to set out materiality thresholds, as these will necessarily be different depending on the case under investigation. We are consulting on an Overlapping Powers Policy, setting out our approach to situations in which our financial penalty powers could be engaged, and we have consulted on and are publishing a document setting out our approach to situations in which our criminal powers could be engaged.
Some respondents requested an update to the clearance guidance to account for the new tests – read a revised version of the clearance guidance.
We asked:
Is the code clear on what the tests are and the circumstances in which we will consider any of the tests to be met? If not, how could we make it clearer, without limiting the scope of the tests?
You said:
In general, respondents said that the description of the tests is helpful but raised questions about some elements of subjectivity inherent in the legislation, such as what is material, and how we will go about using the tests in different circumstances. Some also highlighted that each test has a statutory defence and requested guidance on when those might apply and how we would assess whether the defences are made out.
Some respondents also asked whether we would need to balance the tests where an act could have an adverse impact under the employer insolvency versus a positive impact under the employer resources test. Some also commented on the metric chosen for the employer resources test.
Our response:
We note respondents’ call for more examples or more guidance on how the tests will be used, or a comprehensive list of examples in which the tests could be met or not. However, providing such list would not be feasible nor helpful, given that the decision to impose a CN on a target also depends on whether it is reasonable. The examples in the code do not contain a reasonableness assessment.
Similarly, providing thresholds on materiality or on how we would assess specific elements of the test would be impractical, as what is material or what we consider to be necessary to calculate the tests, other than those as set out in the legislation, would depend on the circumstances of the case.
Some respondents have commented on how we would consider balancing the fact that one test could be met and the other not. For example, taking on a new debt to grow the business could meet one test, but the purpose of the act would result in a good outcome for the employer and the scheme. As explained in the code, even if a test is met, we won’t automatically issue a CN as we will also need to demonstrate that it would be reasonable for us to take such action.
The purpose of the code and its related guidance is to set out the circumstances where a CN could be issued and illustrate them by way of examples. Because of this we do not believe it would be helpful to set out how we would assess whether a target could make the statutory defence as this will depend on the circumstances of a case.
In relation to the metric of the employer resources test and how it sets out the way that different terms should be calculated, this has been set out in DWP regulations that have already been consulted on.
We asked:
Are the examples provided in the code-related guidance useful in illustrating the circumstances in which we might consider the new ‘act’ tests to be met? Are there any other examples you would consider helpful?
You said:
Most respondents asked for more nuanced examples introducing some of the complexity that is likely to take place in practice. Some also suggested incorporating case studies that illustrate all the steps involved in a typical CN case investigation, including giving very specific feedback on what examples might look like.
Our response:
We understand respondents’ ideas about more complex scenarios, but the purpose of this code and its guidance is to illustrate possible situations in which the tests could be met, rather than doing a thorough analysis of all the factors that could lead to a CN being imposed.
Respondents’ feedback on the specific examples was useful and we have updated many of them to improve clarity. We have removed two examples that would not normally be materially detrimental to the likelihood of members receiving their accrued benefits or meet the employer insolvency or employer resources test. We have replaced these with an example concerning the sale of assets and reduction of covenant, where the covenant remains strong enough to cover the scheme’s s75 deficit by a significant margin. We have also included a new example in relation to guarantors that we consider may fall within the circumstances outlined in the code.
Appendix: List of respondents to the consultation
We received 17 responses in total. 11 of the respondents gave their express consent to be listed, with 6 either requesting confidentiality or not specifying consent at all.
- Association of Pension Lawyers
- Employers Covenant Practitioners Association
- Institute for Family Business
- ISIO
- Lincoln Pensions
- Mercer
- Penfida Limited
- Pensions Management Institute
- Sackers
- The Society of Pension Professionals
- Travers Smith