Geopolitical volatility makes covenant reliability an important focus for trustees

In a blog published today (8 April), the consultancy urged trustees to understand the importance of robust stress testing and regular covenant monitoring.

It said financial market volatility can lead to a fall in the value of a scheme's investments, potentially creating or increasing a deficit – noting this was happening at the same time that the employer is also financially exposed, which means trustees risk having a bigger scheme funding need supported by a weaker covenant.

LCP said The Pensions Regulator's 2025 annual funding statement emphasised that trustees should consider trade and geopolitical uncertainty, as well as other longer-term economic dynamics like the energy transition, when assessing covenant. TPR added that, where these factors could materially impact the employer, trustees should ensure scheme risk remains appropriate.

LCP said it expects to see more guidance on these issues in the 2026 annual funding statement, which is due to be published in the coming weeks.

The consultancy said that, under the new Defined Benefit (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.

LCP said 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 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 conflict in the Middle East – 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 are not just from events this year; they have 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 is 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 do not 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 is 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 partner Helen Abbott explained: "Understanding covenant reliability is central to managing a DB scheme. Recent global events have shown how quickly circumstances can deteriorate, with significant and persistent impacts on employer strength.

"Trustees who monitor covenant continuously and maintain open, proactive communication with their sponsor will be far better placed to navigate difficult periods and take decisive action when needed."