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Covenant Quarterly Q2 2022

Deal-making set to continue despite headwind

The conflict has already halted some prospective deals and slowed others in the earlier stages. It has also prompted some acquirers, particularly those looking at targets in Europe, to conduct additional due diligence or question whether transactions are worth the legal or financial risk. Inflationary pressures and the likely increase in interest rates (which may impact leverage capacity) add further market pressure.

Notwithstanding this, it is expected that levels of corporate activity will remain robust during 2022, with private equity firms seeking to deploy record levels of ‘dry powder’.

Furthermore, we could see an increase in internal corporate activity as efficiencies are sought to help offset inflationary cost pressures. Together with robust deal-making activity and the introduction of the Pension Schemes Act 2021 (PSA 2021), this means that trustees will have to scrutinise events which could materially alter a pension scheme’s covenant.

When assessing corporate events, there are a number of points for trustees to consider, including:

1. The strategic benefits of the transaction, together with the risks it introduces;

2. The impact on a sponsor’s capital structure (including increased debt and use of proceeds);

3. Value leakage in the form of, among other things, reduced profitability, dividends and intra-group movements either as part of the deal or post-deal;

4. Movements of assets in and out of sponsors post-deal. For example, in the case of an acquisition, the acquirer may seek to streamline operations post-transaction; and

5. The potential triggering of a section 75 debt and/or impacts on trustee powers under a scheme’s trust deed and rules (e.g. wind-up powers)

In the post-PSA 2021 world, it is important for trustees to demonstrate how they have proactively evaluated the covenant impact of corporate activity (even where the covenant is strong) to meet regulatory obligations and help facilitate an outcome that benefits all stakeholders.

Often the issues faced by a pension scheme as a result of a transaction can be overcome through innovative mitigation packages and suggested changes in transaction structures to benefit the pension scheme. Cardano’s Pensions Structured Solutions can help navigate these challenges and wrap mitigation into a scheme’s broader risk management and journey plan framework.

Read the full Covenant Quarterly Q2 2022 which also includes the following articles:

  • Datawatch: UK inflation reaches 40 year high
  • Ask the Analyst: What do trustees need to think about when determining an end-game?
  • Regulatory developments: TPR’s 2022 Annual Funding Statement (AFS)

For more information contact Hamish Reeves, Director


Hamish Reeves