New tougher powers for the Pensions Regulator start to bite

News Alert 2021/03

At a glance

New powers for the Pensions Regulator become effective from today, mostly relevant to Defined Benefit pension schemes.

A final Regulator Policy and Code issued on 29 September provides some more practical context on how the Regulator intends to use its new powers.  However, even with these helpful examples and practical considerations, it is still not clear where the new regulatory boundaries will lie, particularly when it comes to what many might call ordinary commercial activity – for example moving cash funds around a group of companies or a parent company paying a dividend.

With the new powers raising the bar when it comes to the Regulator’s oversight of corporate activity, companies need to tread carefully and cautiously to avoid falling foul of the rules. There are also new considerations for trustees.  Company and Trustee boards will need to be aware of the new regulatory boundaries and have robust governance processes in place to identify corporate activity that may be drawn into the new regulatory net, take appropriate action, and ensure they have clear records of decision-making.

This News Alert highlights some of the key areas from the new guidance and some practical steps for sponsors and trustees of DB schemes.  The guidance is extensive, and this is not a complete summary of all points that may be relevant in any particular circumstance.

Key Actions

Scheme sponsors

• Arrange training for the relevant company boards and key management to ensure awareness by key decision makers
• Review corporate governance procedures around key business events, including ‘business as usual’ activities such as dividend declarations, to ensure DB schemes are appropriately considered
• Consider how record keeping will work, to demonstrate compliance
• Review any information sharing agreements with trustees (or introduce one if not already in place)
• Ensure procedures are in place to meet new expanded regulatory reporting requirements

Trustees

• Be aware of the new powers and how they can impact the interaction between the sponsor and the trustee body, arranging training as appropriate
• Review and update any information sharing agreements with the sponsor (or introduce one if not already in place)

The Detail

Pension Schemes Act 2021

The Pension Schemes Act 2021 legislates for the following strengthened powers for the Pensions Regulator in relation to sponsors, company directors, trustees and other parties involved with DB schemes (including advisers):

• Criminal offences, with penalties including up to 7 years in jail or an unlimited fine
• Two new Contribution Notice tests – increasing the range of activities where the Regulator could use its power to make a legal demand on a company, company director, shareholder or connected party to make a cash contribution to a scheme
• Financial penalties of up to £1m, including for failing to meet notification requirements or providing misleading information
• Information gathering, inspection and interview powers

Most of this legislation came into force on 1 October 2021.  On 29 September the Regulator released a suite of documents that set out how it will use its new and strengthened powers.  See our Pensions Bulletin 2021/40 for links to the various documents.

Criminal offences

The Act introduces two new criminal offences.  These are:

• The intentional avoidance of an employer debt due to the scheme
• Conduct risking accrued scheme benefits where an individual knew (or ought to have known) the conduct would have had this impact – this includes conduct that materially worsens the sponsor covenant that supports a pension scheme

In each case the offence can only be established if the person carrying out the act did not have a reasonable excuse for acting or conducting themselves in the way they did.

The Regulator’s final policy on investigating and prosecuting the new criminal offences was published on 29 September, following consultation earlier in the year. The policy sets out the following:

• Who is in scope: ‘any person’ (including directors, trustees, advisers and third parties such as lenders). This includes any person who helps or encourages someone else to commit the offence (‘the secondary offender’) but excludes those acting within their functions as an insolvency practitioner.
• The Regulator’s approach to reasonable excuse: a person can only commit the offence if they did not have a ‘reasonable excuse’ for their conduct. The policy document says that the Regulator will take a ‘principles-based’ approach to assess if the party had a ’reasonable excuse’ and will seek to recognise individuals’ reasons for acting as they did; the circumstances (time constraints are referenced); and acknowledge individuals’ experience and skills.  Three key factors are set out for the Regulator to consider in determining if an individual has a reasonable excuse – the extent to which the detriment to the scheme was an incidental consequence of the act or omission, the adequacy of any mitigation provided to offset the detrimental impact, and where no, or inadequate, mitigation was provided, whether there was a viable alternative which would have avoided or reduced the detrimental impact.  The provision of adequate mitigation will be a key consideration – albeit ‘adequate’ will be based on the Regulator’s view in determining whether to bring a case (and will ultimately be determined by the courts where a case is brought).  In relation to where no, or inadequate, mitigation was provided, helpful examples are set out, which include a recognition of some of the practical constraints which directors and trustees may face.  For example, there is an acknowledgement that the extent to which ‘viable alternatives’ have been considered will be context dependent and that, with the timescales of some M&A/restructuring, some decisions need to be made quickly.
• How cases will be selected for investigation: additional factors are listed in terms of when the Regulator may consider bringing a case and include the extent of communication and consultation with the trustees. There is reference to a risk-based selection of cases taking into account the impact in the context of the funding level of the scheme and consideration of the Regulator’s available resources.

The policy also contains a very helpful case study in the Appendix setting out the Regulator’s decision-making process for various parties involved in a case.

Staging

Schemes will be required to connect to the dashboard in a staged manner with the largest schemes going first.  The DWP proposes three staging cohorts – large schemes (1,000 + members: April 2023 – September 2024), then medium schemes (100 to 999 members: October 2024 – October 2025), followed by small and micro schemes (expected from 2026, but not covered by the regulations).  MaPS will give every scheme a window for connecting and once connected, a scheme should be able to respond to ‘find and view’ requests.

However, in a change from MaPs’ Call for Input in May 2021 (see Pensions Bulletin 2021/23) the definition of a member for staging purposes now excludes pensioners and therefore schemes with large pensioner but small active/deferred populations may find they have more time before they are staged.

Exceptionally, schemes will be able to ask the Secretary of State to defer their staging deadline by up to one year.  Guidance on the deferral process is promised but the regulations require that any request for deferral must be made within twelve months of the regulations coming into force.

The consultation notes that public service pension schemes represent nearly 20% of all active and deferred memberships in scope for dashboards and so the Government wants these schemes to stage as early as possible despite the challenges associated with implementing the McCloud remedy (see Pensions Bulletin 2021/06).  The regulations set the staging date as 30 April 2024 for all public sector schemes.

The Government is also committed to making State Pension data available via dashboards “from day one”.

New Contribution Notice tests

The Act introduces two new tests that, if met, would enable the Regulator to consider using its Contribution Notice powers.  These are:

• The Insolvency Test – are the recoveries for a pension scheme materially worse on a hypothetical insolvency as a result of an event or action
• The Employer Resources Test – are the profits of a company reduced as a result of an event or action and is the reduction material as a proportion of the scheme’s section 75 (ie buyout) deficit

To support these expanded powers, the existing Code of Practice No 12 (and related guidance) which sets out how the Regulator will use its Contribution Notice powers has been updated, with the guidance providing examples of activities which may be in scope of the expanded powers.  It is important to note that, whilst the new tests are expected to be met far more frequently, including for corporate activity that may be considered as “business as usual”, the Regulator has to also demonstrate that it is “reasonable” to impose a Contribution Notice before doing so.

Examples of such activities include:

• Where sponsor or guarantor support is removed, substantially reduced or becomes nominal
• Increase in debt/prior-ranking security which weakens the scheme’s creditor position
• ‘Some instances’ of paying a dividend
• Unscheduled repayments to other creditors of the employer over the scheme

The Regulator has also issued an updated version of its Clearance guidance to reflect its new expanded Contribution Notice powers and other developments in how it regulates DB schemes.  Clearance is a voluntary process whereby parties that are undertaking transactions can make an application to request that the Regulator will not, in relation to that particular transaction, (based on the information provided) seek to use its Contribution Notice or Financial Support Direction powers.  It is worth noting that a successful Clearance application can also help mitigate the risk of the Regulator launching a criminal prosecution, although it has made clear that Clearance is not specifically available in relation to its criminal offences’ powers.

The new Clearance guidance has been written in a way so that the events for which Clearance may be sought – “Type A events” – in some cases do not map over to the sort of events that could satisfy one of the new Contribution Notice tests.  Therefore, going forward, we expect there to be situations (for example the payment of dividends) where regulatory risk will remain, but Clearance is not available.

Financial penalties, information gathering and overlapping powers

The Regulator has also published a new consultation in relation to the following draft policies:

• Financial penalties – The Regulator newly has the power to issue a financial penalty of up to £1m in certain circumstances, including for the same activities that could fall foul of the criminal offences described above and for failure to comply with the Regulator’s information gathering powers (including under the expanded notifiable events regime yet to come). In many cases it is proposed that the amount of the financial penalty will be based on culpability and harm caused
• Information gathering powers – The Regulator’s information gathering powers have been significantly expanded, including the power to compel anyone to attend an interview. The Regulator also gains a broader inspection power, in the context of enforcement cases.  The draft policy sets out the types of information the Regulator might ask for, including trustee meeting minutes, board resolutions and minutes, bank statements, correspondence and advice
• Overlapping powers – this covers where the Regulator has the option to pursue both criminal and/or regulatory powers in respect of the same set of circumstances. The policy references that Contribution Notices are likely to be used in circumstances to provide a remedy, while financial penalties and criminal proceedings are directed towards punishment for serious behaviour and to act as a deterrent