There is always a risk in life of worrying about yesterday’s problem while another comes straight at you.
And so it has seemed in employer covenant work for many schemes looking to conclude their valuations – where yesterday’s problem was coming out of COVID-19, and yet today’s problem is a billowing of economic turbulence – whether at sponsor or scheme investment level.
What has this meant for trustees and sponsors looking at scheme covenants?
“For many it has meant a rapid reappraisal – but not panicking. Looking at what 'is' rather than what they thought it might be, and adjusting, amending and flexing to make the pieces of the jigsaw fit the new reality.”
So what’s changed? The problems of cost inflation, tight labour supply, rising interest rates and supply chain disruption have all been extensively trailed. Their impact on sponsors will clearly be idiosyncratic and sector-driven.
We have seen a number of situations where economic uncertainty has led to fundamental reappraisals of a sponsor’s financial outlook – for better or worse – over narrow time frames. This has required flexibility and compromise in agreeing an appropriate valuation approach to meet statutory valuation deadlines.
The second trend, which is just starting for some, is increasing leverage tightness on businesses that needed to borrow to get through COVID-19 and have to now manage the economic headwinds as they seek to get back on track. The restructuring profession is famous for predicting that downturns are only months away – but reading informed commentary and looking at the realities faced by some businesses, it’s not hard to see that some may have tough times with their leverage later this year.
“In addition to the clear and present economic factors impacting businesses, arguably two of the largest impacts have been uncertainty and – more subtly – the knock-on effects of the latest wave of challenges on some already highly geared balance sheets.”
Another trend we have noticed as a result of the uncertainty is the mainstreaming of Information Sharing Protocols: these have proven to be a widely accepted tool by both trustees and sponsors and seem to us to be compelling as a means of keeping abreast of fast-changing circumstances.
Protocols will usually include “business as usual” information requirements – but importantly need to include “event-led” provisions so that trustees are kept abreast of strategic issues which may have a material bearing on covenant.
A linked trend we have observed – following PSA 2021 – is increasingly proactive notifications by sponsors to trustees of corporate activity: the secondary legislation around the notification provisions is still to be enacted, but The Pensions Regulator (TPR)’s message around early engagement clearly seems to have landed.
We consider that early notification of transactions to trustees will usually secure a better result for both the sponsors and the scheme as time can be taken to identify an approach which works for all in a measured way.
Finally, there has rightfully been an increasing understanding of the impacts of ESG factors, including climate change, on sponsor covenants. We have seen climate change make a material impact on sponsor business models (usually, but not always, through transition risks to the low carbon economy). Members of our team are proud to have been amongst the authors of various professional publications in this area – including the ECPA paper on climate change and employer covenant work.
Explore our insights and experience below, and get in touch to discuss how we can support you in the second half of 2022.
Our award-winning pensions advisory team are experts in supporting pension scheme trustees and sponsors through change and challenge.
