By Jonathan Wolff, Partner and Head of Covenant at LCP
But this article is not about technical details. Instead, I want to highlight four essential covenant-related actions that trustees should be considering as they prepare for their first valuation under the new regime (ie for valuations on or after 22 September 2024).
1. Arrange an initial brainstorming session with key advisers
Every situation will be different, but my early experience suggests that valuations under the new regime will fall into two main categories:
The scheme will be reliant on the sponsor for many years, scheme risk-taking is relatively high, there may be concerns over the sponsor’s long-term future, and a recovery plan is still needed.
The scheme is well funded, and there are minimal concerns about the financial strength of the sponsor.
While some characteristics may appear very obvious, an early discussion with your actuarial, investment, and covenant advisers can provide valuable insights. This is because TPR allows for a proportionate approach to covenant assessments for well-funded schemes with minimal reliance on the sponsor, so being comfortable on this at an early stage can help ensure compliance while avoiding unnecessary work.
For example, if advisers can agree at an early stage that the scale of the likely investment stress test required under the new regime will be well covered by the sponsor’s liquid resources, the covenant work can be pragmatic. Conversely, if concerns arise regarding the covenant’s ability to support scheme risk, deeper analysis will be needed, focusing on cash flows, reliability, longevity, and maximum affordable contributions.
Early discussions can also help trustees determine whether the scheme may be able to meet “Fast Track” parameters, or if a “Bespoke” route will need to be taken. That can also help with covenant scoping as it will help to determine the level of covenant information that needs to be documented in the Statement of Strategy.
2. Engage early with your sponsor on the new covenant requirements
In many cases, sponsors will need to provide more financial information than they have been used to, in order to support the trustees’ covenant assessment. In a recent project we were involved in, the trustees gave the finance team an early "heads-up", ensuring that there were no surprises when we came to have our kick-off meeting with them.
This pre-engagement warmed management up to our information request, which included additional questions on cash flow, business prospects, and capital investment plans. It also meant the finance team was able to ask us the questions they had on the new regime, which helped to foster a collaborative approach between us.
3. If you have a contingent asset, how critical is it to your funding and investment strategy?
Many schemes have contingent assets, with varying levels of importance. Some are crucial for supporting scheme risk-taking, while others may have become less needed recently due to improved scheme funding levels. Establishing how reliant the scheme is on its contingent asset early-on is crucial, particularly for complex arrangements and guarantees.
If the contingent asset remains an important underpin, the new funding regime requires more detailed assessment of its potential value at the time of need, and information about the trustees’ assessment will need to be submitted to TPR. These new requirements should be factored into the work plan.
4. Consider whether you need a covenant adviser, or to expand the scope of your review
Lots of trustees will have made their own assessment of the covenant for valuations under the previous regime. However, in the past the linkage between specific covenant conclusions and valuation assumptions / longer term strategies was less prescriptive.
Even well-funded schemes, including those fully bought-in, must confirm in the Statement of Strategy whether the covenant adequately supports the risk in the scheme’s funding and investment strategy. While this may seem straightforward in some cases, having a specialist who can pragmatically document this conclusion can be highly beneficial—particularly in the eyes of trustee chairs or sole trustees who must personally sign off on the Statement of Strategy.
Final Thoughts
These covenant-related actions stem from real cases we have worked on since TPR’s new regime came into effect. Addressing them early-on will make the valuation process significantly smoother, helping trustees comply with the new regime while ensuring a well-supported funding and investment strategy.
If you’d like some more information about the new Guidance you can find an overview in our webinar from back in January, as well as our summary on the key covenant aspects of the regime. Or the team is always happy to chat, so feel free to get in touch!
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