The Government is planning for a tougher regulatory environment for workplace pensions. The Department of Works and Pensions' (DWP) response to its consultation (Protecting defined benefit pension schemes - a stronger Pensions Regulator) set out a range of new criminal and civil offences with tough penalties. But the Government's response goes further than simply tackling the reckless mismanagement of pension schemes.
We consider how the Government intends to change the regulatory regime for defined benefit pensions and explain what it means for trustees and employers.
Six key points on the Government's plans
1. New criminal offences and tougher penalties for offences relating to workplace pensions
The Government will legislate to introduce a range of new offences relating to workplace pensions. The penalties for these will be tougher than anything that is currently on the statute books. Wilful or reckless behaviour in relation to a pension scheme will carry a maximum criminal penalty of seven years' imprisonment and/or unlimited fines.
2. The Pensions Regulator's powers to gather information will be strengthened
The Pensions Regulator (TPR) will gain a new power to require attendance at an interview. In addition, TPR's powers of inspection will be broadened to cover any premises where documents or records (including in electronic format) are kept which are relevant to the exercise of any of TPR's functions.
3. The Pensions Regulator will have greater oversight of corporate transactions
This will be achieved by broadening the notifiable event regime and requiring parties to issue Declarations of Intent in respect of certain transactions. TPR will also undertake a review of its voluntary clearance process.
4. The Government will amend the anti-avoidance regime
The Government has confirmed that it will go ahead with plans to streamline and enhance the way that the Contribution Notice and Financial Support Direction processes work.
5. The Government will not go ahead with all of its proposals
The DWP has confirmed that it will not go ahead with all of the proposals set out in the Consultation.
6. The DWP will legislate "as soon as Parliamentary time allows"
In the Consultation Response, the Government states that it intends to implement the new measures using primary and secondary legislation "as soon as Parliamentary time allows". It isn't likely that this will be during the current parliamentary session. Subject to Brexit, we expect legislation to feature in the Queen's Speech in June 2019.
Why is the Government making these proposals?
The collapse of BHS highlighted the management of defined benefit (DB) pension schemes. The clamour for action intensified when Carillion declared insolvency. Against this backdrop, the Government issued a Green Paper in February 2017 to consider policy objectives (Defined benefit pension schemes: security and sustainability) followed by a White Paper in March 2018 setting out more detail on its proposals (Protecting Defined Benefit Pension Schemes).
In the White Paper, the Government stated that the existing regime is working well for the majority of DB pension schemes, members, trustees and sponsoring employers but that it could see ways in which the system could be improved. To that end, on 26 June 2018, the DWP launched a consultation setting out specific proposals (Protecting Defined Benefit Pension Schemes - A Stronger Pensions Regulator). The Government has now published its response to the comments received during the consultation period.
Which proposals is the Government going ahead with?
New offences and penalties
The Government will legislate to introduce a new system of criminal offences and tougher penalties for various offences relating to workplace pensions. These will include:
- a maximum penalty of up to seven years' imprisonment and/or unlimited fines for wilful or reckless behaviour in relation to a pension scheme;
- unlimited criminal fines or civil fines of up to £1 million for failing to comply with a contribution notice;
- the introduction of new civil fines of up to £1 million for:
- failing to comply with a financial support direction (FSD);
- failing to comply with the notifiable events framework;
- failing to comply with the requirements for a Declaration of Intent (see Greater information gathering powers for TPR below); and
- knowingly or recklessly providing false information to trustees or to TPR.
The potential targets of these sanctions will include sponsoring employers, trustees and persons/companies that are connected or associated with the employers.
In addition, the Government intends to introduce fixed and escalating civil fines as an alternative sanction for non-compliance with TPR information requests (also known as section 72 requests). These will cover inspections and interviews and also delays in providing information.
Greater information-gathering powers for TPR
TPR is to get two new information-gathering powers in a bid to "harmonise and broaden" its powers and thereby enable it to conduct its investigations "in a more efficient way".
- Power to require attendance at an interview - the Government will legislate to introduce a power to require attendance at an interview. Such requests will be accompanied by a written notice along the lines of the notice currently issued to obtain information under section 72 of the Pensions Act 2004. It is intended that when issuing such a notice, TPR will explain broadly the purpose of the interview and set out the recipient's legal rights and responsibilities.
- Broadening the power of inspection - TPR's power to inspect premises will be expanded to cover any premises where documents or records (including in electronic format) are kept which are relevant to the exercise of any of TPR's functions.
These powers extend to trustees, employers, and other relevant persons. They also extend to professional advisers, and will override the adviser's duty of confidentiality, except insofar as legally privileged material is concerned.
Increasing TPR's oversight of corporate transactions
The DWP will legislate to increase TPR's oversight of corporate transactions. This will be achieved by broadening the notifiable event regime and introducing Declarations of Intent. Under the new regime for Declarations of Intent, sponsors will have to provide trustees and TPR with an explanation of the impact of a proposed transaction on a workplace pension scheme and set out any mitigating steps that are being proposed.
Changes to the notifiable events regime
The Government will consult on regulations to introduce new employer-related notifiable events. These will be triggered on the:
- sale of a material proportion of the business or assets of a scheme employer which has funding responsibility for at least 20% of the scheme's liabilities; and
- granting of security on a debt to give it priority over debt to the pension scheme.
The existing notifiable event of wrongful trading of the sponsoring employer will be removed (because a self-reporting obligation for wrongful trading is not very effective).
The Government has also committed to work with TPR and the pensions industry to identify where earlier notification could be beneficial in relation to each of the employer-related notification events. An assessment of the impact of the changes to the notifiable events framework on business will also be carried out by the DWP.
Introduction of Declarations of Intent
Despite opinion being divided over this proposal, the Government will introduce a requirement for 'corporate transaction planners' (which will include, among others, the scheme sponsor or parent company) to provide a Declaration of Intent to the trustee board and TPR. The need for a Declaration of Intent will be triggered by certain existing and new notifiable events, namely:
- the sale of a controlling interest in a sponsoring employer;
- the sale of a business or assets of a sponsoring employer; and
- the granting of security in priority to the scheme on a debt to give it priority over debt to the scheme.
TPR will update its guidance and Code of Practice on notifiable events to set out the timing for sharing the Declaration of Intent. The consultation response notes that a 'flexible approach' needs to be developed which takes into account the particular circumstances of individual transactions and also commercial sensitivities.
The exact content of the Declaration of Intent is also still to be decided. It is expected that it will require an explanation of the transaction and how any resulting detriment to the scheme is to be mitigated. The idea is that this requirement should act as an early warning that would compel sponsors to engage with trustees on transactions that are likely to have a significant impact on the pension scheme.
Voluntary clearance
TPR is to undertake a review of its guidance on the voluntary clearance process, which enables employers to obtain comfort from TPR that a cleared transaction will not subsequently be the subject of TPR's anti-avoidance powers. The review will focus on:
- how "material detriment" (one of the conditions for TPR issuing a contribution notice) should be defined;
- the types of events to which clearance is particularly relevant; and
- information about the clearance process.
Amending the anti-avoidance regime
The "anti-avoidance regime" has several aspects but the most important are TPR's powers to issue "contribution notices" and "financial support directions". Broadly, contribution notices are a demand to pay a specified sum into a pension scheme, and financial support directions require the target to give financial support to the scheme, which can take various forms.
The practical effect of the regime is to impose pension liabilities on other persons or companies beyond the employers who have the direct legal obligations to the scheme under its deeds and the statutory scheme funding regime.
Contribution Notices
Contribution notices may be issued if an employer or a connected or associated person has acted, or failed to act, in a manner which had a "materially detrimental" effect on the pension scheme. They can also be issued if the action or failure had as one of its main purposes the reduction of a debt due to the scheme, or reduced recovery of such a debt.
The Government will change the way that Contribution Notices function. Proposals include the following:
- The Regulator can only issue a contribution notice if it considers it reasonable to do so, and there is a prescribed list of factors to consider in assessing reasonableness. The Government proposes to add to this list the actual or potential impact of the act (or failure to act) on the scheme's assets or liabilities.
- The effect of the act (or failure) on the value of the assets or liabilities already forms part of the test for material detriment (as do numerous other things), but the Government proposes to add two additional limbs to the material detriment test. This would enable the test to be met if an act (or failure) reduces the potential insolvency dividend of the scheme and/or reduces the level of "cover" available to support a statutory debt to the pension scheme if one were to be triggered. This would give TPR more scope to issue contribution notices.
The Government will consider whether an uprating mechanism to reflect the time between the act and the determination to issue a Contribution Notice needs to be set out in legislation.
Financial support directions (FSDs)
FSDs can currently be issued if the employer in relation to a pension scheme is "insufficiently resourced" (defined broadly as having resources of less than 50% of the buy-out deficit) or is a service company.
The Government will work with TPR and the Pension Protection Fund (PPF) to streamline the FSD process to a single-stage process. FSDs will also be renamed as Financial Support Notices (FSNs).
FSD/FSN targets will be expanded to include controlling shareholders of the sponsoring employer (who are individuals) and the 'insufficiently resourced' test will be replaced with a new scheme-focused test, details of which have not yet been provided.
The forms of financial support that may be imposed under a FSD/FSN will be limited to cash and/or making the target of the FSD/FSN jointly and severally liable for the employer's obligation to the pension scheme.
Which proposals will the Government not take further at this time?
There were various proposals floated in the consultation paper which the Government has said in its consultation response that it is not currently minded to take forwards.
New offences and penalties
The Government will not introduce criminal offences for failing to comply with the notifiable events framework. In addition, the penalty for the criminal offence of failing to comply with a Contribution Notice will not include imprisonment.
Corporate transaction oversight
The Government will not change the notifiable event framework to:
- include new notifiable events on the significant restructuring of the employer's board of directors and certain senior management appointment and sponsoring employer taking independent pre-appointment insolvency or restructuring advice;
- extend the existing notifiable event on the breach of banking covenant to include covenant deferral, amendment or waiver; or
- extend the notifiable events framework to cover the payment of dividends.
Anti-avoidance regime
In relation to FSDs/FSNs, the Government has decided not to:
- progress with the proposal to enable TPR to issue an FSD once a scheme has transferred to the PPF;
- pursue the amendment to the reasonableness test to make clear that the actions of a target in creating or increasing risk would be a relevant factor;
- broaden the scope of FSD targets to include directors; or
- increase the lookback period but may come back to look at whether this remains appropriate in light of other changes (e.g. moving to a single-stage process for FSDs).
What's next for trustees and employers?
The Government's intended direction of travel has been fairly clear since the publication of the White Paper in March 2018 and the Consultation in June 2018. Now we have a better idea of how that approach will work in practice.
In the Consultation Response, the Government states that it intends to implement the new measures using primary and secondary legislation "as soon as Parliamentary time allows". However, new primary legislation will not be forthcoming until the next Parliament. If all goes to plan on Brexit and there are no more surprises like a general election, or second referendum, the Queen's Speech is expected to be in June 2019. Of course, what actually happens could be very different.
There is no immediate action for scheme trustees or scheme sponsors, but it is useful to be aware of these developments and the Government's stated aims as regards the further protection of DB pensions and to understand the direction in which the regulation of this sector is moving.