Pensions Regulator (Employer Resources Test) Regulations 2021

Monday 6th September 2021 Grand Committee

Considered in Grand Committee

18:06

Moved by

[Baroness Stedman-Scott]

That the Grand Committee do consider the Pensions Regulator (Employer Resources Test) Regulations 2021.

[The Parliamentary Under-Secretary of State, Department for Work and Pensions (Baroness Stedman-Scott) (Con)]

My Lords, I am pleased to introduce this instrument, which was laid before the House on 28 June 2021. Subject to approval, these regulations provide essential details on the new employer resources test that was introduced by the Pension Schemes Act 2021 in connection with changes to the contribution notice regime.

The new employer resources test will enable the Pensions Regulator to overcome existing challenges of assessing the “act” or “failure to act” that has affected the financial strength of the sponsoring employer, and therefore its ability to support the scheme, rather than damaging the scheme directly.

These regulations outline that the profit before tax measure will be used to assess the resources of the employer. This measure is widely known and understood by the industry and gives the most appropriate picture of net profits available to provide support for a defined benefit pension scheme. The regulations set out specifically how the value of the resources of the employer is to be determined, calculated and verified.

I am satisfied that the provisions in the regulations are compatible with the European Convention on Human Rights.

Part 3 of the Pension Schemes Act 2021 strengthens the powers of the Pensions Regulator. It fulfils our manifesto commitment to take action against those who think they can plunder the pension savings of hard-working employees. These regulations provide essential details on the new employer resources test which forms part of the Pensions Regulator’s contribution notice regime. This regime enables the Pensions Regulator to demand that money is paid into a pension scheme from those found to have caused it detriment. A recent example is Dominic Chappell, who was ordered by the Pensions Regulator to pay £9.5 million into the British Home Stores pension scheme.

The new employer resources test, which these regulations relate to, will enable the Pensions Regulator to overcome existing challenges of assessing the “act” or “failure to act” that has affected the financial strength of the sponsoring employer and therefore its ability to support the scheme rather than damaging it directly.

With these new provisions, we will also avoid the associated challenge of having to project into the future to assess the likelihood of members receiving their accrued benefits. The purpose of the employer resources test is to provide the Pensions Regulator with a tool to make a simple snapshot assessment of the impact of the act or failure to act on the employer at the time. This allows for the act or failure to act to be assessed on its own terms, relative to the employer’s current potential exposure to the scheme, rather than an assessment of what could happen in future. Assessing whether the act or failure to act has reduced the value of the employer’s resources is just one part of the wider employer resources test. The Pensions Regulator, in addition to looking at the health of the employer, also has a focus on the scheme, where it is required to assess whether the reduction of the employer’s resources was material when compared to the scheme’s estimated Section 75 liability.

On the specifics of these regulations, what constitutes the resources of the employer is determined as being the employer’s profits before tax. This is a widely known and understood measure used by the industry and gives the most appropriate picture of net profits available to provide support for a defined benefit pension scheme. How the value of the resources of the employer are determined, calculated and verified are set out in these regulations. The general approach assesses the annual profit before tax position of the employer had the act or failure to act not occurred, which is then compared to an assessment including the act or failure to act. An adjustment is then applied to the profit before tax position that represents the impact which is expressed as a pound figure. The calculated figure would then be assessed against the scheme’s Section 75 debt immediately before the act or failure to act occurred. When the employer resources test has been met, the Pensions Regulator will follow the existing contribution notice process, whereby it will consider other factors, including the reasonableness of issuing a contribution notice.

Working in tandem with these regulations is the Pensions Regulator’s code of practice, which aims to provide further clarity to the industry on how it will interpret and use the powers. The Pensions Regulator launched a consultation in May 2021 on its contribution notice code of practice, which included clear examples covering scenarios of how the different tests would apply. The consultation concluded in July, and the Pensions Regulator is reviewing the responses with a view to publishing the code later in the year.

In closing, we remain committed to ensuring that there should be no hiding place for those who put workers’ retirement savings at risk, and these regulations will play a vital role in enhancing the Pensions Regulator’s ability to take action to protect pension scheme members. I commend this instrument to the Committee and beg to move.

[Baroness Janke (LD)]

My Lords, enabling the TPR to use contributory notices more widely to correct any detrimental action or failure to act is very welcome. However, I have a few questions about the method chosen for defining employer resources.

The Explanatory Memorandum refers to other methods being considered— EBITDA, or earnings before interest tax depreciation and amortisation, and a holistic measure based on covenant strength—but they were dismissed. Can the Minister explain why they were rejected, particularly the holistic assessment based on covenant strength? She will be aware that in very large university superannuation schemes, the level of contributions is affected by covenant strength. Can she explain why a snapshot of net income or profit before tax provides a better approach than this? If the snapshot route is to be followed for defining employer resources, what about the strength of employer assets? What part do they play in any assessment? I also question whether it is reasonable to allow the TPR absolute discretion in determining what are or are not exceptional or non-recurring items. I would welcome the Minister’s clarification on these points.

18:15

[Baroness Drake (Lab)]

My Lords, I thank the Minister for her clear explanation of these regulations. I welcome them, but I would like to raise one or two questions which seek some clarity.

The Pension Schemes Act 2021 gave the regulator new moral hazard powers with the introduction of two new criminal offences and by extending the flexibility available to the regulator to make connected parties such as group companies and directors liable for pension scheme deficits, and make payments to a scheme, by issuing a contribution notice. The Act introduces two new tests for imposing contribution notices: when the regulator considers that an act or failure to act materially reduces the employer debt likely to be recovered if a Section 75 debt has fallen due immediately after an insolvency event or reduces the resources of the employer in a manner which was material when compared to the debt in the pension scheme—the employer resources test, which is the subject of these regulations.

They set out that employer resources test for assessing whether a relevant act or failure to act reduced the value of the employer’s resources and whether that reduction was materially relevant to the pension scheme’s debt. I read in detail that the employer resources will be assessed through the pre-Act normalised annual profit before tax measure, under which non-recurring or exceptional items are removed, and then the impact of the act or failure to act on that profit is determined. If that impact is material, the regulator can start to build its case for a contribution notice. Indeed, it is a measure akin to the employer’s ability to support the scheme. The measure is sometimes used in the preparation of an employer covenant analysis undertaken for trustees.

For the record, as it is not clear, can the Minister say how dividends, including payments within a group of companies, will be treated in the normalised annual profit before tax measure and in the assessment of material detriment? That certainly proved a controversial issue of concern during scrutiny of the Pension Schemes Act 2021, and it is not clear—certainly not to me—how those will be considered under the new test. From a pension scheme member’s point of view, if the resources of the employer sponsoring the scheme are weakened through transferring assets or dividends, leveraging more debt or some other reason, the employer basically may be less good for the money and pension benefits will be less secure. They will look to the cavalry at the regulator to come over the hill and issue a contribution notice, and they need to have the confidence that that will actually be done with more focus, positivity and speed of action than the past has demonstrated.

In their response to the consultation published on 29 June, the Government set out their reasoning for the employer resources test. In summary, it said that, in the majority of past contribution notice cases, the regulator faced

“difficulty in forecasting the medium and long-term performance of a business for the purposes of the … ‘material detriment test’.”

This is because it had to extrapolate from an employer-related act into the future, with the uncertainty and challenges that causes evidentially. Indeed, trustees can experience exactly those similar difficulties in trying to assess those implications for the employer covenant, because there is no industry consensus on how to value the employer covenant. Therefore, the employer resources test removes the need to forecast how the employer might or might not have performed in the absence of that act and assesses the impact on a snapshot basis. So it is quicker, sharper and more efficient.

However, the regulator still will not be able to issue a contribution notice if a party can show that they meet the conditions for a statutory defence and can provide reasonable excuse. The three premises are that they gave prior consideration to the test and to the extent that the failure or failure to act would reduce the value of the employer’s resources in a material way; that they took all reasonable steps to mitigate any such detrimental impact; and that it was reasonable for them to conclude that the act would not detrimentally affect in a material way the likelihood of the scheme members receiving their benefits.

I sighed a little because, even after applying the employer resources test, the regulator still has to conclude that it would be reasonable to impose a contribution notice, taking into account all relevant factors including the extent of any mitigation provided and a broader assessment of the employer’s strength. I just wonder whether we are going to face a potentially long and drawn-out process, which the employer resources test was intended to remove, in the way in which the defence arguments can be applied and whether the Government’s intention of deploying an employer resources test as a quick and efficient snapshot—rather than on a holistic basis—could be undermined.

I ask the Minister: what powers or processes are relied on to prevent the statutory defence conditions undermining the policy intention to have a quick and efficient employer resources test? Is it the intention to issue fuller guidance on how measures to mitigate the detrimental impact on pension schemes of an act or failure to act will be assessed as to whether they are sufficient to meet the statutory defence? These are the kind of realities that trustees will need to understand and employers will need to know.

Just as a concluding line, poor behaviour affects not only the value of members’ benefits paid but, as the Pension Protection Fund is funded by a levy, it affects those businesses which abide by the rules but end up bearing the costs and subsidising those businesses which seek to avoid their pension liabilities. Good employers and trustees or members have an interest in these new regulations working efficiently.

[Lord Vaux of Harrowden (CB)]

My Lords, it seems like quite a long time ago that we were last in this Room. In fact, I think the last time I spoke in this Room was in the discussion on pension schemes, so it is nice to see a lot of old faces. There is a nice feeling of déjà vu about it. These regulations are reassuringly brief, so I will try to keep my comments equally brief, if I can.

First, I was a bit confused by the name of this, which refers to an employer resources test, that test being profit before tax. Profit before tax is not a measure of a company’s resources. It is a backward-looking measure of a company’s profitability. I question the comments in the Explanatory Memorandum that

“profit before tax … is less subjective than other options”.

Notoriously, profit before tax can be made to be whatever one wants it to be. A cash-flow measure would be an altogether less subjective, more objective measure. Profit before tax also does not, as the noble Baroness, Lady Drake, has said, take account of other forms of leakage of resources out of the company, be they dividends, share buybacks or massive capital expenditure. It is perfectly possible for a company to be highly profitable and highly indebted at the same time and therefore to have very low levels of employer resources.

I was a bit confused by the title, and would therefore like to add my name, as it were, to the question asked by the noble Baroness, Lady Janke, about why the Government did not go down the holistic route of looking at multiple measures that give a full picture of the employer resources rather than this one very narrow picture which is only a backward snapshot.

I have two other questions that relate to the discussions we had at the time of the Pension Schemes Bill. This instrument is obviously relevant to the subject of dividends that companies with deficits pay. The noble Baroness will remember that we had quite a lot of discussions about that back then. Indeed, the Minister at the time agreed that the Government would keep the question of dividend payments by companies in deficit under review.

I have two questions. First, can the Minister explain what assessment the Government have made of the impact that these regulations might have on the ability of companies to pay dividends? There has been some speculation in the press that it might significantly depress the payment of dividends by companies, something which on the whole is a good thing, but there could be situations where that could be a negative. Secondly, I would welcome confirmation from the Minister that the Government are still keeping under review the question of payment of dividends by companies that have deficits, as they promised.

[Lord Davies of Brixton (Lab)]

I am glad that it was an accountant who made the comment that profits can be whatever you want them to be, which was my concern. However, I am struggling to grasp what role this is playing. In some ways, I suspect that we could overengineer the definition of “resources” and make it very complicated. There are strong arguments for keeping it as simple as possible so that the regulator can take a holistic view. This is what I understood the process to be. My guess is that the regulations will enable the regulator to do what we always thought it could do in the first place, and it tripped over some regulatory legal point. There are strong arguments in favour of keeping it simple and leaving it essentially to the judgment of the regulator.

Whenever I mention the regulator, I have to add my qualification that of course it does not represent scheme members in any way. It does not have the accumulated knowledge of unions and employers who actually do the business of agreeing pension schemes. I have questions about the Pensions Regulator but the ideal should be a Pensions Regulator that knows the field and can apply the test proportionately.

I have one specific question. I have no idea what this means. Regulation 4(8) says that

“the Regulator must take into account all relevant information in its possession”.

Well, yes, it is not going to take into account information that is not in its possession. However, it goes on to use the word “verification”. I am not sure what “verification” is doing in that paragraph.

[Baroness Sherlock (Lab)]

My Lords, I thank the Minister for her explanation of the reasoning and intent behind the employer resources test, and all noble Lords who have spoken. I too welcome a move to strengthen the power of the Pensions Regulator. We should say that most employers with DB schemes act professionally and responsibly and maintain good relations with their scheme trustees. However, the Pension Schemes Act 2021, from which these regulations flow, rightly gave the Pensions Regulator stronger powers to deal with the small number of circumstances where parties decide to evade their obligations to their pension schemes or behave recklessly. The test is whether these measures will enable the regulator’s approach to be clearer, quicker and tougher. This is what we are exploring today, so I hope that the Minister can help to reassure us on that point.

I will not go back over what the regulations do, but as we have heard, employer resources will be assessed through normalised annual profit before tax, with non-recurring or exceptional items removed. The Minister explained how that would happen: you would take NAPBT, the regulator would then look at the impact on NAPBT caused by the act or the failure to act, produce an adjusted NAPBT and then decide whether to issue a contribution notice. It would compare the two and then argue that the reduction was material in relation to the estimated Section 75 debt.

The case for the test must be that it removes the evidential challenges and uncertainties in forecasting how the employer might or might not perform in the future— absent the act or failure to act—and therefore presumably would provide a quicker measure of assessing the employer’s ability to support the scheme and reveal whether a reduction in resources was material.

18:30

The Minister indicated her belief that a simple snapshot would give the regulator a quicker, more efficient tool to make an assessment. I shall not go back over the questions raised by the noble Lord, Lord Vaux, the noble Baroness, Lady Janke, and my noble friends Lord Davies and Lady Drake, about whether this was the right measure and how well it would work—they have done that way better than me and I am certainly not an accountant—but underlying this is a problem which this is trying to tackle. While it acknowledged that most employers with a DB scheme act responsibly, the information gathered and published by the Work and Pensions Select Committee when it looked at controversial cases of poor and reckless company behaviour towards their DB schemes provided clear evidence of the weaknesses of the existing regime where there is poor employer conduct. So we need some action.

Where the employer test is met and material detriment is revealed as a consequence of an act or failure to act, there is then a separate statutory test for reasonableness, where the regulator must take account of all relevant factors before imposing a contribution notice. As we have heard, that can include a broader assessment of the employer’s strength than that provided by the resources test. Does that not reveal some uncertainty and ambiguity about how quick and efficient the amended contribution notice regime will be? My noble friend Lady Drake raised the question of a statutory defence. I want to ask the Minister some specific questions. Where a party invokes the statutory defence of reasonableness, will there be a time limit on the submission of evidence relied on in support of that defence? What are the limits on the regulator’s powers to determine whether the statutory defence has been met by a party whose act or failure to act has resulted in a material detriment to their scheme?

On the employer resources test, Regulation 4(3)(a) refers to the regulator determining whether an item is to be treated as non-recurring or exceptional or the value of such an item when determining the value of the profits of the employer. To what extent is the regulator’s determination of that binding on the relevant parties?

In the consultation, some stakeholders asked how the regulations would apply to charities and non-profit bodies—which I am sure the Minister’s past will stand her in good stead to answer. The Government’s response is in the form of Regulation 3, which states that

“in the case of an employer which is … (i) not trading for profit; or … (ii) a charity, any reference to ‘profits’ in these Regulations shall be read as if it referred to ‘net income’ … In this regulation, ‘net income’ means income after the deduction of expenditure”.

While helpful, that is not quite as helpful in the case of charities—I think we want a bit more than that. What is the definition of net income in the case of charities subject to the SORP? Is it total net income? Is it just net unrestricted income? If it is total income, I presume that the net income includes restricted items which the charity may or may not be able to apply to the pension scheme depending on the nature of those funds—the Minister will know what I am talking about; she, like me, has run charities and we have all wrestled with restricted funds and their accounting over the years. I would be interested if she could unpack that a bit.

Under the contribution notice regime, the Pensions Regulator can make connected third parties liable for pension scheme deficits and make them make payments to the UK DB schemes. Given that we have left the EU, and given the regulator’s previous experience in pursuing foreign parent companies for payments—which we discussed at some length during the passage of the then Pension Schemes Bill—has any thought been given to complications that might arise in seeking contributions from such parent companies?

Finally, once the new contribution notice regime commences in October, companies will have to assess the impact of their business activities against the new tests and conclude whether a reduction in employer resources and/or reduction in scheme insolvency recoveries are material. The companies and connected third parties may need or want to apply to the regulator for clearance to get comfort that it will not exercise its own powers to issue a contribution notice. Have the Government made additional resources available to the regulator to meet such a demand? Equally importantly, will it be able to recruit people with the requisite skill sets? I look forward to the Minister’s reply.

[Baroness Stedman-Scott (Con)]

Again, I thank all noble Lords for their contributions. I shall start with the points raised by the noble Baroness, Lady Janke, and the noble Lord, Lord Vaux, on why we do not have a holistic measure. There is no industry consensus on how to value an employer’s covenant strength, and we believe that introducing a holistic measure would introduce a number of uncertainties. There is a statutory requirement for the regulator to consider whether it is reasonable to impose a contribution notice, which includes an obligation to take account of all relevant factors, including the broader assessment of the employer’s strength. We therefore believe that the wider regime should provide comfort to those concerned that the regulator will not take a holistic view.

The noble Baroness, Lady Janke, raised the issue of earnings before interest, tax and depreciation. I confirm that we looked very closely at the suitability of this and concluded that it is unsuitable, as it is not covered by the financial reporting standards relating to accounting practice published by the Financial Reporting Council and is therefore not audited. We think that it is relevant to have the interest charge allowed for in the figure, which earnings before interest, tax, depreciation and amortisation does not take into account, because that could be where the detriment was reflected if the company raised more debt.

The noble Baroness raised a point about why we have selected the profit before tax measure. The purpose of the employer resource test is to provide the Pensions Regulator with a tool to make a simple snapshot assessment of the impact of the act or failure to act on the employer. Profit before tax was selected for measuring the resources of an employer because it is a term widely understood by the industry and regulator. We believe that it is less subjective than other options that would be indicative of the employer’s ability to support the scheme.

The noble Baroness also raised how the Pensions Regulator would determine and remove exceptional and non-recurring items from an employer’s annual accounts. The Pensions Regulator would not ordinarily exercise its discretion in relation to exceptional and non-recurring items in audited accounts which mirror the prescribed test period because an audit process will already have examined them. When no accounts are produced, for example, non-recurring and exceptional items will be determined by the regulator, which must have regard to the financial reporting standards relating to accounting practices published by the Financial Reporting Council.

The noble Baroness, Lady Drake, raised a point about how dividends will be treated in the profit before tax test, and I am advised that we will write to clarify that and, of course, place a copy in the Library for everyone to see. The noble Baroness also raised a point about the regulator’s guidance. The Pensions Regulator launched a consultation on the revised code 12 contribution notices code of practice, which includes clear illustrative examples covering scenarios of how the different tests would apply. This would provide further clarity on how the regulator will interpret and use the new powers. The regulator has received useful feedback from stakeholders as part of the consultation which it is currently analysing, and I understand that the regulator intends to use that feedback to strengthen certain aspects of its policy and further illustrate the approach that will be taken and where its interests lie in terms of acts and conducts pending from any decisions from the courts on these points.

The noble Lord, Lord Vaux, understandably raised the question of why we selected the profit before tax measure. The purpose of the employer resource test is to provide the Pensions Regulator with a tool to make a simple snapshot assessment of the impact of the act or failure to act on the employer. Profit before tax was selected for measuring the resources of an employer because it is a term widely understood by the industry and the regulator. We believe it is less subjective than other options and will be indicative of the employer’s ability to support the scheme.

The noble Lord, Lord Vaux, also raised the issue about the new pension rules change threatening to scupper a big dividend pay-out. We do not wish to crowd out investment, nor do we wish to prevent the payment of proportionate dividends to shareholders. During the passage of the then Pension Schemes Bill through Parliament, the Government opposed and defeated opposition amendments which sought to subject dividend payments by companies with a pension scheme funding deficit to approval by the Pensions Regulator. We argued that it could deter investment and undermine employers.

The noble Lord, Lord Davies, raised the point of verification. The regulations set out that the Pensions Regulator is making a determination and must take into account all relevant information in its possession. The prescribed methodology set out in the regulations also makes it clear that annual accounts will be used which will have already been verified. In terms of verifying the regulator’s determinations, ultimately, any target can make representations to the regulator about the determination, and any decision to impose a contribution notice can also be referred to the Upper Tribunal.

The noble Baroness, Lady Sherlock, raised the question of reasonableness of statutory defence, and whether the Pensions Regulator has a way to determine if this is met. The Pensions Regulator will publish a code of practice and guidance that will illustrate how the tests will apply. The noble Baroness raised the very important issue of charities, and I am advised that we will write to her with clarification on the points she raised.

The noble Baroness also raised the issue of recovery from overseas employers. Again, we will continue to review the situation. She also asked whether this will create an influx of clearance requests and whether the Pensions Regulator is resourced to handle them. The Pensions Regulator does not expect that there will be a significant increase in clearance requests coming in but, if this is the case, the regulator is used to reprioritising its resources and activities, as it has demonstrated during the recent Covid crisis.

To confirm, the draft regulations debated today provide greater security for members’ defined benefit retirement savings by setting out the details of the employer resources test that the Pensions Regulator can use in combating acts of those seeking to avoid their responsibilities to pension schemes. I commend this order to the Committee.

Motion agreed.

Committee adjourned at 6.42 pm.