Refinancing Risks – Trustees are the First Line of Defence

15 / 09 / 2022

The Pensions Regulator (“TPR”) has published a blog describing trustees as “the first line of defence in the assessment and mitigation of corporate events that impact covenant, including refinancing“. We discuss below TPR’s expectations of trustees and sponsoring employers in relation to corporate events such as refinancing and the risks that refinancing may present to the employer covenant. Given the absence of the amended Notifiable Events Regulations, see Stop – Press in the Introduction to this Pensions Compass, the blog may be TPR’s attempt to fill the gap.

There are several considerations that TPR expects sponsoring employers and trustees to consider when refinancing which may have a material impact on the employer covenant. These can be summarised as follows:

1. Interest, costs and fees: how might changes in the cost of debt (interest and fees) impact the employer’s ability to pay pension contributions?

2. Debt structure: what is the impact of replacing one debt arrangement with another and will the debt-burden be increasing?

3. Security / guarantees: are any lenders taking security or guarantees for the sums they are lending and, if so, how do any changes impact the trustees’ claim priority as a creditor on an employer insolvency?

4. Financial covenants: what powers do the lenders have to call in their debt and how might any changes impact the trustees?

5. Restrictive covenants: are there any restrictive covenants which prevent or hinder the employer’s ability to pay deficit repair contributions or to grant security to the pension scheme?

6. Counterparty: to what extent may the trustees need to engage with any potential new lenders directly?  

Whilst none of the above points are necessarily new areas for trustees and sponsoring employers to consider, as markets rebound from the impact of Covid-19 but now face turbulent economic headwinds, refinancing has become more challenging. Lender concerns around climate change and ensuring adequate investment returns mean higher interest rates and tighter covenants with potentially more onerous security terms.

Key Point

It is critical for sponsoring employers and trustees to understand the implications of any refinancing on the pension scheme and the employer covenant, and to mitigate any detriment caused.

TPR expects trustees to engage well in advance of any potential refinancing to ensure that trustees have a strong understanding of the employer’s debt arrangements and to consider monitoring debt covenants. Similarly, TPR expects employers to provide meaningful and timely information on debt refinancing proposals to trustees. Not only may this include providing the relevant legal documents, but also forecasts and other information provided to the lender as part of the process.

TPR expects trustees’ understanding to extend beyond the basic quantum of the debt to consider the six points summarised above. For example, if additional debt is being introduced beyond that required to meet existing debts, TPR expects trustees to ensure they have a clear understanding of the purpose of any additional debt and associated risks to the covenant. Likewise, trustees should be cognisant in their analysis of the risks that could arise in the event debt is not refinanced e.g. the sale of any assets to meet an employer’s financial obligations.

Key Point

Early engagement between trustees and sponsoring employers is critical to assess the extent to which a corporate event is detrimental to the covenant.

Trustees of occupational pension schemes have a fiduciary duty to act in the best interests of their schemes’ beneficiaries, which typically means their best financial interests, and trustees must also have regard to the overall purpose of the scheme which inevitably includes the health of the employer. Pension scheme members will rightly expect trustees to engage with sponsoring employers and, if necessary, seek covenant and legal advice in relation to debt refinancing proposals. Therefore, in addition to TPR’s expectations, trustees arguably have a legal duty to engage with and understand the implications of any proposed new arrangements.

What are the risks of not adequately engaging with and understanding the impact of an employer’s refinancing proposals on the pension scheme?

Under the Pension Schemes Act 2021 (the “PSA 2021”), TPR has recourse to the criminal offences of:

  • avoidance of employer debt; and
  • conduct risking accrued scheme benefits,

including sanctions of unlimited fines and/or up to seven years imprisonment.

TPR can also impose civil fines of up to £1m in similar circumstances to the criminal offences.

TPR will have to show that the person concerned did not have a “reasonable excuse” for its act, or failings. Intent is an ingredient for the avoidance of employer debt. In contrast, risking scheme benefits is a broader test as it extends to where the person “ought to have known” as well as where the risk was known.

Key Point

Complying with TPR’s expectations when it comes to refinancing could help to provide evidence of having a “reasonable excuse” for the purposes of the criminal offences under the PSA 2021.

TPR’s blog can be read in full here:

If you, as a trustee or sponsoring employer, have any questions or concerns in relation to TPR’s expectations when it comes to refinancing, or other corporate events, please do not hesitate to contact a member of our team who would be happy to advise further.