Communicating with clarity

Former Mirror newspaper proprietor Robert Maxwell once said: “I own the pension scheme.” And he believed his own declarations so much that he proceeded to dip into the fund to the tune of £460m to prop up his own business dealings. Then, when it became clear what he’d been up to, Maxwell belly-flopped off the back of his yacht off the Canary Islands in November 1991, never to be seen again.

The affected pensioners endured retirement prospects that were shattered by Maxwell’s fraudulent activities. Many received pensions that were less in value than the stamp used to mail their monthly cheque.

In 1995, the Pensions Act was a direct response to the Maxwell scandal, setting up a regulatory framework and compensation scheme. More recently, the Pensions Act 2004 further cemented the regulatory framework by setting up the Pensions Regulator, and the levy-funded Pension Protection Fund, which is a statutory fund run by the Board of the Pension Protection Fund.

While pensions regulation in the UK is not specifically targeted at private equity, the growing role of private equity in the general economy, in particular with deals focusing on nationally recognised brands and service providers, has generated interest and scrutiny from Parliament, the Pensions Regulator and labour unions, as well as the increasingly vigilant pension fund trustee community.

The areas focused on this year by the Pensions Regulator are of direct relevance to any organisations involved in M&A activity, not least the UK’s buyout market. Particular attention has focused on guidance on abandonment of pension schemes and also clearance issues that are currently open for consultation.

In September, the Pensions Regulator in its draft guidance provided further clarification of how it will use its powers with respect to corporate events such as mergers and acquisitions and private equity transactions. This draft clearance guidance updates the existing guidance that was published in April 2005.

The regulator’s revised guidance sets out the expectations of how professional advisers will work with trustees and employers in considering corporate events that may have a detrimental effect upon a pension scheme.

“I believe that the pensions industry will generally welcome these proposals, particularly insofar as they add clarity to the clearance application procedure. I think this will also be true of private equity investors generally,” says Wyn Derbyshire, head of the pensions group at SJ Berwin.

The main changes contained in the draft guidance are to encourage a move away from a reliance on prescriptive tests in deciding which events should be considered for clearance, to a more principles-based approach; to provide greater clarity in respect of the level of mitigation that trustees should be looking for; a simplification of the classification of corporate events, with removal of “type B” and “type C” events; a fuller description of scheme-related events (such as compromises and apportionment) that could be “type A” events; an extension of the list of employer-related events which could be “type A” events; further guidance on assessing the materiality of corporate events; updating the basis for assessing the relevant deficit to include section 179; and explicit reference to technical provisions.

Obtaining clearance is an appropriate consideration for events which are financially detrimental to the ability of a defined benefit scheme to meet its pension liabilities, and the regulator has classified such events as “type A” events.

“Our revised guidance, on which we are seeking comments, reinforces the need for mitigation to the pension scheme where there is detriment as a result of a “type A” corporate event. It sets out the principles that we expect all trustees, employers and advisers involved in corporate transactions to follow,” says Tony Hobman, chief executive of the Pensions Regulator.

A full description of the clearance guidance can be found on the regulator’s website ( Comments are invited to arrive by November 2.

“The regulator does not take a view on the use of private equity or the suitability of a transaction per se, rather our concern is that sufficient mitigation is provided for the pension scheme. Under the Pensions Act 2004 the regulator has anti-avoidance powers, and the issue of a clearance statement where requested gives assurance that the regulator will not use these powers in relation to the transaction once it is completed,” says Sue Rivas, head of defined benefit, research and the determinations panel at the Pension Regulator.

“The regulator does not ‘approve’ deals and has no power to stop a transaction from proceeding even where clearance is refused. While clearance is always optional, we recommend that it is sought where there is a potential material impact on the pension scheme,” says Rivas.

Lovells pension partner Duncan Buchanan notes that while clearance is voluntary, it is appropriate to apply for clearance in certain “type A” situations such as changes in security; returns of capital; changes in control structure; or compromises of s.75 debts.

Buchanan also adds: “If the Regulator issues a clearance statement it cannot later issue contribution notices and financial support directions in relation to the application, as long as there have been no material changes to the circumstances.”

The Pensions Regulator enjoys a favourable reputation for its impartiality, intelligence and swiftness of decision-making. But, aspects of the Pensions Act 2004 that fuel the regulator’s powers have yet to be challenged fully.

“While some changes to the clearance process have been proposed by the UK’s Pensions Regulator, it’s possible that people are reading too much into them. Many of the proposed changes were in fact either implicit in existing guidance, or have developed in practice over the last year or two in any event. I do not believe that the proposals, if implemented, will change the way the Regulator approaches clearance applications to any great extent,” says SJ Berwin’s Derbyshire.

“Having said that, insofar as the proposals clarify the approach that pension fund trustees and employers and connected parties should take, and in particular, emphasise that in making clearance applications, it is important to follow the spirit of the guidance as well as the letter, this is to be welcomed.”

“Since the Pensions Regulator was set up in 2005 there have been no contribution notices announced. So, one might conclude that the moral hazard legislation has been so successful that it has been unnecessary for the Regulator to use his powers to any great extent. The role of the Regulator has really focused everyone’s attention on pension issues, and the clearance process has generally worked well,” says Derbyshire.

A Contribution notice requires a payment to the defined benefit pension scheme; a financial support direction requires the recipient to put in place financial support for the life of the pension scheme.

A financial support direction can be issued if the Regulator is of the opinion that an employer in relation to the pension scheme is a service company or is “insufficiently resourced”. An employer is insufficiently resourced if its net assets are less than 50% of the estimated s.75 debt and if a connected or associated person has sufficient assets to meet the shortfall.

The Pensions Regulator is currently taking steps to enforce a financial support direction on the Bermuda-based parent of Sea Containers, highlighting the fact that the regulator can and will seek enforcements even outside of the UK when a UK pension scheme is affected.

A very important area for pensions regulation in the UK marries guidance on scheme abandonment and pension trustee empowerment. In abandonment guidance published by the Regulator in May it said that trustees should apply a high level of scrutiny to such transactions and should understand any changes to the employer covenant, and the impact on the scheme of removing the link with an employer of substance.

“We encourage innovative methods that help manage and reduce the risk to employers and members in pension schemes. However, trustees must consider whether any proposals are in the best interests of members. We consider that generally the best protection for members is the support of an ongoing viable employer, and removing that support will, in the majority of cases, not be in the best interests of members. The Regulator has issued guidance for trustees to help them recognise arrangements that may result in abandonment and sets out the factors they should take into account when such an arrangement is proposed. Trustees must apply a high level of scrutiny to such transactions,” says Rivas.

The abandonment guidance is broad in scope and can apply to any transaction that reduces the covenant of employers remaining with the scheme to a nominal level when compared with the previous covenant – unless mitigation has been provided that is sufficient to fully buy out benefits (that is, the s.75 measure). Full details of the guidance are available on the Pension Regulator’s website.

To buyout or not?

The Regulator considers pension fund buyouts where there is an FSA-regulated insurance product to be of low risk to members and does not consider such a case as abandonment. It is where the link to an ongoing viable employer is replaced with a vehicle not able to provide this kind of ongoing funding that the Regulator would be concerned.

Debate in the UK maintains strong momentum about defined benefit pension schemes and whether corporates can continue to offer these schemes to employees, or whether they opt to close those schemes and replace them with cheaper and less beneficial defined contribution schemes.

There is also considerable need for private equity and the labour unions to communicate on pension fund abandonment, or the perception of it.

Labour union GMB General Secretary Paul Kenny gave oral evidence at the UK Treasury Select Committee investigation into private equity earlier this year, stating that private equity backers have walked away from some £2bn worth of insolvent pension fund liabilities.

The accusation generated very little in the way of debate. And even the BVCA failed to submit any written evidence to counter the GMB claim.

Specialist insurers and the insurance big guns have established businesses in the so-called pensions buyout sector in the UK which could result in many pension schemes being sold to them, taking the burden away.

According to the findings of a straw poll of nearly 100 companies with defined pension schemes in the UK conducted by consulting group Watson Wyatt earlier this year, one in four UK companies are looking to transfer pension liabilities to insurance companies within the next five years if the cost reduces sufficiently.

This is the kind of research that independent FSA-regulated insurance companies like to use, with talk of a deal pipeline reaching as much as £24bn, or one quarter of the £1.2 trn defined benefit pensions market.

“The common issue today is companies have the cash to settle any pension fund deficits, as many pension funds invest 50% to 60% in listed equities, the values of which have increased substantially,” says Mark Wood, chief executive of insurance company Paternoster.

“What we have observed with the companies that have dealt with us to date is that they tend to be the early adopter groups including companies backed by private investors and private equity,” he says.

Others active or gearing up are Prudential, which focuses on large-scale bulk purchase annuities; UK insurance giants Aviva, through its subsidiary Norwich Union Life and Aegon, with its tie-up with UBS; and Legal & General is moving more into solvent schemes away from insolvent schemes, all of which are small scale. Legal & General has bulk purchase annuity assets under management totalling around £1bn.

US insurers Metlife and AIG are also said to be recruiting for UK-based teams to enter the market, and Canadian insurer Sunlife is said to be looking at the market. All three insurers are expected to develop a UK product offering before setting up similar schemes in the US and Canada.

Despite pension fund trustees holding out for a better deal ahead of KKR’s acquisition of Alliance Boots earlier this year, KKR is said to be considering offloading the high street chain’s massive £3bn company pension scheme to a specialist buyout vehicle.

UK media organisation Emap is widely believed to be one of a number of other companies looking to sell its pension scheme in order to enhance its attractiveness as a buyout target. A spokesman for Emap declined to comment beyond saying the media company is examining corporate options right now.

Some commentators go further to say that some private equity sponsors have placed an embargo on buying companies with defined benefit schemes because these are difficult-to-manage liabilities, especially with a vigilant and clued-up Pensions Regulator primed to act.