Dear Trustee: Might your DB sponsor become another insolvency statistic?

The Insolvency Service has issued its Q3 2023 insolvency statistics (Commentary – Company Insolvency Statistics July to September 2023 – GOV.UK (www.gov.uk)) painting a stark picture of how the increasing economic challenges are hitting some businesses hard.  The brewing storm of rising borrowing costs, inflationary pressures and softening demand is now creating pressures on business that we have not seen since before the global financial crisis of 2007-2009. These statistics show these risks are now triggering corporate failures, in increasing numbers.

When it comes to employer covenant, our experience is that each employer will have its own set of key risks that are more likely to trigger or accelerate a decline into corporate distress, which may include restructuring or insolvency.  In any economic environment, it is crucial that trustees understand those key risks and have established, proportionate processes that monitor how those risk factors change over time.  Trustees will also need the necessary analysis to form an adequately informed and objective view of the overall covenant strength to support good risk management and decision making. 

Being prepared to spot the signs of emerging corporate distress means looking at much more than the most recent audited financial accounts.  It takes a strong commercial understanding of the sponsoring employer as it stands today, and careful, sponsor-specific consideration of the risk environment within which it operates.   

Given high current levels of company insolvencies, what should trustees be aware of with regards to covenants?

Trustees should hold a clear view of the key drivers of, and risks to, their sponsor’s performance and ensure those are kept under regular review, proportionate to the level of scheme dependence on the covenant. 

In order for trustees to be armed to spot the warning signs of distress they should have information sharing protocols in place to ensure visibility of adequate and timely information, and the right processes and skills in place to analyse and deliver a view on shifts in covenant strength. Looking more broadly, it is important to remember that failures both up and down the supply chain can create very sudden operational and financial shocks for scheme sponsors, quickly fuelling corporate distress. 

A well-developed and ongoing understanding of the internal and external risk landscape for the sponsoring employer will support good trustee decisions around the appropriate frequency and depth of covenant monitoring, and support the quality of that monitoring in itself.  

More often than not, consideration of covenant alongside each triennial valuation is far from enough to enough to warn trustees of emerging sponsor distress.

What actions do you recommend pension scheme trustees who are concerned take in this environment?

It is important for trustees concerned about the health of a sponsoring employer to follow the regulatory guidance, carefully consider their scheme’s position across various scenarios and develop a strategy to engage with key stakeholders as necessary. 

Trustees should be aware that restructuring and insolvency involving sponsors of DB pension schemes can be complex, technical and fast paced.  Trustees should take care to maintain contemporaneous evidence of decisions taken and be aware of their legal responsibilities to the scheme. As distress pressures increase on a sponsoring employer, often the options to secure the interests of the scheme can quickly diminish. Taking early advice can mean more options are available to improve outcomes for members of the scheme and often the future of the sponsoring employer.  

For schemes where the employer is not at risk but could be in the future, what should trustees do to prepare?

Exercising Integrated Risk Management (IRM) as part of good governance will ensure trustees are in a strong position to spot the early signs of corporate distress, allowing time to explore more options to protect the interests of the scheme and to develop an appropriate strategy.  Trustees may also benefit from reviewing the overarching governance to ensure that the right structure, skills, experience and processes are in place to best identify, monitor and manage the interests of the scheme in the event of corporate distress.

Trustees should set triggers that then ring alarm bells for emerging corporate distress and develop contingency plans for various corporate distress scenarios.  

Well prepared trustees will also have a clear understanding of any legal obligations to the scheme, legal recourse to contingent assets and their value, and a view of the likely outcome for the scheme in the event of various insolvency scenarios. They will understand the role, ranking and powers of various other stakeholder interests in the event of restructuring or insolvency.  

Specialist Covenant Advice & Support

Our team of covenant advisors have wide ranging experience across transactions, restructuring and insolvency and a deep understanding of DB pensions. We deliver bespoke services that range from covenant monitoring, through to strategic support engaging with stakeholders.

Take control of your covenant risks and opportunities

This article should not be relied upon as advice.  Trustees should consider the applicable regulatory guidance available at www.thepensionsregulator.gov.uk and https://www.ppf.co.uk/ and seek professional advice as necessary.