The new Covenant Guidance: The building blocks when considering the adequacy of covenant

The covenant advisory industry was met with an early Christmas present as the long-anticipated Covenant guidance (the "Guidance") finally landed on 4 December 2024, forming the final part of the jigsaw for the new defined benefit funding regime.

Whilst the key changes had been introduced through the regulations and the Funding Code of Practice (the "Funding Code"), this does not mean that the Guidance didn't have a few surprises up its sleeve. Indeed, whilst the Regulator undertook a limited consultation within the industry, the Guidance was not subject to a wider consultation process (unlike the Funding Code). Now, a few months on, the industry has had a chance to digest the Guidance and can begin to consider the practical implications.

So - from look-through guarantees to supportable risk, maximum affordable contributions to reasonable affordability, reliability periods to covenant longevity - let's take a look at the key learning points.

Overall, the new covenant guidance is intended to drive better, more risk-focused assessments of covenant. The output from a covenant review under the new regime will no longer be limited to simple ratings (e.g. "Tending to Strong" or a mark out of 10) but will define reliability periods, maximum affordable contributions, covenant longevity periods, maximum supportable risk, contingent asset valuations and reasonable affordability; to be taken into account by the trustee (with the help of their advisors) to produce a coherent journey plan, actuarial assumptions and investment strategies. For many schemes, ascertaining what is proportionate and how, if at all, these outputs impact on funding and investment strategy is likely where the biggest changes and challenges lie.