The Pensions Regulator’s Employer Covenant Guidance[1], released in December 2024, provides a helpful framework to aid trustees in assessing employer covenant risks[2]. This guidance is part of the new defined benefit (“DB”) funding regime[3]. However, it offers limited direction when it comes to navigating the complexities of multinational corporate structures. For trustees, this presents a significant challenge, as they must consider variations in legal frameworks, financial reporting standards, and regulatory protections across different jurisdictions.
In this blog, we explore three key challenges trustees face when assessing covenant strength in global corporate structures and outline proactive measures that can be taken now to mitigate risks.
Understanding the Parent Company’s Legal Obligations
One of the hurdles trustees encounter is determining whether a global parent company has any legal obligations to support a UK pension scheme, particularly in situations where such support is considered necessary in light of concerns over the strength of the covenant of the sponsoring employers.
Where express legal obligations from a parent company do not exist, this can create uncertainties for trustees assessing covenant strength. Trustees cannot always rely on implicit financial relationships or goodwill, as these do not provide a reliable safeguard against parental support being withdrawn or unavailable. Additionally, enforcement issues outside the UK further complicate matters. Differences in insolvency laws across jurisdictions can obscure trustees’ understanding of the recourse available in the event of parent company insolvency.
There are a number of mitigating actions that trustees can look at now to alleviate some of the issues. For example, trustees can get legal opinions to:
- determine whether the parent company has any legal obligations to support the UK scheme, either directly or indirectly (e.g., through intercompany guarantees or contractual agreements); and
- clarify the enforceability of existing guarantees or contingent assets, including charges over assets, under the relevant jurisdictions’ laws.
It would be sensible to schedule periodic reviews of these arrangements (and of any legal advice) to ensure that they remain valid and adequately protect the scheme’s interests.
Where possible and considered necessary in order to support the covenant, trustees should seek to put in place agreements with parent companies to include express legal obligations to the pension scheme, such as financial guarantees, regular financial disclosures, or triggers for action in the event of financial distress of the sponsoring employers.
Managing Financial Dependency
Where the financial health of a UK sponsoring employer is dependent on a global parent company, there are inherent risks.
Economic vulnerability is a significant concern. Employers that rely heavily on their parent company’s cash flow may face substantial risks if the parent encounters financial difficulties due to economic downturns or geopolitical events. Financial contributions from foreign-based parents may also be impacted by currency fluctuations. In addition to financial dependence, employers could similarly be impacted by operational dependence. For example, subsidiaries may rely on parent company funding for capital expenditure, research and development, or operational continuity. A shift in the parent’s strategic priorities could lead to reduced financial support, threatening the stability of the employer.
To help manage these risks, trustees should analyze the financial position of the parent company by requesting and reviewing consolidated financial statements. This will allow for an assessment of debt levels, liquidity ratios, and profitability trends, particularly in sectors or regions prone to volatility. It is also important, where the sponsoring employer is financially dependent on the parent company, to consider the issues set out in the section above by ensuring that there is sufficient legally binding support in place. Engaging in scenario planning is also beneficial, modelling potential financial distress scenarios to understand how reduced or withdrawn parental support would impact the employer’s cash flow and overall stability. Additionally, trustees should remain informed about sector-specific and geographic risks that could affect the parent company’s financial position. Consulting external advisors can provide valuable insights into early warning signs of financial instability.
Addressing Cross-Border Regulatory Risks
Differences in regulatory frameworks across jurisdictions add another layer of complexity to covenant assessments, particularly where there are varying pension regulations, financial reporting standards, and/or disclosure rules.
In some jurisdictions, data privacy laws may restrict trustee access to critical financial and operational information. Limited transparency is another concern, particularly when parent companies operate in jurisdictions with weaker regulatory standards. These can lead to inconsistencies and opaqueness with financial reporting, disclosure requirements, and insolvency protections.
To navigate these issues, trustees can develop information-sharing protocols with the parent company to help ensure regular and transparent access to financial statements, cash flow forecasts, and management accounts. Where such protocols can be established, the frequency and scope of disclosures should be clearly defined. Engaging cross-border legal and financial experts is another important step, as they can provide guidance on the regulatory landscape of the parent company’s jurisdiction and confirm compliance with relevant laws. Using globally recognised financial reporting frameworks, such as IFRS or GAAP, allows for a more consistent benchmark when evaluating financial information. Checks can be undertaken to ensure that the parent company’s governance structures align with its obligations to the UK employer and pension scheme. Finally, where possible, trustees should engage with the parent company’s board or management to understand their commitment to supporting the scheme.
Final Thoughts
The guidance from the Pensions Regulator provides a helpful framework for employer covenant assessments, but it does not offer a definitive roadmap for navigating multinational corporate structures. Trustees must adopt a proactive and thorough approach, combining legal analysis, financial scrutiny, and risk mitigation strategies to safeguard pension schemes against uncertainties in global corporate relationships. By staying vigilant and implementing protective measures, trustees can ensure that schemes remain secure despite the complexities of operating within a multinational framework.
[1] Covenant guidance – The Pensions Regulator
[2] Dentons – Small Schemes and the proportionality principle in TPR’s updated Employer Covenant guidance
[3] For the Pensions Regulator’s DB funding code of practice, see here. For additional commentary, please see the piece on our website here.
