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Using escrow in times of uncertainty

  • United Kingdom
  • Pensions

27-05-2020

As COVID-19 continues to disrupt the rhythm of the economy, close monitoring of cashflows and liquidity will be vital to the safe passage of businesses until normal trading can resume. Tom Speller, Head of Escrow EMEAPAC at Barclays, and Steven Hull, pensions partner at Eversheds Sutherland, consider how escrow arrangements are helping businesses facing COVID-19 related disruption achieve a short-term deferrals of their defined benefit contributions.

New guidance from The Pensions Regulator

Deficit reduction contributions (DRCs) for defined benefit pension plans are once again in sharp focus, with a significant proportion of plan sponsors looking to defer or suspend such payments. In anticipation of this, The Pensions Regulator (TPR) published guidance for trustees receiving such requests.

In an unprecedented move recognising that the greatest protection for a pension plan is a strong employer, TPR has stated that “trustees should be open to requests to reduce or suspend DRCs”. Trustees should consider such requests carefully it added, not only in terms of present cashflows, but also giving consideration to the position taken by the company’s other creditors and its likely ability to remediate the impact of a suspension within the current recovery plan timeframe.

TPR has advised that plan trustees may be able to agree short term suspensions of up to three months initially to allow time (a) for trustees to carry out analysis and take appropriate advice, and (b) for plan sponsors to provide trustees with the financial information they need to fully assess the employer’s position. TPR also recognises that longer suspensions may be appropriate with a variety of specific terms and arrangements to suit the specific circumstances.

Steven Hull comments that:

“We’re finding what is often driving plan sponsors’ deferral requests is uncertainty. They know challenges lie ahead and may already be experiencing the impact of COVID-19 but they may not yet be able to assess the full extent of the damage it will do to the business.

TPR is clear that a plan trustee will need detailed information from the sponsor in order to agree to a deferral request, particularly if deferral is for longer than three months. With the current uncertainty, it can be really challenging for sponsors to provide the level of detail trustees ideally need and to demonstrate a clear business need for a lengthy deferral. Gathering the information together quickly when there are so many competing demands on management time can also be challenging.

A lot of plan sponsors are after breathing space in which to conserve cash while they monitor how this unique situation develops and fully understand the impact on their business. A structure such as an escrow may be a way of providing that much-needed breathing space, in a way that ensures the interests of all parties are protected.”

How can escrow support during current uncertainty?

Such is the flexibility and versatility of escrow arrangements, both Barclays and Eversheds Sutherland are now seeing escrow being tabled as a compromise solution for those looking to defer or suspend DRCs in the wake of COVID-19. The arrangement can be tailored to suit the specific circumstances, but overall ensures that the sponsor and trustees retain sight over, and pre-agreed access to, funds that could be critical to both parties during any periods of uncertainty. Typically, sponsors and trustees will agree upfront under what circumstances the monies held in escrow will be paid into the plan and in what circumstances they will be returned to the employer. This can be particularly useful in the current climate for employers and trustees who agree that some form of DRC deferral may become appropriate in the future but who can’t yet point to a definite business need, or where employers are seeking a significantly longer deferral than 3 months.

Steven Hull comments further:

“An escrow account can be a highly appealing option for managing DRC deferrals, and can overcome many of the hurdles that might otherwise prevent an agreement between the sponsor and trustees from proceeding when faced with a highly uncertain future.

The potential to agree an escrow as part of any change to the payment of DRCs should be considered by the parties at an early stage, and areas of mutual agreement should be established quickly. The documentation which covers the management of the escrowed funds also needs to be considered very carefully. In particular, the parties will need to ensure that the escrow terms fit with any agreed arrangements for deferring, suspending or reducing DRC’s (that might sit alongside the escrow documentation), and that the mechanisms for releasing the funds (to either party) are sufficiently robust. The parties may also wish to document a clear procedure for resolving any disputes over the payment of funds, or circumstances where the employer may be required to make additional payments to the escrow, if funds are withdrawn to cover business critical expenditure. Finally, security arrangements need to be considered carefully to protect Trustees in the event of employer failure.”

There are over 5,000 traditional defined benefit plans sponsored in the UK with estimates suggesting 1 in 10 sponsors may look to defer up to £ 1 billion in the fall out from COVID-191 (Financial Times; 2020). TPR’s unprecedented move may represent a significant lifeline for business in the worst affected sectors and escrow accounts the perfect solution for resolving understandable company and trustee concern during such an uncertain and unusual time.

Find out more about escrow accounts

The use of escrow accounts to successfully resolve funding negotiations, conflicting company and trustee views on investment strategies, mismatches in company-side and trustee-side covenant assessments and otherwise manage the agendas of sponsors and trustees has long been associated with defined benefit pension contributions.

An escrow arrangement consists of a bank account held with an independent third party bank on behalf of two or more parties with competing interests in the escrowed cash. The circumstances in which either party may have access to the cash is usually set out in an agreement between those parties, with both parties entering into a separate tri-partite escrow agreement with the escrow bank governing the terms of the operation of the bank account. Typically, a unanimous instruction will be required from both counterparties to the bank to release funds from the escrow account, ensuring no one party takes direct payment risk on the other, whilst providing visibility on a ring-fenced pot of cash to both sides of the transaction.

Barclays escrow accounts have been used extensively to successfully balance the interests of employers, seeking to avoid overfunding their pension plans or worse still “trapped surplus”, with those of the trustees, eager to achieve a fully funded status for their plans. Paying funds into escrow (rather than directly into the plan) can be a viable alternative giving trustees comfort that cash contributions are safely held with a third party custodian bank, such as Barclays, whilst allowing the employer comfort that, should the funds not ultimately be required by the plan at the next valuation, they could be released back to the employer without:

  • 1. incurring the significant fiscal penalties associated with withdrawals from the plan itself
  • 2. violating any rules of the plan mandating that surplus funds must only be used to improve member benefits (regardless of whether benefits are already provided for in full)
  • 3. overriding statutory legislation that, absent the above circumstances, still requires Trustees only to return surplus when it is in the members’ best interests to do so (a high bar indeed and often an impossible one for most trustees to cross)

The factors highlights in 2 and 3 above make trapped surplus so often a one-way street for the benefit of the member that employers can really only approach on a prevention is better than cure basis.

Consequently, escrow arrangements have often been used to prevent surplus being built up in defined benefit plans, whether nearing a fully funded status or not.

1 https://www.ft.com/content/d45c1aee-8af4-405b-abe5-695956aad3a3

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