Pension fund trustees should redouble their efforts to monitor the strength of their employer covenant to avoid their funds becoming neglected in a possible massive wave of refinancing over the next few years, Punter Southall claim.

A new report from the actuary and consultancy group illustrates the level of debt maturing in the medium-term at companies who borrowed heavily in the boom years of 2005 to 2007. Trustees should be aware of their employer covenant, which details a company's support to its pension fund, weakening if companies struggle to refinance debt in the years ahead, Punter Southall suggests.

Lorant Porkolab, head of covenant consulting at Punter Southall Transaction Services said: "Refinancing is now a regular feature of most businesses but it is important to make sure that the pension scheme does not get overlooked in this process. The trustees, in their position as a creditor of the business, may wish and need to take a seat at the negotiating table. However, trustees should not rush into seeking such a position without fully understanding the employer covenant."

It has been calculated that a staggering $1 trillion of corporate debt is on course to mature between 2011 and 2014. Porkolab says that "whilst it may be hoped that the terms available in the market will be more favourable than those prevailing in the post credit-crunch era, the implications of a refinancing and the security offered to the pension scheme, as an unsecured creditor of the businesses, should be kept under careful review by all parties."

Jacqui Woodward of Punter Southall's Transaction Services team explained that it is vital that trustees who see their employer covenant weakening seek mitigation as compensation. This mitigation can take a variety of forms, including a one-off cash contribution, granting the pension scheme prioritised creditor status, and providing contingent assets or non-cash assets via a Special Purpose Vehicle.

For instance in October 2010 multinational Tata Steel Europe injected £100m into its pension fund as part of a £3.5bn refinancing package agreed with banks.

Punter Southall recommend that trustees monitor their employer covenant every quarter in order to stay abreast of any significant changes in sponsor companies that will affect their position. Woodward conceded however that at times "it is difficult to act quickly enough as trustees" when a sponsor goes through significant changes as a result of refinancing, restructuring or insolvency.

Another scenario in which determining the strength of the employer covenant becomes vital is when a pension fund's deficit significantly overshadows the market capitalisation of the sponsor. This was the case when food manufacturers Uniq were prompted into a radical debt-for-equity restructuring earlier in 2011 as a £150m pension deficit overshadowed a business worth only £6m.

The covenant was deemed so weak that the fund took a 90% stake in the company which became relieved of its pension burden. Richard Jones, principal of Punter Southall Transaction Services, says that the Pensions Regulator is likely to increasingly focus on schemes with similarly oversized pension funds.

First published: 30.06.2011

dbillingham@wilmington.co.uk