The Pensions Regulator (TPR) has published a blog by its executive director of regulatory policy, analysis and advice, David Fairs, setting out details of the issues TPR expects both pension trustees and sponsoring employers of UK defined benefit (DB) pension schemes to consider before refinancing. TPR recognises that corporates will be seeking to return to business as usual following the Covid-19 pandemic. TPR expects that this will likely lead to companies turning to lenders in order to increase liquidity by drawing down or extending lending facilities. However, TPR also acknowledges that new macroeconomic challenges are making refinancings more challenging. In general, rising interest rates and a slowing of issuance volumes provide for more difficult financing conditions although for the moment at least many commentators believe that maturity rates for corporate debt appears to be manageable as companies used the more favourable financial conditions in 2021.
When it comes to a refinancing however, corporate groups with UK DB pension schemes will need to be prepared to engage with, and share certain information with, their pension trustees as TPR expects active engagement from pension trustees so that they can understand the impact of a refinancing on the covenant supporting the pension scheme. While we have seen many examples of corporate groups putting in place formal arrangements to share information with pension trustees, they may not be adequate to meet TPR’s expectations that corporate groups share information with pension trustees about the sponsor’s debt structure and the financing documents to assist trustees in understanding the financing terms, any relevant restrictions that apply to the group and any financial covenants.
As part of this process, TPR expects pension trustees to work with pension scheme sponsors and lenders to assess the impact of the refinancing on the covenant supporting the pension scheme and to consider how to mitigate any potential detriment to the pension scheme. However, TPR also reminds trustees to understand the risks to the group and the covenant supporting the pension scheme if debt is not refinanced, for example, a sale of assets may be needed to meet a group’s financial obligations.
Corporate groups are also reminded that they will need to consider whether any refinancing could fall within the scope of the criminal offences introduced under UK pensions legislation which came into force last October (see our blog posts here and here).
Key issues for trustees and employers to consider on a refinancing
TPR’s blog sets out a list of issues for sponsoring employers and trustees alike to consider, ahead of a refinancing, any or all of which could have a material impact on the employer covenant supporting the pension scheme. These include: costs and fees, debt structure, security and guarantees and financial covenants. Further details are set out below.
- Costs and fees: Changes in the cost of interest and fees relating to the debt could impact on cash flow and therefore the employer’s ability to meet pension contributions. Before refinancing, trustees are expected to ensure that they understand the impact of these changes on the employer covenant.
- Debt structure: Trustees are expected to understand the impact of the replacement of one type of debt with another. The blog includes an example of replacing a term loan with an asset backed security, which fluctuates over time and potentially resulting in a higher overall debt burden.
- Security and guarantees: Where lenders take security TPR urges trustees to ensure that they understand the implications that a change in priority could have on any potential insolvency outcome.
- Financial covenants: Financial covenants are key indicators of a company’s financial performance and once breached potentially allow a lender to call in the debt. Trustees are expected to recognise that changes to financial covenants could result in a power shift between trustees and lenders in the event of financial distress.
- Restrictive covenants: TPR emphasises that clauses in finance documents could potentially restrict the sponsoring employer from agreeing to additional protections for the pension scheme, for example, granting security to the pension scheme.
- Counterparty: Refinancing can take place with the same lender or with a new lender and TPR reminds trustees that different lenders have different risk appetites and lending strategies.
What the above makes clear is that earlier engagement with pension stakeholders is even more critical now and across a wider range of transactions that have the potential to cause detriment to the pension covenant. Without such early engagement there is an increased risk that refinancing transactions are not properly considered from a pension‘s perspective or get to a stage where it is much harder to make sensible accommodations that could have been more easily negotiated at an earlier stage. If you would like to discuss any of the issues raised above, please get in touch with your usual Freshfields contact or call or email any of the authors of this post.