DWP draft pension schemes regulations embed covenant in legislation for the first time

On 26 July the DWP published draft regulations ‘Occupational Pension Schemes (Funding and Investment Strategy and Amendment) Regulations 2023’ for consultation.

Commenting on the regulations, Guy Mander, partner and head of covenant assessment services at RSM UK said: ‘We view the draft regulations as significant. While the concept of the employer covenant has been developed over the past 17 years through TPR (The Pensions Regulator) guidance, codes of practice and market practice, this is the first time that the requirement to assess the employer covenant on defined terms is being embedded in legislation.’

Context and key developments in the draft regulations

The Pension Schemes Act 2021 (the ‘2021 Act’) strengthened the existing scheme funding regime by requiring defined benefit occupational pension schemes to have a funding and investment strategy, to review/revise this strategy from time to time and to submit a written statement of strategy to TPR. The statement of strategy must specify the intended funding level and investments to be held at the relevant date(s), as well as various supplementary information.

The draft regulations provide further detail on key concepts that form part of the funding and investment strategy, particularly around ‘scheme maturity’, ‘significant maturity’ and ‘low dependency’ (under reasonably foreseeable circumstances, the scheme is not expected to need further employer contributions) – and also the concept of ‘employer covenant’.

The draft regulations also extend the range of matters which must be included in the statement of strategy, notably now requiring an assessment of the strength of the employer covenant, how long it is reasonable to rely on this assessment and any changes in the strength of the employer covenant since the last review of the statement of strategy. The consultation on the draft regulations seeks views on how such concepts are to be detailed in the final regulations and how much is left for TPR’s revised Defined Benefit Funding Code of Practice (‘Funding Code’), which is expected to be published in draft for consultation later in the year.

Employer covenant

The draft regulations define ‘strength of the employer covenant’ by reference to (a) the financial ability of the employer in relation to the scheme to support the scheme; and (b) the level of support for the scheme from any contingent assets (to the extent they are legally enforceable and sufficient to provide that support if, and when, enforced). The strength of the employer covenant is assessed in relation to the size of the deficit on low dependency and solvency bases.

The matters to be considered in assessing the employer’s financial ability to support the scheme include its cash flow, the likelihood of its insolvency, and other factors which are likely to affect the performance or development of the employer’s business; for example: the employer’s market position and outlook; strategic importance within any corporate group; range of products, customers, suppliers and regions it operates in; environmental, social and governance issues; and resilience. All of this is to be set out by TPR in the revised draft Funding Code.