The Pensions Regulator (TPR) executive director of regulatory policy, analysis and advice, David Fairs, has detailed what the regulator expects pension trustees and sponsoring employers to consider when refinancing in the current economic climate.

In a blog, Fairs noted that new macroeconomic challenges are presenting themselves as the business world looks to bounce back from the Covid-19 pandemic, which could make refinancing more challenging for sponsoring employers.

Many sponsors sought to bolster their liquidity as the UK responded to the pandemic, typically turning to their existing lenders to both draw down and extend their facilities, he continued, while the return of a more normalised business environment was likely to also see a return of refinancing in a more traditional sense.

When refinancing, there are several things that TPR expects employers and trustees to consider, any or all of which could have a material impact on the employer covenant.

These include interest costs and fees, as changes in the cost of debt (interest and fees) could impact the employer’s ability to meet pension contributions; debt structure, with the regulator expecting trustees to have a good understanding of any impact of replacing one type of debt with another; and security/guarantees, with trustees urged to be aware of the implications of any changes to claim priority on their potential insolvency outcome.

Furthermore, trustees are expected to consider financial covenants, as changes to such covenants could represent a power shift between trustees and lenders in the event of financial stress; restrictive covenants, as clauses that restrict the ability of the employer to undertake certain activity could restrict trustees’ abilities to agree to appropriate funding plans or protections for the scheme; and counterparty, with trustees encouraged to be mindful that different lenders may have different risk appetites and objectives, and that a change in lender may facilitate engagement with trustees as a key stakeholder.

“Whilst none of the above are new areas for trustees and employers to consider, a challenging and inflationary financial climate makes changes in these areas potentially more likely,” Fairs wrote.

“Despite continued buoyancy in some markets (eg asset backed lending), credit conditions are tightening and larger refinancings have become more challenging, impacted by lender concerns around certain sectors, costs associated with climate change and ensuring adequate returns on their investment.

“These conditions are likely to be reflected in higher interest rates and tighter covenants, with potentially more onerous security requirements and greater restrictions on use of funds.”

He added that the regulator’s refinancing expectations of sponsors and trustees were “simple”: That it is critical to understand the implications of any refinancing on the pension scheme and the employer covenant, and to mitigate any detriment caused.

“This understanding should extend beyond the basic quantum of debt to consider the areas highlighted above, and any other factors considered relevant,” he continued.

“Trustees should also be cognisant in their analysis of the risks that could arise in the event debt is not refinanced, such as any need to sell assets to meet financial obligations.

“Whilst not strictly a ‘refinancing’, we also expect trustees to be mindful of debt transactions. Where trustees become aware of such a transaction, we would expect them to proactively work with the employer and new lender to assess any change in the circumstances of the employer or the lending strategy, and any consequent impact on the trustee’s assessment of covenant.”

To support this, trustees were urged to engage with management well ahead of any potential refinancing and employers should be prepared to share relevant information with trustees.

Fairs stated that trustees were the first line of defence in the assessment and mitigation of corporate events that impact covenant.

“As set out in our guidance on corporate transactions and clearance, it is critical that trustees and sponsoring employers engage effectively to assess the extent to which a corporate event is detrimental to covenant and agree adequate mitigation,” he concluded.

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