The pace of recovery in dividends could be slowed as a result of increased powers for The Pensions Regulator (TPR), which are due to come into force from 1 October 2021, with analysis from LCP suggesting that the 'dividend bubble' could burst "in weeks".

The firm noted that whilst there were depressed dividend levels amid the pandemic, the first half of 2021 has seen a recovery in payouts, with much of the fall seen in 2020 expected to be recovered this year.

However, LCP stated that new TPR powers will ‘beef up’ the regulator’s scrutiny of shareholder dividends, and other forms of ‘covenant leakage’ such as executive remuneration, to a new level for corporate sponsors of defined benefit (DB) pension schemes.

It also stressed that this will not be limited to the largest FTSE 100 blue chips, but will impact “all sponsors of DB schemes”, and will also be relevant for intra group and special dividends, as well as ongoing regular dividends paid to investors.

The new powers, introduced by the Pension Schemes Act 2021, were designed to strengthen the rules around the funding of company pension schemes following high-profile cases such as BHS and Carillion.

As a result, company directors and others involved could face a legal challenge if a dividend payment leads to a ‘material reduction’ in the recovery that a DB pension scheme can expect to get in the event of a hypothetical insolvency under the new rules.

Considering this, LCP warned that, where directors of companies with a DB scheme wish to pay dividends and where the DB pension scheme has a deficit, they will need to analyse the impact of dividends on the scheme at an early stage of discussions.

In particular, it suggested that companies build in the impact on their pension scheme in dividend discussions, as this will demonstrate that the scheme was considered as part of the directors’ decision making and sets out the basis for conclusions on whether any mitigating measures could be appropriate to manage the risk of regulatory intervention for a dividend.

It also warned that even robust employers with a pension fund surplus in their accounts cannot afford to ignore the new rules, as the test will apply to companies whose DB schemes are in deficit relative to the cost of buying out all its liabilities with an insurance company, which is a tougher measure than the measure used in company accounts.

In addition to this, the test is applied on the basis of if the company were to go to bust, rather than being based on the likelihood of this happening, meaning that if a dividend is less likely that a deficit would be covered if the company went bust, action would be taken by the regulator even if the company was regarded as in good health.

Furthermore, whilst LCP clarified that companies with a DB scheme deficit will not be banned from paying substantial dividends, it acknowledged that they may, in some cases, be expected to take other mitigating measures to provide further security, such as giving he pension scheme priority claim on certain company assets.

LCP principal, Laura Amin, commented: “Government and regulators are keen to avoid a repeat of scenarios where a company goes bust leaving a hole in the pension scheme after a period when large dividends have been paid to shareholders.

“The new powers for TPR may lead to more frequent regulatory intervention. We expect the new powers to generate much debate when they come into force from 1 October and it may be challenging for company directors to understand where the new boundaries lie.

“At the very least, company boards will have to think much more carefully when setting their dividends about the impact on the position of their pension scheme, whilst schemes will be in a stronger position to press for greater security if a large dividend payment goes ahead.

“Depending on how companies react, we could see the 2021 ‘dividend bubble’ burst in a matter of weeks."

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