Articles - Why covenant comes first

Trustees are often given verbal assurances from their sponsors or parent companies that they will always be looked after. Unfortunately, such promises are not recognised by the Regulator and this is an area they are increasingly looking to trustees for better standards of practice. Boards should be finding out how enforceable such promises are and considering what written guarantees or contingency assets could be provided to them.

 By Ruth Thomas FIA, Partner at Barnett Waddingham

 Our recent survey of trustees indicates that few have done this.The Regulator’s integrated risk management guidance wants all risk measures assessed together to find what relationships lie between them. In that context, we believe the relative strength of the employer’s covenant is the starting point for such risk management. This is critical for assessing where trustees set their technical provisions, recovery plans and investment strategy.

 A guarantee from a sponsor or parent company would allow trustees to consider taking more risk in their investments or potentially shortening their recovery plan. These are the sorts of steps the Regulator wants more evidence of.

 It might be a difficult question for trustees to ask a healthy sponsor for a cash injection but this is a conversation that is happening more and more. Such contributions can guard against a time in the future when either the sponsor or the scheme might be in a worse position.

 Where sponsors are already in a weak position, this can be a starting point for a conversation around the length of recovery plans, for instance, how a guarantee given by an employer or an overseas parent could help restructure recovery plans in ways that are mutually beneficial.

 Lastly, trustees need to think more about how they assess the health of the sponsor over time as well as in the short term. Is the sponsor gaining or losing market share? Do they operate in a declining market? The overall covenant needs to be monitored in the same way funding ratios and the performance of fund managers are. We recommend that trustees consider the issue of covenant on a regular basis and take outside advice where necessary.

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