Pensions Regulator (Employer Resources Test) Regulations 2021

Lord Vaux of Harrowden Excerpts

Monday 6th September 2021 Grand Committee

[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.