Legal Panel (November 2007) - Making things clear

Chairman: Edwin Mustard, partner, Shepherd Wedderburn
Mustard joined the firm in 1993. He has a wide range of experience in pensions law work, advising employers, trustees and pension providers on occupational and personal pension/stakeholder schemes. He is a full member of the Association of Pension Lawyers.

Jennifer Bell, partner, Nabarro
Bell is a partner in the pensions team and editor of the Pensions Law Handbook. Her experience includes general advisory work covering all aspects of occupational pensions for both sponsoring employers and trustees, including Finance Act 2004 issues, age discrimination and corporate transactions.

Monica Ma, partner, Simmons & Simmons
Ma is a partner in the pensions department of Simmons & Simmons. She has wide range of pension experience including the design, establishment, revision and winding-up of pension schemes. Ma also advises trustees and employers on their powers and obligations.

Andrew White, partner, Mayer Brown
White is a partner in the UK pensions practice of Mayer Brown. For several years, White was chairman of the legislative sub-committee and following that, the divorce sub-committee.

David Saunders, associate, Sacker & Partners
Saunders has experience of a wide range of pensions law issues, advising both trustees and employers of pensions schemes on issues including the legal aspects of scheme funding and the regulator’s anti-avoidance powers and clearance procedures. Saunders also frequently advises on the pensions aspects of corporate acquisitions, disposals and reorganisations and is a member of the firm’s unit which provides services to other law firms.

Ben Miller, partner, DLA Piper
Miller advises a full range of schemes on all aspects of pensions law and provides pensions related support on company acquisitions, re-organisations and disposals. Miller also has experience in outsourcing contracts and pensions litigation.


Mustard: The (voluntary) clearance procedure was introduced by The Pensions Regulator to provide those potentially affected by the regulator’s moral hazard powers with reassurance certain transactions contemplated would not give rise to the use of those powers. The regulator has reviewed how clearance has operated in practice and has published revised clearance guidance, on which it is now consulting. If implemented, would the revised guidance assist potential clearance applicants or would it serve to be of more use to schemes’ trustees in their negotiations with employers?

Bell: It could perhaps be seen on one level as assisting both parties. It would clearly be of more use to trustees than the current clearance guidance, not only setting out more clearly the processes and analysis trustees should adopt but also giving more focus to the expected negotiation and mitigation.
It is also helpful to applicants, as the revised guidance would flag to them what the trustees’ approach is likely to be. To the extent however that applicants would prefer to see prescriptive guidance it will not be helpful, as the proposed guidance anticipates a more detailed, and in some aspects subjective, analysis of the impact of an event by both the potential applicant and the trustees.

Ma: It is likely that trustees rather than potential clearance applicants will benefit from the revised guidance.
Elements of the revised guidance such as the recommendation that trustees should enter into negotiations with the employer in relation to Type A events even if the employer or other parties do not intend to apply for clearance and the recommendation that where trustees identify a possible detrimental effect, they should negotiate the most appropriate mitigation, rather than assisting potential clearance applicants, all give support to the trustees to demand a far greater role in corporate activity.
Similarly, the inclusion of extensive guidance on the monitoring of the employer covenant by trustees regardless of whether clearance is to be sought will strengthen the trustees’ position in any such negotiations with the employer.

White: The main objective of the regulator is that all defined benefit schemes should be fully funded as quickly as possible. Therefore, anything the regulator issues is designed to achieve this objective and one of the main ways of doing this is to assist trustees in their negotiations with employers. The draft guidance seems to pay more attention to this than to assisting potential clearance applicants.

Saunders: Clearance was and is a voluntary process but arguably there is now increasing pressure on employers to make a clearance application.
The draft guidance “focuses on [TPR’s] expectations of professional advisers working with trustees and employers in considering events that may have a detrimental impact upon a pension scheme” and suggests trustees should “blow the whistle” where an appropriate quid pro quo (mitigation) is not being offered. The guidance therefore appears to be a negotiating tool with trustees firmly expected to move up into the driving seat. The strength of the trustees’ negotiating position will, though, be very different from scheme to scheme depending on their powers.

Miller: The revised guidance would seem to aid trustees. Standard approaches have been established and relevant parties have structured deals (where there was a need to mitigate against a reduced employer covenant) to fit in with these standards.
Mitigation against a weakening covenant should now be based on the circumstances of a particular scheme. Parties to a transaction will no longer be able to hide behind what were becoming standard arrangements which were known to be sufficient to gain clearance. A true dialogue will hopefully be promoted between employers and trustees around what steps are needed for clearance to be given.


Mustard: Does the revised clearance system proposed raise any practical issues for parties making clearance applications, often working to very tight deadlines?

Bell: Tight deadlines have always been an issue on clearance and timing is one of the factors a potential applicant would need to consider when deciding whether to apply for clearance or risk continuing without it.
The increased focus on employer covenant assessment and negotiation will mean employers should, to the extent they do not already, get trustees involved at an early stage to ensure they have adequate information to perform their duties and that any independent professional advice they wish to seek can be obtained as speedily as possible. That said, many of the processes and required documents should and would be provided as part of the transaction in any event.

Ma: The increased emphasis which the revised guidance places on the trustees’ need to negotiate with the employer in relation to corporate activity means it is likely that parties considering making a clearance application will need to enter into more prolonged negotiations with trustees than was previously the case.
Consequently, it is likely that such parties will need to involve the trustees at a much earlier stage and ensure trustees have all relevant information relating to the proposed transaction to enable negotiations to be concluded within the transactional timeframe.

White: The focus of the regulator in relation to clearance applications will be on whether the proposed transaction leads to a material weakening of the employer covenant. Applicants who can satisfy the regulator that there is no weakening of the covenant should get clearance. A clearance statement indicates the regulator’s opinion is that it would not be reasonable to impose a contribution notice or financial support direction on the applicant because of the transaction. Potential applicants will therefore need to consider whether a contribution notice or financial support directions is a real possibility, in which case they may wish to seek clearance.

Saunders: The prescriptive tests in the old guidance made it relatively straightforward to assess whether there was a Type A event. The principles-based approach now proposed is “aimed primarily at professional advisers” and concentrates on the effect of an event on the employer covenant. TPR recognises that this will require expert assistance which will inevitably increase the time and expense involved with an application.

Miller: There are now far more variables to the proposed steps which need to be explored. Existing guidance and practice established standards, which if attained, were likely to guarantee a clearance statement would be given. The revised guidance shows no degree of prescription and those involved will not have the same degree of confidence that a clearance statement will be given based on the deal agreed with trustees. This is likely to hamper timescales of transactions.
There remains the difficulty of producing “full and accurate disclosure”. Any clearance statement made without this full disclosure will expose the validity of the clearance statement given.


Mustard: Does the move away from reliance on prescriptive tests to a more principles-based approach in deciding which events should be considered for clearance, more closely align the clearance process to the real issues affecting the financial security of schemes, or does it simply introduce a greater degree of uncertainty?

Bell: One of the main reasons given for issuing the revised draft is that some applicants had been interpreting the original guidance more restrictively than had been intended. In theory a more principles-based approach is to be welcomed and should more closely align the process to genuine security issues.
Employers may consider that it creates more uncertainty, particularly where they are inclined not to apply for clearance and in practice it may make employers even more cautious in their approach and more likely to apply for clearance if the risks of not doing so appear too great. That is likely to meet the regulator’s objectives.

Ma: The move to a more principles-based approach, together with the inclusion of the guidance on the monitoring of the employer covenant, should encourage employers and trustees to focus on the key question of an event’s potential impact upon the financial security of the scheme rather than on whether the event falls within a particular type of event or not.
However, at the same time, a principles-based approach is by its very nature more uncertain and decisions as to whether an event falls within the definition of a Type A event are likely to require more consideration than under the previous guidance.

White: The draft guidance focuses on whether the proposed transaction could materially weaken the employer covenant rather than on whether the proposed transaction is of a particular description. This is closer to the focus of the regulator and means applicants need to be ready to convince the regulator that there will be no material weakening. The new process will require a greater degree of judgement from applicants. It will not be simpler than the existing process but will focus more on the important issues.

Saunders: The new guidance implies clearance will be available only where there is appropriate mitigation. This may be an area which will give rise to confusion amongst trustees about TPR’s expectations. The point of mitigation is presumably to compensate schemes for TPR giving up the right to exercise its anti-avoidance powers. But it is important trustees do not overly focus on the push to negotiate without any proper consideration of the scheme’s balance of powers and their legal rights to enforce mitigation. Trustees may otherwise find themselves trying to achieve unrealistic outcomes.

Miller: The change in focus should assist trustees in undertaking their primary duty; which remains the proper funding of their schemes. The less prescriptive approach allows trustees to consider the effect of corporate transactions on the funding of pension schemes. Prescriptive triggers and approaches under the existing procedure simply allowed benchmarks to be established which were not scheme specific. The whole essence of scheme specific funding, taking into account employer covenant, is the individual circumstances of the scheme and not industry standards.


Mustard: Given the emphasis in the draft revised guidance on employer covenant – a common theme of The Pensions Regulator – should trustees now be considering putting in place ongoing formal arrangements to monitor the covenant of the employer (if they have not done so already)?

Bell: Although formal information sharing and gathering procedures would be advisable for all trustee boards, not all schemes should find it necessary to have professional covenant assessments, and certainly not on a regular basis.
Many schemes may have sufficient knowledge and expertise on the trustee board and will not routinely require extensive and expensive external advice. Each case will depend on its individual circumstances. Trustees will need to be aware, however, that a failure to monitor the covenant on any level is likely to be the subject of criticism if their actions are subsequently scrutinised for any reason.

Ma: Trustees should certainly consider putting in place ongoing arrangements to monitor the strength of the employer covenant if they have not done so already. Such monitoring should not take place purely with a view to potential corporate activities.
The key objective for trustees should be to ensure the scheme is as financially secure as possible and able to withstand the impact of events such as, but not limited to, corporate activities. If trustees wait until a corporate transaction is announced before monitoring the strength of the employer covenant, it may already be too late to protect the scheme.

White: The employer covenant is the main focus of the regulator. It will expect trustees of any defined benefit scheme with a deficit to have considered the strength of the employer covenant backing their scheme. For some schemes – such as those with a single UK-based employer which is not part of a larger group – the process may be fairly simple. Other trustees will face more difficult issues in assessing the financial position of the sponsoring employer(s) and may need to call in outside professional advice.

Saunders: The guidance expects employers and trustees to put in place procedures for the routine sharing of information. However, what level of information it is appropriate to share will depend on a number of factors including the size of the scheme, the size of the deficit relative to the employer and the level of corporate activity at the employer.
It is questionable whether it would be necessary or proportionate for trustees to pay professionals to analyse reams of complicated financial information other than in the context of, say, a significant transaction affecting the employer. For day-to- day purposes, a steady flow of basic financial data may often suffice in many cases.

Miller: Trustees should be considering the employer covenant under their schemes, either as part of the on-going monitoring of the security of scheme funding or, more specifically, as part of scheme specific funding.
All trustees should understand the employer covenant behind their schemes and be discussing changes to the covenant with employers. Discussion should ideally be taking place prior to the changes being implemented, but at the very least when such changes have taken place.
Continued transparent discussions between the two parties is key but what is also often seen as helpful is an easy reference protocol (such as changes in key performance indicators) which automatically triggers discussions between the employer and trustees.