Consultation on strengthening the Pensions Regulator's powers

The White Paper on protecting defined benefit (DB) pension schemes was published in March, with consultations on several of the proposals promised in 2018 and 2019. The first consultation has now been published. It covers the first group of proposals in the White Paper around strengthening the Pensions Regulator’s powers and provides further details in keys areas for employers and trustees. These include changes to the anti-avoidance regime, the introduction of punitive fines and criminal sanctions, and the proposed new declaration of intent. The impact on corporate transactions could be far-reaching. Further consultations on scheme funding and consolidation are expected later this year and into 2019.

The consultation includes the following proposals:

Punitive fines and criminal sanctions

The government is proposing to introduce:

• A new civil penalty (up to a maximum of £1 million) to provide the Regulator with the flexibility to issue different levels of fines for a range of breaches (including non-compliance with new requirements being introduced as a part of the White Paper). In particular, the Regulator will be able to apply high-level fines to deter behaviours which are more serious in nature and have resulted in actual harm to the scheme or have the potential to do so if left unchallenged. The Regulator will determine the amount of the fine (within the cap) based on the seriousness of actions.
• New criminal offences to punish: wilful or grossly reckless behaviour in relation to a DB pension scheme, non-compliance with a contribution notice (CN) and failure to comply with the notifiable events framework. This will give the criminal courts the power to impose further penalties, including a further tier of unlimited fines and / or custodial sentences. The intention is that these sanctions will be used in the most serious cases of wrongdoing, where the Regulator decides that it is appropriate to bring a prosecution.

The consultation says that the range of possible targets should include all of those who have responsibility to the pension scheme, including directors, sponsoring employers, any associated or connected persons, and in some circumstances trustees.

Anti-avoidance powers

The government is proposing to strengthen the CN regime by:

• Amending the “reasonableness” test so that there is a stronger focus on the loss or risk caused to a scheme by the act when assessing the amount to be demanded under a CN, as opposed to consideration of issues such as the relationship between the target and the sponsor, or benefit received by the target from the sponsor. Scope would also be given for the employer’s justification for the act as a determining factor.
• Providing a specific mechanism for adjusting the CN sum to reflect the delay in payment, rather than allowing for differing approaches under the reasonableness test. For example, if an act caused quantifiable harm to a scheme on a particular date (which is earlier than the date of issue of the CN), this amount could be adjusted by the increase (if any) in the value of a prescribed notional asset allocation, by reference to publicly available inflation indices.
• Changing the date on which the cap on the level of a CN is calculated. Rather than calculating the cap at the date of the act, the cap will be calculated at a date closer to the final determination.
• Creating an additional limb to the material detriment test, assessed by reference to the weakening of the employer rather than the prospect of scheme benefits being paid many years into the future.

The government is proposing to strengthen and improve the way financial support directions (FSDs) work by:

• Creating a single-stage process, under which the FSD would create a specific and enforceable obligation on the target (rather than this occurring at some later stage as in the current regime).
• Tightening up the forms of financial support the target is required to make to the scheme, so that the FSD will either require a cash payment or impose a form of statutory guarantee in relation to some or all of the sponsoring employer’s liabilities to the scheme. Obligations under the statutory guarantee will be enforceable by the trustees without the need for further action by the Regulator.
• Reviewing whether the “insufficiently resourced” requirements should be amended or replaced in order to make the criteria for imposing an FSD clearer and more certain for all parties.
• Allowing FSDs to be issued to a broader range of individuals, where they are associated with or connected to the sponsoring employer (provided the other tests are met), mirroring the scope of CNs.
• Amending the reasonableness test to make clear that the actions of a target in creating or increasing risk are a relevant (but not necessary) factor.
• Providing the Regulator with a power to impose a CN on any person associated or connected with the recipient of the FSD.
• Exploring how and whether the lookback period could be increased beyond two years, and what appropriate protections would need to be put in place for businesses brought within scope by a longer lookback period.
• Providing the Regulator with a power to issue an FSD after a scheme has entered the Pension Protection Fund and enable it to enforce the FSD in the form of a cash payment.

Declaration of intent

The government is proposing that the following corporate transactions should trigger the need for a declaration of intent:

• sale of controlling interest in a scheme employer;
• sale of the business or assets of a scheme employer; and
• granting of security in priority to scheme debt.

It is envisaged that the provision of a declaration of intent should be required according to risk-based criteria (e.g. level of funding) as prescribed by the Regulator.

The declaration of intent would be addressed to trustees from the transaction’s corporate planners (usually the Board of the company), shared with the Regulator, and:

• explain the nature of the planned transaction;
• confirm that the corporate planner has consulted on its terms with the trustees and confirm the trustees’ agreement (or otherwise) to the planned transaction; and
• explain any detriment to the scheme and how this is to be mitigated.

A declaration of intent will be required at a later point in a corporate transaction than a notifiable event notification (see below), when there is greater certainty as to whether the transaction is going ahead, its nature and the implications for the scheme. The consultation says that this will be after parties have completed due diligence and transaction financing has been finalised, but before sale and purchase contract signature.

Notifiable events framework

The government is proposing adding the following as employer-related notifiable events:

• sale of a material proportion of the business or assets of a scheme employer which has 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; and
• sponsoring employer taking independent pre-appointment insolvency / restructuring advice (such as an independent business review).

The government is also proposing to extend the existing breach of banking covenant notifiable event to include covenant deferral, amendment or waiver. It is proposing to remove wrongful trading of the sponsoring employer as a notifiable event.

On timing, the government is proposing that notification of the following notifiable events should occur when a heads of terms agreement is first put in place:

• sale of controlling interest in a sponsoring employer;
• sale of the business or assets of a sponsoring employer; and
• granting of security in priority to scheme debt.

Clearance

The consultation confirms that the Regulator will be reviewing its guidance on the clearance process to clarify its expectations as to what employers and trustees should do. Areas of the guidance that the Regulator expects to clarify and / or expand include:

• the material detriment definition, and how applicants and trustees should approach the test;
• revision of the definition of event types, including the circumstances in which clearance is given in relation to FSDs (given that FSDs are not an act or transaction-based power);
• more information about how the clearance process works, and what applicants and trustees can expect; and
• to include expectations around timing of applications (as early as possible).

Engaging with other regulators

The consultation paper notes that this is an ongoing process. The Regulator is currently reviewing its working protocols and information sharing with existing regulators. As part of this review, it will also ensure that any other regulator not currently captured by existing protocols is taken account of. A programme of engagement is planned over the summer.

Next steps

The consultation closes on 21 August 2018. In relation to the other White Paper proposals, the consultation confirms that:

• Scheme funding: the Regulator will be talking to interested stakeholders about the design of clearer funding standards over the coming months, culminating in a formal consultation on a revised DB funding code of practice in 2019.
• Consolidation: The DWP will also be consulting on the design of the legislative framework and authorisation regime for commercial consolidation of DB schemes later this year.

For more information, please speak to your usual Linklaters contact.