The Pensions Regulator (TPR) in the UK has put out new guidance for trustees of defined benefit (DB) schemes on how to assess and monitor the covenant from the company sponsoring the scheme, giving trustees flexibility in how often they examine the promise.

The guide is the first in a series that the regulator says it will publish to help trustees apply the DB code of practice, which it issued last year.

Lesley Titcomb, chief executive of TPR, said: “I urge trustees to use this important guide to assess and monitor their employer covenant in a way that is proportionate to the circumstances of the scheme and the need for an employer to grow.”

Trustees and employers should work openly and collaboratively together, she said.

“Our code highlights how trustees need a strong understanding of a scheme’s covenant in order to take an integrated approach to risk management, and use the full flexibility of the funding regime,” she said.

Though formal covenant assessments are to be performed at least every three years at the time of the funding valuation, the guidance is flexible in telling trustees how often they ought to monitor the employer covenant in between these assessmements.

It states that the strength of the employer covenant can change materially over a short period of time, and that this could have big implications for the scheme’s investment and funding strategy.

“Trustees should therefore monitor the covenant regularly between formal assessments alongside key investment and funding risks,” the guide said.

“The frequency and depth of monitoring should be proportionate to the circumstances of the scheme and employer,” it says.

The regulator said one of the code’s main principles was the need for an integrated approach to risk management. 

“Understanding the strength of the employer covenant underpins effective risk management,” it said.

The National Association of Pension Funds (NAPF) applauded the practical approach of the guide.

Helen Forrest, policy lead for defined benefit at the association, said: “We welcome the pragmatic nature of the document and the thoughtful and extensive approach TPR has taken to engaging with industry in its development.”

Simon Kew, on the pensions advisory team at Deloitte, said the guidance reinforced the principle that assessing covenant, including an appreciation of wider market dynamics, was not a ‘one-off’ process. 

“Monitoring should be in force, along with appropriate triggers, to ensure that trustees can react nimbly and appropriately to changes in covenant,” he said.

Darren Redmayne, head of  covenant advisers Lincoln Pensions, said: “We’re particularly glad that approaches that just focus on enterprise value comparisons or credit ratings have been cited by the regulator as over-simplifying the analysis and should not be seen as a substitute for a proper review.”

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