In a consultation published on 26 June, the Government has proposed a major overhaul of the Pensions Regulator's powers. The proposed changes could have a significant impact, particularly on the way in which pensions are dealt with on corporate transactions. The consultation, which runs until 21 August, fleshes out the proposals contained in the White Paper on Defined Benefit Pension Schemes published in March.
A more stringent "notifiable events" regime
Significant changes are proposed to the "notifiable events" regime under which certain events have to be notified to the Regulator. These include the creation of the following new notifiable events (which will apply when the scheme is underfunded on a specified basis, details to be confirmed):
- sale of a "material proportion" of the business or assets of a scheme employer which had funding responsibility for at least 20% of the scheme's liabilities;
- granting of security on a debt to give it priority over debt to the scheme;
- significant restructuring of the employer's board of directors, and certain senior management appointments (eg a lender appointing someone to the board to protect its own interests); and
- sponsoring employer taking "independent pre-appointment insolvency/restructuring advice".
The consultation also proposes:
- bringing the timescale for notification forward in the case of the sale of a controlling interest in the sponsoring employer, a sale of the business or assets of the sponsoring employer, or the granting of security in priority to scheme debt, so that notification is required when a heads of terms agreement is first put in place; and
- extension of the existing "breach of banking covenant" notifiable event to include covenant deferral, amendment or waiver.
Requirement for a "declaration of intent"
For transactions posing the highest potential risk to a defined benefit scheme, the White Paper proposed a requirement for sponsoring employers or parent companies to make a declaration of intent prior to the transaction taking place, confirming that they have considered the impact on defined benefit schemes and setting out proposals for "mitigating detriment" to the scheme. The consultation proposes that this would occur "after parties have completed due diligence and transaction financing has been finalised but before sale and purchase contract signature". The declaration would be addressed to the trustees and shared with the Regulator.
Sale of a controlling interest in a scheme employer, sale of the business or assets of a scheme employer, or granting of security in priority to scheme debt would all potentially trigger a requirement for a declaration of intent. Whether this would be required would depend on a scheme's funding level.
If declarations of intent become the norm for corporate transactions where a defined benefit scheme is involved, this would be a major shift in practice. The consultation suggests the declaration would form part of an "enhanced early warning system". This seems somewhat at odds with the reality of corporate transactions where any gap which occurs before signing the contract but after finalising due diligence and transaction finance may in practice be very short.
New criminal offences and civil penalties
The consultation fleshes out the White Paper's proposals for the creation of new criminal offences and Regulator powers to impose civil penalties. The proposed new criminal offences are:
- "wilful or grossly reckless behaviour" in relation to a defined benefit scheme;
- failure to comply with a contribution notice; and
- failure to comply with the notifiable events framework.
The Regulator would also have the power to impose civil penalties for these offences. New powers to impose civil penalties would also apply to:
- non-compliance with an information request from the Regulator or deliberately providing false information;
- deliberately providing false information or failing to provide required information to trustees;
- non-compliance with elements of the defined benefit funding code; and
- non-compliance with the requirement to provide a declaration of intent.
The maximum level of civil penalty would be increased to £1 million. The high level penalties are intended for use in relation to behaviour which has resulted in actual harm to the pension scheme or has the potential to do so if left unchallenged. As well as sponsoring employers and their directors, it is proposed that penalties could be imposed on any associated or connected persons and in some circumstances trustees.
Overhaul of Regulator's "moral hazard" powers
A number of changes are proposed to the Regulator's "moral hazard" powers which allow it to require scheme employers and persons "associated or connected" with them to make additional contributions into an underfunded scheme or to put in place additional financial support. These include:
For contribution notices:
- more focus on the loss or risk caused to the scheme (rather than relationship between target and scheme employer, or benefit received by target) when deciding whether it is reasonable to impose a contribution notice;
- changing the formula for calculating the maximum contribution that can be required to take account of the time lag between the act triggering the contribution notice and the notice itself; and
- altering the test for "material detriment" so that a contribution notice may be issued if an employer has been weakened.
For financial support directions:
- allowing the Regulator to require financial support in the form of a cash payment or guarantee, rather than simply being able to require proposals for putting in place financial support;
- broadening the categories of person who can be issued with an FSD;
- amending the reasonableness test to make clear that an FSD can be imposed even if the target has not committed a specific act; and
- possibly extending the two year "look back" period for determining whether a person is connected or associated with an employer.
The proposed changes would amount to a significant broadening of the Regulator's powers, giving it a very broad discretion to impose significant liability on persons associated with a defined benefit pension scheme. In many cases, liability can be imposed without any need to prove deliberate wrongdoing, and possibly with the benefit of hindsight years after the event. Given the amounts at stake, that makes it important that the Regulator has adequate resources, including staff with the necessary skills and experience to exercise that broad discretion in a proportionate and consistent manner.
The proposed changes could cause buyers and funders in corporate transactions to be even more wary of defined benefit liabilities, but even where no corporate transaction is contemplated, the proposals may give board directors pause for thought when making decisions that could potentially impact the scheme. It may be that the changes will provide greater impetus for companies to fully fund or buy out pension liabilities, which could ultimately benefit scheme members or the PPF.