Geopolitical volatility makes covenant reliability an important focus for trustees

Trustees should be considering how their covenant is impacted by economic and geopolitical volatility and factor that uncertainty into their assessment of covenant reliability, according to LCP.

In a new blog, they are urging trustees to understand the importance of robust stress testing and regular covenant monitoring.

Financial market volatility can lead to a fall in the value of a scheme’s investments, potentially creating or increasing a deficit. This is happening at the same time as the employer is also financially exposed, which means trustees risk having a bigger scheme funding need supported by a weaker covenant.

The Pensions Regulator’s 2025 annual funding statement emphasises that trustees should consider trade and geopolitical uncertainty, as well as other longer-term economic dynamics like the energy transition, when assessing covenant. Where these factors could materially impact the employer, trustees should ensure scheme risk remains appropriate. LCP expect to see more guidance on these issues in the 2026 annual funding statement due to be published in a few weeks.

Under the new DB funding regime, trustees are asked to determine a ‘covenant reliability period’ – which means they need to say in what time frame they have ‘reasonable certainty’ about how much cash the employer is expected to generate and what could be available for the scheme. This includes looking at the employer’s cash generation and its uses, reviewing its future cash flow forecasts and business plans, and establishing how reliably it is generating cash and at what level (i.e. a £ amount) it would be available to fund the scheme.

Other key points raised in the blog about covenant reliability are:

• Some schemes will be directly impacted by the current Middle East conflict – for example, those with energy-intensive operations or supply chains that run through impacted geographies. For others, there will be less direct, but still potentially material impacts. This could be from cost inflation they can’t fully pass on to customers, declining demand for their products and services due to ever-increasing cost of living pressures, or difficulty obtaining financing facilities.
• For many businesses, the issues aren’t just from events this year; they’ve been facing headwinds since the Ukraine conflict impacted supply chains and energy costs, and then the imposition of US tariffs and retaliatory actions on global trade. And some businesses that were particularly hit during Covid are yet to recover fully. There’s also the impact on costs of actions taken by the UK Government, such as increased National Insurance and minimum wage rates, and material increases to business rates this year.
• Covenant reliability still matters for well-funded schemes. A lot of schemes don’t have a funding deficit now, but trustees still need to take a proportionate look at the strength of the covenant, including its reliability. This means that they should be checking that the covenant can underwrite scheme risks, making sure that if downside events materialise, the employer can afford to make them good over a reasonable period of time.
• Where there are concerns about covenant reliability, this could mean it’s appropriate to conclude on a shorter time period for covenant reliability, or a lower level of cash availability (or MAC) for the scheme. In some cases, it may mean considering mitigating actions, such as seeking contingent asset support, accelerating funding for the scheme, derisking the scheme’s investments, or revisiting whether run-on remains the best option.

LCP is hosting a webinar on 21st May, which will examine how schemes can navigate this period of uncertainty when considering longer-term scheme strategies.