The number of trustee bodies carrying out formal covenant monitoring could be a lower number than believed, particularly amongst trustees of smaller schemes, according to Richard Bryant, Head of Trustee Services at Atkin Trustees

An apparent failure of trustees to adequately monitor their sponsor's covenant was exposed by a Mercer survey in February 2011 of 800 trustees and 119 schemes which found that 37% of respondents carry out formal covenant monitoring less frequently than once a year, despite the Pensions Regulator indicating in 2010 that all trustees should possess frameworks for regular monitoring.

But Bryant has told Pension Funds Insider that in his experience the number of trustee bodies carrying out formal covenant monitoring is actually worse than Mercer's figure.

"The reasons for the low incidence of covenant monitoring may be manifold: trustees are often company directors and believe that their knowledge of the business means that a formal covenant review is unnecessary," he said. "Another reason is cost, as a full review may represent a significant proportion of the annual costs of running a smaller scheme.

"Lay trustees may not feel confident about their own ability to review the company's covenant," Bryant added.

Bryant also said that despite the disincentives, proper formal monitoring was one of the most important tasks to be carried out by trustees: "In some cases a covenant review might actually reduce the burden on the company as it gives the trustees the confidence to review the allowance for prudence in their funding assumptions".   

Paddy Briggs, a trustee of the Shell Pension Fund said that he was surprised that any trustee believed that they could carry out their duties without covenant monitoring.

"The proof of the pudding is in the eating," he said. "All too many funds in the past have let their funding ratios gradually decline with insufficient challenge to sponsors to rectify matters."

Richard Butcher, Managing Director of Pitmans Trustees, questioned the need for formal monitoring, however, saying: "Employed trustees are often not best placed to ask occasionally demanding questions of a company's executive. They also find it hard to be objective; we all generally want to believe the best of our own employer.

"A series of informal meetings can be just as adequate, efficient and useful as a series of formal meetings," he added. Butcher raised the possibility of implementing covenant performance criteria as an alternative to formal reviewing, with the idea that performance is regularly reported by employers against set criteria and trustee boards are then spurred into action only if criteria are breached.

Simon Kew, Senior Manager of employer covenant specialists Jackal Advisory, told Pension Funds Insider that value is a major issue for smaller schemes considering covenant monitoring: "Appointing a covenant advisor, has, in the past, been seen as poor value for money by a great number of trustees – with good reason. Paying many tens of thousands of pounds to be told what you already know, as has been the case with many covenant reports I have seen, will not provide encouragement to other trustees to commission an external covenant review."

Kew conceded though that monitoring should be a priority, saying: there were many dangers in failing to monitor a sponsor covenant, especially in the current economic climate.

"Trustees can consider smaller covenant providers, who can have experience, ability and greater flexibility to provide a proportionate covenant report at a lower cost," he added.

dbillingham@wilmington.co.uk