Using escrow in times of uncertainty

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, a pensions partner at global law firm, Eversheds Sutherland, consider how escrow arrangements are helping businesses facing Covid-19 related disruption to achieve 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 from global law firm, Eversheds Sutherland, 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 of Eversheds Sutherland 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 DRCs (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. 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); or
  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 highlighted 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.

To find out how Barclays can support you with an escrow-based solution, speak to your Relationship Director or visit our escrow page.

Read more from our clients

Reach PLC is the largest commercial national and regional news publisher in the UK, producing and distributing content through newspapers, magazines and digital platforms.

To conserve cash reserves during the fallout of the Covid-19 pandemic, Reach sought to utilise the flexibility afforded by the pensions regulator to agree certain pension payment deferrals with their plan trustees. The challenge was to find a solution which could facilitate such arrangements, whilst ring-fencing the cash and preserving the respective interests of the company and its trustees.

Barclays provided six escrow accounts in which to safeguard the deferred pension contributions until the fallout of Covid-19 can be fully assessed and a longer term arrangement can be implemented.

“The efficient management of liquidity continues to be a cornerstone of our business’ response to coronavirus. Barclays’ pragmatic and flexible escrow solutions provided the key to unlocking deferrals with our pension trustees, helping to conserve vital cash in the business whilst safeguarding the positions of all parties.

We are very grateful for the magnificent help that Barclays’ escrow team gave us in setting up and opening our accounts at short notice. We are all very appreciative for the team’s sustained efforts, without which we might not have made it over the line. Against the backdrop of uncertainty created by the COVID-19 pandemic, it is comforting to find such a dependable partner in Barclays.”

Stephen Field, Head of Tax and Treasury, Reach PLC

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