THE BOARD OF THE PENSION PROTECTION FUND. Guidance in relation to contingent assets 2016/2017

Transcription

1 THE BOARD OF THE PENSION PROTECTION FUND Guidance in relation to contingent assets 2016/2017 Pension Protection Fund i December 2015 v1.2

2 CONTENTS CHAPTER/SECTION PAGE 1 INTRODUCTION Pension Protection Fund ( PPF ) recognition of contingent assets - General Sources of information RECOGNISING CONTINGENT ASSETS Use of standard form documents Changes to standard form documents Sanctions PROCEDURE FOR RECOGNITION OF NEW CONTINGENT ASSETS Submitting documents via Exchange Documents to be submitted by post Certified copies requirements Declaration Next steps Subsequent changes to information contained in the certificate 7 4 PROCEDURE FOR RECOGNITION OF EXISTING CONTINGENT ASSETS Introduction Legal opinion Declaration TYPE A CONTINGENT ASSETS Strength of Type A contingent assets The Board s assessment of the strength of guarantors Partial recognition of Type A contingent assets Requirements as to the guarantor as Employer s Associate Liability caps Deemed value based on liability cap Recognition for levy purposes - single Type A guarantee Recognition for levy purposes - multiple Type A guarantees Type A contingent assets in multi-employer schemes Adjusting the guarantor s levy band.22 6 TYPE B CONTINGENT ASSETS Introduction Security over cash (Type B(i)) Security over land (Type B(ii)) Pension Protection Fund ii December 2015 v1.2

3 6.4 Security over securities (Type B(iii)) Liability caps Deemed value based on liability cap Deemed value based on liability cap and value of underlying assets Recognition for levy purposes Release of underlying assets where oversecured TYPE C CONTINGENT ASSETS Introduction Format Recognition for levy purposes LEGAL OPINONS Key Requirements Limiting liability in legal opinions Legal opinions sample wording Caveats in the legal opinion AMENDMENT AND REPLACEMENT OF CONTINGENT ASSETS Policy background Reduction and replacement - Standard form agreements Reduction and replacement the Board s approach Reduction and replacement exercise of the Board s discretion Advance notification of proposed changes to the Board Examples of acceptable changes Examples of unacceptable changes Impact of future transactions on the contingent asset APPENDIX 1: SUGGESTED FORM OF COVERING LETTER APPENDIX 2: EXAMPLE CONTINGENT ASSET CERTIFICATES Pension Protection Fund iii December 2015 v1.2

4 1 INTRODUCTION 1.1 Pension Protection Fund ( PPF ) recognition of contingent assets - General In accordance with its statutory objectives under section 175(5) of the Pensions Act 2004, the Board of the Pension Protection Fund (the Board ) publishes each year a determination of the pension protection levy (the Determination ), setting out the rules by which the scheme based and risk based levies for that year will be calculated for every eligible scheme. The Determination includes details of how contingent assets are recognised for the relevant levy year. Further details are contained in the Contingent Asset Appendix to the Determination The Determination for the 2016/17 levy year was published in December 2015 and is available, together with the Appendices at: This guidance seeks to assist schemes and their advisors as to how to put in place a contingent asset under Part G of the Determination and the Contingent Asset Appendix. It is an accompaniment to the Determination and the Contingent Asset Appendix, not a substitute A contingent asset is an asset that will produce cash for a pension scheme if certain events happen, in particular where the sponsoring employer suffers an insolvency event. They must reduce the risk that an insolvency event results in a claim on the PPF, or reduce the size of a claim if one occurs. The types of contingent asset arrangements that are recognised by the Board are: (a) (b) (c) Guarantees given by parent/group companies and undertakings (Type A); Security over cash, real estate and securities (Type B); and Letters of credit or demand guarantees (Type C) For the 2016/17 levy year the Board has introduced new rules providing for the recognition of asset-backed contribution ( ABC ) arrangements in the levy calculation. Our approach to recognising ABCs will differ to our approach to contingent assets. Schemes should refer to the Board s published ABC Appendix and Guidance, rather than referring to this Guidance, to confirm our requirements in respect of ABC arrangements The definitive rules on calculating the levy are set out in the Determination for that year, and in the event of any conflict between this guidance and the Determination, the Determination will prevail. This guidance may be further updated and expanded from time to time in the light of, for example, issues arising, or queries received by the Pension Protection Fund. 1.2 Sources of information This guidance should be read alongside the following documents, all of which are available through the pension protection levy section of the Pension Protection Fund's website at save for the certificates, which are available via Exchange on the Pensions Regulator s website (a) standard form agreements for contingent assets; 1

5 (b) (c) (d) (e) (f) certificates for notifying the Pension Protection Fund; the 2016/17 Determination and the Appendices; the Board s previous Determinations; any FAQs in relation to contingent assets added to the PPF website; and the Board s consultation documents, including the 2016/17 Levy Consultation published in September You should read this information in full before taking action in relation to new contingent assets or certifying any such assets to the Board. The person submitting the contingent asset certificate on Exchange will be required to declare that they are aware of this guidance References to trustees in this guidance include references to managers, except where the context requires otherwise In the case of sectionalised schemes, all references to a scheme in this document should be taken to apply to the relevant section All dates and times are measured by GMT or, if it is in force at the relevant time, BST In the event that there is a discrepancy between the wording on Exchange and the Contingent Asset Appendix of the Determination, the Contingent Asset Appendix should be considered the applicable requirement. 2

6 2 RECOGNISING CONTINGENT ASSETS 2.1 Use of standard form documents Contingent asset agreements must be in the PPF standard form in force at the date of execution of the agreement. Trustees (or a person authorised by them) must certify that the contingent assets for which they seek credit are in the Board's standard form and are legally valid, binding and enforceable A full list of the PPF s standard form agreements in Word format can be found at: Assets.aspx The Board s standard form agreements were updated with effect from 17 December 2014, in particular to allow for surety bond arrangements to be recognised as a Type C(ii) contingent asset, and generally to reflect legal developments and changing market practice. The updated versions of the standard form agreements must be used for any contingent asset arrangement entered into with effect from 17 December The trustees will need to provide a legal opinion, prepared by an appropriately qualified person, addressing the matters referred to in paragraph below The agreement should then be completed (with legal advice) to include the parties involved, details of any underlying assets charged (including secured creditors) etc. prior to execution by the parties You should not rely on this guidance or other documents provided by the PPF. The Board accepts no responsibility to trustees or any other person for the efficacy of the standard documentation or for any legal effects that such documentation may have if used in any circumstances. 2.2 Changes to standard form documents Changes that, in the opinion of the Board, would have a materially detrimental effect on the rights of the trustees by comparison with the standard forms are not permitted Companies and trustees are free to agree changes which are not materially detrimental, e.g. name and address of the guarantor, changes which are minor or reflect the legal form of the contingent asset provider or which enhance the position of the trustees. Please see paragraph below in this regard. The Board will not provide prior confirmation as to the acceptability of any proposed variation to the standard form documentation. Trustees and their legal advisers must satisfy themselves, prior to making their contingent asset submissions, that the proposed variations do not have a materially detrimental effect as compared with the standard form, Where changes have been made to the standard form, the trustees must ensure that: (a) (b) (c) the Board receives a clear statement of the changes; a legal opinion is obtained which confirms why the changes do not have a materially detrimental effect on the rights of the trustees as compared with the standard form; and a comparison against the standard form is provided, where any changes have been made beyond selecting options and inserting party details. 3

7 2.2.4 The Board will then consider whether the changes are materially detrimental as compared with the standard form. The requirement that any variations from the standard form must not be materially detrimental to the rights of the trustees is a deliberately stringent test in order to ensure fairness between schemes. If the document is negotiated between the parties, with the result that some changes are made which benefit the trustees and some are materially detrimental to the trustees, the trustees' legal adviser will not be able to give the confirmation required and the contingent asset cannot be recognised A single materially detrimental change will mean that the contingent asset cannot be recognised even if there may be materially beneficial changes which the parties involved believe outweigh the negative change. Furthermore, the requirement is that the variations are not materially detrimental compared to the standard form; the fact that the agreement might represent a more favourable position for the trustees than no agreement at all is not relevant Parties cannot mix and match provisions from different versions of the same standard form. 2.3 Sanctions It is a criminal offence under section 195 of the Pensions Act 2004 for a person knowingly or recklessly to provide materially false or misleading information to the Board in circumstances in which that person intends or could reasonably be expected to know that it would be used by the Board for the purposes of exercising its statutory functions, including calculation of the pension protection levies. 4

8 3 PROCEDURE FOR RECOGNITION OF NEW CONTINGENT ASSETS 3.1 Submitting documents via Exchange Trustees (or their authorised representative) must submit, via Exchange, details of the contingent asset using the appropriate certificate by no later than midnight on 31 March Trustees must certify a number of statements relating to the benefit resulting from the agreement. The legal opinion should provide the basis for certification (see chapter 8 below). Failure to correctly certify each statement will result in the contingent asset being rejected Detailed guidance on the specific certification requirements for each contingent asset type can be found at paragraphs of the Contingent Asset Appendix. 3.2 Documents to be submitted by post Trustees (or their authorised representatives) must also send (depending on the type of arrangement being used see paragraph below) hard copies of the following documents to the Board (or to any other address specified in accordance with the Determination) by no later than midnight on 31 March 2016: (a) (b) (c) (d) (e) (f) certified copy of the legal agreement; legal opinion covering certain matters set out in the agreement (with an overseas legal opinion if required see paragraph below); comparison document showing changes from the standard form (or, if no changes, confirmation of this via the legal opinion or a letter); copy of the Contingent Asset Certificate; evidence that the corporate benefit to the guarantor from entering into the agreement has been established (e.g. confirmation from the relevant directors, board minutes or in the legal opinion); and valuations and other documents (where required by the certificate) The exact documents to be sent will depend on the form of the contingent asset. Further details are set out in the Contingent Asset Appendix at: (a) (b) (c) (d) (e) (f) Paragraph 27 Type A arrangements; Paragraph 30 Type B(i) arrangements; Paragraph 34 Type B(ii) arrangements; Paragraph 37 Type B(iii) arrangements; Paragraph 40 Type C(i) arrangements; and Paragraph 43 Type C(ii) arrangements All hard copy documents must be sent to: Head of Legal Re: Contingent Assets 5

9 Ref [insert pension scheme/section registration number] The Pension Protection Fund Renaissance 12 Dingwall Road Croydon CR0 2NA (or to any other address that is specified for this purpose on the Board s website at the point of delivery of the contingent asset) A suggested form of covering letter is included in this Guidance. If contingent assets in respect of more than one scheme/section are included in the same package, they should be clearly identifiable as such. 3.3 Certified copies requirements A certified copy is a photocopy of the original executed agreement which has been certified as a true copy of the original, usually by the legal advisers Trustees can certify a copy of the agreement themselves, by stating I certify that this is a true and complete copy of the original document followed by (in block capitals) their signature, name and the capacity in which they are signing, and the date on which the certificate is given If counterpart agreements have been signed, the Board would prefer a certified copy of one counterpart only with the additional signature pages attached. Please do not send full copies of all the counterparts. 3.4 Declaration The trustees (or their authorised representatives) providing the certificate must declare that they are aware of this guidance and, so far as they are aware, this guidance has been followed in putting the contingent asset in place and certifying it to the Board. 3.5 Next steps Once the Board receives the relevant documents, it will: (a) (b) (c) acknowledge receipt of the submission in writing; check whether the submission contains all the required documents and content, and meets the conditions for recognition. This may involve making further enquiries of the scheme; and write to the trustees and/or advisers to confirm whether the contingent asset will be recognised for levy purposes When confirming whether or not the contingent asset is accepted or rejected, the Board will not confirm the acceptability or otherwise of any qualifications to opinions or variations to documents. For any contingent assets that are rejected, the letter notifying the scheme of the rejection will include the key reasons for rejection but may not be a comprehensive list of all the deficiencies in the contingent asset The fact that a contingent asset is recognised does not imply that the Board has reviewed the documents in detail and does not rule out a future review The Board will also select a number of Type A contingent assets in each levy year foa detailed review of the financial resources of the guarantor. 6

10 3.5.5 If you have any queries about your submission please call the PPF Stakeholder Support Team on the number shown on the PPF website. 3.6 Subsequent changes to information contained in the certificate Trustees must notify the Board if the information in the certificate changes during the levy year up until 31 March The levy may then be recalculated in light of the notified changes. 1 1 We have noted that Exchange currently uses the date 31 March 2016 in the certificate relating to this point. This should be read as 31 March

11 4 PROCEDURE FOR RECOGNITION OF EXISTING CONTINGENT ASSETS 4.1 Introduction The Board will recognise, for 2016/17, contingent assets that were accepted for the 2015/16 levy year provided the contingent asset is recertified on Exchange no later than midnight at the end of 31 March 2016 and the other conditions in paragraph G2.5 of the Determination are met The information required by the Board on recertification will, in particular, depend on: (a) (b) (c) whether the contingent asset itself has been amended since the previous submission; whether the scheme s contingent asset position in general has changed; and whether any documents are specified in the Determination and Contingent Asset Appendix as being required on recertification (such as an updated valuation) If the contingent asset is to be amended, trustees should record this in the usual accepted form (namely, a deed of amendment). Re-executing the agreement will be regarded as a new contingent asset submission, not an amendment to the previous contingent asset, and all the requirements for a new contingent asset will need to be met The submission of a Type C contingent asset which is on the same terms as, and replaces, the previous recognised arrangement (under the evergreen provisions) which is due to expire should be treated as a recertification rather than as a new contingent asset Rules G2.6 and G2.7 of the Determination provide further details about the recognition of existing contingent assets for levy year 2016/17. Specific details about the recertification requirements can be found at paragraphs of the Contingent Asset Appendix Where the contingent asset has been amended, or where any other documents are being provided to the Board, a certified copy of the amended contingent asset agreement along with a copy of the recertification certificate itself and any relevant supporting documents, should be posted to the Board at the address given at paragraph above. As with new contingent assets, the deadline for submission is no later than midnight on 31 March Subsequent changes to the matters contained within the certificate should be notified to the Board as per paragraph above The Board introduced a change in policy in 2014/15 with regard to recertifications. Previously, schemes that had certified a contingent asset but then (for whatever reason) had not recertified it for the succeeding levy years were in the position where, in order for that contingent asset to be recognised again by the Board, it had to be resubmitted as a new contingent asset with all the attendant documentation requirements. The Board now allows such contingent assets to be resubmitted as recertifications rather than new contingent asset submissions provided that the requirements in Rule G2.6 are met (including that the contingent asset was originally submitted or last certified no more than 5 years previously, and the certifier can confirm that the agreement has remained in place during the years that it was not certified for levy purposes). 8

12 4.2 Legal opinion A new or revised formal legal opinion is not generally necessary, but trustees should provide one if they think the legal position may have changed since the original opinion was given such as might prevent the trustees from giving the relevant certifications on Exchange unless the opinion is updated. For example, if a Type A guarantor is replaced, a new opinion dealing with the capacity of the new guarantor to enter into the agreement will be necessary The Board will accept a short-form new opinion which refreshes and refers to the previous opinion. 4.3 Declaration Trustees must also: (a) (b) declare that they are aware of this Guidance; and provide the form of certification set out at paragraph below. 9

13 5 TYPE A CONTINGENT ASSETS 5.1 Strength of Type A contingent assets The aim of the contingent asset regime is to enable schemes to achieve a levy reduction through reducing the risk of PPF compensation becoming payable by putting in place effective risk reduction measures. The Board recognises a contingent asset by wholly or partly replacing the insolvency risk of the scheme employer with the insolvency risk of the (more stable) guarantor The Board s expectations of trustees in considering guarantor strength, and its own approach, are set out in detail below. However, in summary: The contingent asset regime is designed to offer a reduction in levy where there is a commensurate reduction in risk to the PPF. The only time a contingent asset will be called upon will be if the employer fails, so the assessment of the guarantor must be on the basis that scheme employers have failed. To justify a levy reduction trustees must be reasonably satisfied the guarantor could meet the Realisable Recovery in full if called upon to do so, having taken account of the likely impact of the insolvency of all of the employers whose liabilities are being guaranteed. We may require trustees to provide evidence to demonstrate that the guarantor could pay if called upon to do so before we offer any discount on the levy, so trustees should document their considerations. What is the Certification in relation to Guarantor strength? Rule G2.3(2) of the Determination provides that a contingent asset must appear to the Board to reduce the risk of compensation being payable in the event of an insolvency event occurring in respect of an employer in relation to the scheme, and that the contingent asset must reduce the risk of compensation being payable to an extent that is reasonably consistent with the levy reduction secured To support Rule G2.3(2), trustees must certify on Exchange as to the strength of the guarantor. From the 2015/16 levy year, the Board has changed the form of certification which trustees are required to give, so that they must now certify a fixed cash sum (the Realisable Recovery 2 ). Trustees must therefore certify a figure which the guarantor (or each guarantor) is independently good for in cash terms Broadly speaking the amount which should be certified is the lower of: Any cap defined by reference to a fixed amount in the guarantee; and Am amount no greater than that which the trustees are reasonably satisfied that each certified guarantor could meet if called upon to do so Trustees will now see a different screen when submitting a Type A contingent asset on Exchange. In addition to confirming whether or not the underlying agreement includes a limitation by reference to a percentage of s179 liabilities, and stating that percentage 2 Realisable Recovery is defined in paragraph 4(13) of the draft 2016/17 Contingent Asset Appendix 10

14 if it exists, trustees must now state the amount of the Realisable Recovery, rather than one of the five liability caps stated in paragraph 5 of the Contingent Asset Appendix In its recent consultation on the second PPF levy triennium, the Board detailed the basis for a move to a fixed cash sum basis for the trustee certification. In summary, we believe that the value that is ultimately placed on a contingent asset has not always been clear to trustees in previous levy years. This is because this value is calculated by reference to an up-to-date funding level calculated on the s179 valuation basis, making allowance for smoothing and stressing. However, this process may not be apparent to trustees when looking at the latest reported section 179 valuation results. Requiring trustees to certify a fixed amount is therefore intended to provide clarity as to the value which the PPF will ultimately put on the contingent asset if recognised in the levy calculation The new form of certification is set out in paragraph below. This requirement applies to both new and recertified contingent assets Trustees (or their authorised representatives) are required to certify (the Certification ) that The Trustees, having made reasonable enquiry into the financial position of each certified guarantor, are reasonably satisfied that each certified guarantor, as at the date of the certificate, could meet in full the Realisable Recovery certified, having taken account of the likely impact of the immediate insolvency of all of the relevant employers (other than the Certified Guarantor where that Certified Guarantor is alos an Employer). Certification general points When assessing the guarantor s position, trustees should take account of the impact of the insolvency of the employer(s) on the guarantor s resources. The revised certification wording now expressly refers to this consideration. This is intended to focus trustees minds on the key issue of what the guarantor would be able to pay in the event that the scheme employer became insolvent From the 2015/16 levy year, the Board will (save for certain exceptions) be applying an adjustment to the guarantor s levy band to reflect the impact of the amount that it is guaranteeing on its gearing. The focus of trustees should continue to be on the amount which they consider the guarantor can realistically afford to pay towards the Realisable Recovery. However, certifying the largest Realisable Recovery which they consider possible may impact on the guarantor s levy band A different Realisable Recovery can be certified year on year. This enables trustees to take a sensible on-going view of the guarantor s financial position and the scheme s funding position Calculating the Realisable Recovery will depend upon the circumstances of both the guarantor and the scheme. In previous years where trustees have selected the fixed sum liability cap, we have asked trustees to certify at the amount they have judged the guarantor to be worth, and we consider that trustees should also apply this approach when calculating an appropriate Realisable Recovery The certification is designed to allow trustees to take a rounded view of whether it is reasonable to believe the Realisable Recovery could be met by the guarantor, without having to obtain absolute certainty as to the guarantor s ability to do so. Trustees need to be comfortable (i.e. rather than certain) that the guarantor could meet its full commitment under the guarantee if called upon to do so. 11

15 Trustees should still take proportionate steps to assess the capability of the guarantor to meet any sum that may fall due under the guarantee. What is proportionate will depend on their individual scheme s circumstances, the size of the guarantee being given (for example, the smaller the guarantee, the less likely it is that professional input would be proportionate), and the complexity of intra-group arrangements.trustees should consider whether they have sufficient expertise on their board to know what information is required from the guarantor, and to assess the information received. In particular, they should be able to demonstrate that they have challenged assertions made by the guarantor and, where appropriate, obtained third party professional advice to support their view. The extent to which professional advice is necessary will depend on the circumstances The move to certifying a Realisable Recovery is not intended to require trustees to make an extra assessment of the guarantor s financial covenant, but it is intended to reflect what trustees should already have been doing in previous levy years; namely, considering how much the guarantor is really worth, irrespective of the underlying liability cap selected We strongly recommend that trustees keep comprehensive records and evidence of the basis for their certification so that they can provide this at a later stage if required by the Board. What does the Board consider is required for certification? The circumstances in which the Guarantee would be called on are generally that the employer(s) to the scheme has suffered an insolvency event. Trustees should therefore take account of the likely impact of the insolvency of the employer whose liabilities are being guaranteed 3, assuming that were to occur in the near future Without limitation, the impact of employer insolvency could include effects such as: the diminution in value of the employer(s) shares or investments held directly or indirectly by the guarantor, the loss of inter-company debts owed by the employer(s), the impact of a cross guarantee or the loss of an important supplier (the insolvent employer) to the group At its most basic, this means that Trustees must not attribute value to investments in the sponsoring employer (or businesses controlled by it) in their assessment of the guarantor unless they can be confident that value would survive an insolvency. In particular the Board considers that trustees should normally assume a nil return on the value of any employer shareholding held by the guarantor, as it is unlikely that a return would be achievable in practice The Board has seen instances where trustees have certified guarantors whose principal assets were investments in the very companies being guaranteed and which were, therefore, of no value. In other cases, we have also seen substantial value attributed to intercompany loans or receivables whose value would be questionable on the employer s insolvency Where the guarantor and employer are part of a group of companies, the indirect effect 3 Where a guarantor guarantees the liabilities of multiple employers, then the combined effect of their multiple insolvencies should be considered. Where the guarantor guarantees the liabilities of employers in more than one scheme, then the combined effect of their insolvencies should also be considered, unless it would be particularly difficult for trustees in the circumstances to obtain information about the employers in other schemes. Trustees, when considering the amount to certify as the Realisable Recovery, should also take into account the amount the guarantor is guaranteeing to other schemes. 12

16 of an employer s insolvency should also be considered, in particular whether the employer s insolvency could also lead to the insolvency of the guarantor. For example, where the group as a whole is reliant on an employer for a considerable part of its revenue or assets, trustees need to take this into account and think about whether the guarantor could actually meet the Realisable Recovery if that employer failed. They should think about all the circumstances in which an employer might fail, including those where other group members also fail Where trustees are considering a guarantor which is also an employer in a multiemployer scheme, they should consider the impact on the guarantor of the insolvencies of the other scheme employers. In particular, trustees should consider whether the guarantor would be able to meet the other employers obligations to the scheme in addition to its own. This is particularly relevant where the guarantor s own business is dependent on the continued operation of one or more of the other employers. Trustees should therefore ensure they understand the group structure and analyse the interdependency of trading within the group If a guarantor which is also a scheme employer would be likely to cease trading as result of paying the guaranteed amount, trustees must assess whether it could pay the guaranteed amount on its winding-up alongside other costs such as its own share of the section 75 debt to the scheme Where the guarantor is also an employer, the Board will consider whether it is likely that the guarantor could meet the liabilities of the other employers (which are assumed insolvent) whilst still continuing to trade For the avoidance of doubt, trustees are free to consider a guarantee from or in relation to an employer in a last man standing scheme. The Board will assess such guarantees in the same way as for guarantees relating to other scheme structures Trustees should consider the guarantor s position by refererence to both its standalone position and (where part of a group) on a consolidated basis. Where the guarantor is part of a group, they should not rely solely on consolidated accounts to assess its position, but must also consider the guarantor s resources on an individual basis Trustees should take particular care to consider not just the guarantor s net asset value compared to the guaranteed amount, but to think carefully about the nature and location of the guarantor s assets. Where the guarantor s assets include intangible assets, such as brand value, or primarily consist of intercompany accounts and investments in employer subsidiaries, then trustees should consider whether these assets are likely to deliver any real value to the guarantor if the employer becomes insolvent, which is the time at which the guarantee will be called upon Trustees should also consider how readily the guarantor s assets could be realised in order to meet the Realisable Recovery if required to do so Trustees should take particular care when considering resources only indirectly available to the guarantor, for example if seeking to rely on a cross-guarantee, since the resources may be less readily obtained (or may depend on the continuing solvency of other parties, whose risk differs from the guarantor which could give rise to a disproportionate levy benefit). 4 4 Trustees would also need confirmation that both the cross-guarantor was able to meet the amount guaranteed by the guarantor, with a similarly low insolvency risk, and that the trustees position isn t materially weaker than it would have been under a PPF standard form guarantee given by the cross- 13

17 The Board expects trustees to seek guarantees from companies which are independently able to meet their commitment under the guarantee. It is likely always to be inappropriate to seek to certify a guarantor whose ability to meet its full commitment under the guarantee is dependent on a cross-guarantee being provided by an employer. Any assessment of a guarantor is likely to involve an element of judgement, and trustees should exercise a degree of prudence in assumptions about the value in businesses. For example where a guarantor s value is expressed as a range, it would not be appropriate to use the higher figure. An assessment that a guarantor were valued at 50 million to 100 million would support certification at 50 million but not 80 million, since by definition the trustees could not say that were reasonably satisfied that the guarantor could meet in full a guarantee for 80 million The Board is not prescriptive about the information trustees should consider. As a general example, trustees could consider any available information about the guarantor s financial position, including its most recent accounts. However, the key factor is whether the information enables the trustees to consider whether the guarantor is good for the Realisable Recovery. In some cases they may wish to commission specific advice or request information from directors of the guarantor. In others existing information may suffice. What is appropriate is ultimately for the trustees to decide, based on the guarantor s circumstances For the avoidance of doubt, trustees cannot give the certification purely on the basis that they have attempted to obtain information about the guarantor s financial position but have been unsuccessful in doing so. The certification is to be given on the basis of information obtained, not on the basis of attempts to obtain this information. Trustees need to have adequate financial information in order to make a meaningful assessment of the guarantor s position, and should not accept the withholding of guarantor accounts, for example on the grounds of confidentiality, where those accounts are required in order for the trustees to make a meaningful assessment of the guarantor s financial position Intentionally or recklessly certifying falsely may be a criminal offence under section 195 of the Pensions Act If trustees innocently provide the certification incorrectly, the contingent asset may be rejected by the Board and therefore not recognised in the levy calculation. If information comes to light after a contingent asset has been accepted and used in a scheme s risk-based levy which subsequently shows that the trustees were incorrect to provide the Realisable Recovery certification as at the date of certification, the Board may review the levy calculation and disregard the contingent asset Where trustees have previously carried out a review of the guarantor that is consistent with this guidance, it will generally be acceptable to update that review by reference to what factors may have changed rather than to undertake a wholly fresh exercise Schemes do not need to provide copies of their evidence with their contingent asset submissions. The Board may ask for this information later if the contingent asset is selected for detailed review, so trustees and their advisors should retain the information relied on. Please see section 5.2 below for more details about the testing which the Board will carry out to assess the guarantor s financial strength. guarantor. The Board considers that it may be difficult for trustees to prove that their position is not materially weaker. Trustees in this position should provide to the Board any evidence they have which confirms that this is not the case. This may include, for example, any legal advice they have taken on this point. 14

18 Examples of issues that arose during the Board s assessment of 2014/15 contingent assets The table below sets out some examples of key issues which arose during our assessment of contingent assets submitted for the 2014/15 levy year. These cover areas which we consider should be given consideration by trustees before certification. However they are merely a sample of issues which should be considered, and should not be regarded as a checklist Examples of issues which may need consideration 5 Issue Can the guarantor still trade after the disposal of assets required to meet the guarantee? Points to consider Asset disposals may impact both the guarantor s and the wider group s ongoing businesses. Where the sale of core business assets would mean the guarantor ceases trading, trustees should consider whether other creditors would exist. Are there restrictions on the use of undrawn finance facilities and cash balances post-employer insolvency? An understanding of group cash pooling arrangements, and capacity to draw on unused facilities on employer insolvency, may be needed. For example, a positive cash balance in the guarantor s accounts may not be accessible on employer insolvency where the funder could set off the guarantor s cash on the employer s insolvency. An extreme case we reviewed involved the employers already having negative cash balances at the outset while solvent, which would eliminate the guarantor s cash even before insolvency takes place. What is the impact of inter-company balances? Trustees should appreciate the often complex interaction between group companies and how funds flow around the group. They should consider obtaining an intercompany balance matrix to assess whether intercompany debts held by the guarantor would in fact be collectable once insolvencies occur within the group. Where EBITDA multiples or similar measures are used in company valuations, how was the multiple chosen and is it reasonable? This may involve considering the effect of employer insolvency, the level of debt in the company being assessed, the level of 5 Taken from the Board s Contingent assets guarantor strength document published on its website in January

19 market activity and comparable deals. We have challenged multiples for subsidiaries that could be disposed of to meet the claim which gave little reflection of any change in the market s perception of a group on employer insolvency, the speed with which a business may need to be sold or which otherwise appeared unreasonable. What are the guarantor s funding and borrowing sources, treasury arrangements if used, security structure, cross-guarantee obligations and funding defaults? Are asset valuations appraised on a basis appropriate for the circumstances to support the amount attributed to specific assets? Trustees should consider whether the employer s insolvency would cause any cross default across the group and the impact of this on the ability to move cash around to satisfy the guarantee claim. Such a default could also impact whether undrawn facilities remain in place as mentioned above. Are there any restrictions on value to be taken account of, such as stock retention of title? We have seen valuations that assume that highly specialised assets could be sold without assessing whether a market would exist or what impact the circumstances of the sale would have on price. Where the guarantor cannot trade without the employer, is an estimated outcome statement (EOS) needed? An EOS would consider realisable asset values on insolvency to assess the value the guarantee claim will receive. Sensible assumptions should be made about the asset realisation process including time scales and likely achievable price, together with the level of applicable costs. Although it is rare to conclude a guarantee would be met in full where the guarantor ceases trading, we have seen cases where this conclusion is justified. What value of investments in group subsidiaries and other group assets can be relied on? Due diligence will include a full breakdown and stress testing of the asset on the sale basis required to discharge the guarantee. We have seen examples of assessments simply based on carrying value in accounts or taking little account of the need to sell in a restricted timescale. Can the guarantor control the income stream of connected parties required to meet the Realisable Recovery? Trustees may need to assess the ability to obtain value where this flows from other group companies to the guarantor. 16

20 We have seen situations where trustees appear to have relied on consolidated accounts without considering where value actually lies in the group, or on broad assumptions that other group companies will deliver value if required. Trustees should consider whether group companies have the legal ability, or cash liquidity, to make payments back to the guarantor. We have also seen value attributed to group companies which are subsidiaries of employers assumed insolvent and who if they remained trading might be used for the benefit of the employer s creditors. Is the view that the guarantor could meet the guarantee dependent on an assumption about a recovery from the insolvent employer? What would happen to the value of assets held within the group in a group-wide insolvency scenario? The PPF recognises guarantees whose existence reduces risk. A recovery from the employer, which would be available in any event to the pension scheme, does not provide additional value. Trustees should think carefully about how such a scenario would be viewed by the market. In particular, they should consider the impact on the realizable value of the guarantor or wider group s assets in a fire sale scenario. Partial certification of a Type A contingent asset by the Trustees Partial certification is available for both new and recertified contingent assets Trustees can certify as the Realisable Recovery a lower amount than any fixed face value of the guarantee. In that event, the certification on Exchange should be interpreted as being in respect of the certified amount and certified guarantors rather than the amount of the underlying guarantee. This will mean that reducing the Realisable Recovery or excluding a guarantor without changing the underlying guarantee will not fall within the terms of the amendment and replacement rules (described in Chapter 9) so that it is possible to increase or decrease the Realisable Recovery from year to year. By comparision, altering the underlying guarantee each year would fall within the amendment and replacement rules Trustees should note that each certified guarantor must individually be able to cover the Realisable Recovery, this being a fundamental aspect of joint and several liability. Under our levy rules, where a Type A contingent asset has multiple guarantors that are jointly and severally liable, the guarantor with the best single score is taken into account in the scheme s levy calculation. Our position is therefore that each guarantor that is certified needs to be strong enough to independently meet the full Realisable Recovery Trustees are free to certify only the most substantial guarantors in a particular levy year. Where trustees decide to certify only the strongest guarantors in one levy year 17

21 it is open to them to certify a previously non-certified guarantor in the next levy year, provided that this guarantor is listed as a guarantor in the underlying agreement. The Board will then assess the newly certified guarantor s financial strength (see further at section 5.2 below) to satisfy itself that it can meet the Realisable Recovery certified Where the intention is that multiple guarantors are to have varying caps on their liability, trustees have the option of certifying separate guarantees against each guarantor. Each guarantor will then be considered individually by the Board against their individual Realisable Recoveries under each certified guarantee. However, the Board will not allow a single contingent asset arrangement to be certified using multiple guarantors with a different certified amount applying to each individual guarantor i.e. as if it were in effect a collection of separate guarantees in respect of each guarantor. 5.2 The Board s assessment of the strength of guarantors The Board s assessment of whether to recognise a contingent asset will, in accordance with Rule G2.3(2), involve comparing the guarantor s resources (in the event of the failure of the employer) with the deemed value of a contingent asset for levy purposes. This is the amount of underfunding risk that would be covered by the contingent asset 6 and in respect of which the PPF is reflecting the (lower) risk posed by the guarantor instead of that posed by the employer The Board expects to: select a proportion of contingent assets for detailed review; where the Board requires further information, it will ask trustees to justify in detail that the guarantor would genuinely be able to pay a sum up to the level of the Realisable Recovery certified, assuming the employer is insolvent; and evaluate that detailed information with input from an external financial advisor experienced in insolvency and pensions, together with other information available to it, to determine whether the contingent asset s recognition in the levy would be reasonably consistent with the risk reduction offered A key issue which the Board will consider is whether meeting the Realisable Recovery would be likely to trigger the insolvency of the guarantor, because this would reduce the likelihood that the guarantee could be satisfied. For example, where the sale of the guarantor s assets to meet the Realisable Recovery would mean that the guarantor was unable to continue its business, in reality the guarantor s resources may be used to meet its own liabilities. In this situation, the likelihood of the scheme receiving payment in full under the guarantee would be reduced, and consequently there would be no real reduction in risk to the PPF The Board therefore expressly considers, where a guarantor is also an employer, whether it could meet its certified obligations in respect of the other guaranteed employers while continuing to trade or, in the event it ceased trading, whether it could meet both its own s.75 debt and the Realisable Recovery The Board does not intend to provide further details about how it will select cases for further investigation of guarantor strength (which may include an element of random testing). The focus of trustees and advisers should be on whether the guarantor is 6 It is therefore the lower of the Realisable Recovery as certified and the actual underfunding risk of the scheme as measured in the levy 18

22 good for the Realisable Recovery, not whether it is good enough to escape detailed scrutiny In carrying out its detailed assessment, the PPF may: use financial data regarding the guarantor; assess the guarantor by reference to its accounts on both a standalone and a consolidated basis; and consider which assets of the guarantor are intangible or illiquid assets, and whether they can be realised for value This is not an exhaustive list and we may consider other appropriate information in making our assessment. The Board s assessment will also include understanding how the trustees have addressed the point raised in paragraph above The Board expects to use the analysis that the trustees have done as the basis for assessing the guarantors, provided that this provides sufficient evidence as to the value of the guarantor. In particular, trustees should be aware that the higher the Realisable Recovery certified, the higher the threshold for providing satisfactory evidence will be to demonstrate that, in the circumstances, the guarantor could meet that sum. 5.3 Partial recognition of Type A contingent assets Type A guarantees with guarantors unable to meet the Realisable Recovery will, in general, be wholly rejected even where the contingent asset may be considered to have some value. If the Board were to partially recognise a contingent asset for less than the value (or not all the guarantors) that had been certified, this could encourage the use of under-resourced guarantors (e.g. listing a series of guarantors, of varying substance and levy rate) on the assumption that the scheme would get at least partial credit The Board may partially recognise a recertified or new contingent asset if all the circumstances justify it and if there has clearly been no intention to seek to gain an unfair levy advantage. However, schemes should not assume that the Board will exercise its discretion to partially recognise a contingent asset simply because the contingent asset is unchanged from the previous levy year The Board will only partially recognise a contingent asset in exceptional circumstances. It is not a mechanism to enable schemes which have certified at an unrealistic level to have a second opportunity to secure recognition, in circumstances where they could reasonably have been expected to have certified a lower Realisable Recovery at the outset. Changes to guarantor strength Rule G3.1 of the Determination provides that no contingent assets will be recognised unless the previous year s contingent asset is in place unweakened, and Rule G3.4 provides that where contingent asset cover is removed/reduced, the scheme should not receive any recognition for contingent assets until the scheme s position is no worse than it was prior to all the contingent assets being recognised Where a scheme has put in place a guarantee in all good faith but subsequently the guarantor s position changes, the Board appreciates that the scheme should not automatically suffer if they change their guarantors to keep in line with our requirements. While the Board s general position is that weakening contingent asset 19