Covenants at risk as restructurings rise

After a spike in corporate restructuring actions, a report has warned pension trustees and sponsor employers to keep a closer grip on the details of their covenant. The research, included in an Insight report from Punter Southall Transaction Services (PSTS), cites the challenging economic climate as the driving force behind the rising restructuring trend. 

Against a backdrop of corporate defaults, businesses are restructuring their financial and operational systems to avoid insolvency and a range of inclement factors, like a deterioration in trading performance. Lorant Porkolab, leading the PSTS covenant advisory team, urged businesses to show a consideration of the impact of changes to a pension scheme: 

“Many restructurings affect the legal shape of the business,” Porkolab said. “It is critical for trustees to understand where this leaves the pension scheme and its sponsoring employer.” 

Defined benefit pensions schemes are at particular risk to material changes in the strength of their employer covenant. The list of companies that have instigated some sort of recent restructuring process include Premier Foods, TUI Travel, JJB Sports, Logica and Punch Taverns. 

While PSTS raised concerns over vulnerable covenants, a separate report from Gazelle Pensions Advisory revealed that sponsor defaults may not be the biggest threat to pension security. Based data from 25 years of the FTSE 100 Index, the findings showed the erosion of the pension “promise”, by corporate transactions, strategies and performance, presents a bigger problem to schemes’ financial futures. 

Gazelle Pensions Advisory’s study extended to blue-chip companies, where trustees handled a high level of scheme funding risk. The findings showed: 

  • While only 7% of companies defaulted, 26% experienced a level of financial stress which would have materially affected their ability to fund their pension schemes.
  • 83% of companies experienced some sort of major transaction (including multinational takeover, merger, or restructuring) which would fundamentally change the strength of their employer covenant.
  • Only 17 of the FTSE 100 companies surveyed had not experienced a major transaction, like restructuring. 

In the wake of the findings, pension trustees are being urged to re-adjust their expectations of the capability of their schemes’ regulatory framework to handle the adverse situations linked to restructurings. In practice, this means ensuring a comprehensive understanding of the employer covenant – ensuring REGULAR REVIEWS or using professional COVENANT REVIEW SERVICES

 Chairman of Gazelle Pensions Advisory, Simon Willes, focussed on the changes pension trustees will have to make to bolster the security of their schemes. Willes’ emphasised weaknesses in the current regulatory framework to deal with funding risks posed by “corporate activity and change” – in particular from unsecured creditors. 

“The transaction clearance regime is voluntary and appears to be largely ignored,” said Willes. “If regulation is about ensuring pensioners receive pensions from defined benefit schemes, the status and ranking of pension schemes from long-term unsecured creditors is central to the debate.” 

Covenant reviews are often carried out by Independent Trustees. More information about why independents are brought in to work with pension schemes can be found here. Pension Clarity has further information concerning the nature of covenant reviews as part here.

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