Trustees should consider seeking clearance from the Pensions Regulator where a corporate transaction is financially detrimental to the ability of a defined benefit pension scheme to meet its liabilities or where there is a significant weakening of the employer covenant.
The Regulator recently issued a reminder on this issue which can be found at: www.thepensionsregulator.
Regardless of a scheme’s funding position, the Regulator considers clearance to be particularly appropriate, where one or more of the following occurs:
¦ a highly leveraged transaction, for example where a private equity company seeks to buy a target company
¦ assets normally allocated for the scheme are being removed from the employer group
¦ a transaction which may result in scheme abandonment.
The Regulator has now fi rmly emphasised that, in these sorts of situations, trustees should, in addition to clearance, consider whether to demand a substantially enhanced level of assets and/or security in order to bring scheme funding above that of the FRS17/IAS19 level. Seeking a clearance statement from the Regulator remains a voluntary process, but it may offer comfort to those involved in a corporate transaction. If clearance is granted, it means that the Regulator will not then use its antiavoidance powers, such as the ability to issue fi nancial support directions or contribution notices, in respect of the scheme as a result of the corporate transaction.
Over the last year or so, a number of highly publicised share purchases and leveraged buy-outs have been attempted or concluded in circumstances where pension scheme funding was a signifi cant, and in some cases a highly publicised, issue. Last year’s proposed purchase of WH Smith was scuppered because of the trustees’ ability to pursue a large one-off contribution to the company’s pension scheme.
The Regulator has previously stepped back from indicating whether scheme trustees should seek funding above the FRS17/IAS19 level in such transactions, which has resulted in a degree of uncertainty for the various parties concerned. However, the Regulator appears to have come off the fence by this recent announcement, although it has stopped short of a requiring buy-out funding level.
The Regulator has said that it will be updating its existing clearance guidance (dated April 2005) in June, and it remains to be seen whether the revised guidance will elaborate on the issues highlighted by the above announcement. It also remains to be seen how clearance applications, for example in respect of highly geared leveraged buy-outs, are played out in practice. The announcement is clearly an important one that should be taken into account by prospective purchasers in their negotiations with trustees, and trustees have effectively been given the green light to negotiate a funding basis which is in excess of FRS17/IAS19 level in certain circumstances.
In all things clearance-related, the key issue is whether the proposed transaction would result in a material weakening of the underlying employer covenant. Interestingly, the Regulator is not saying that trustees must request the funding, but rather that they should consider making a funding request in excess of the FRS17/IAS19 level. Much will depend on the circumstances of the transaction, the advice being received by trustees (who will almost certainly require an independent analysis of the employer’s funding covenant), the scheme’s funding position and the scheme’s rules (for example an employer contribution power which lies solely with the trustees gives them a strong bargaining position overall). There may also be a number of ways in which additional funding could be met (indeed the current clearance guidance envisages a number of such options) apart from an immediate lump sum injection, eg accelerated payments and/or other forms of security.
In short, the Regulator’s announcement offers some clarifi cation on what has been a grey area for employers, prospective purchasers and trustees.