Pensions special: Almighty powers that be

The government’s announcement that it will be consulting on extending the
Pension Regulator’s anti-avoidance powers is already causing considerable
difficulty for UK business. The situations in which the regulator could use its
powers are likely to be widened and the changes will be backdated to 14 April
2008. This introduces significant uncertainty around a range of normal corporate
activity, and does so at a time of extreme difficulty in the market for
corporate transactions and restructurings.

The regulator has two main anti-avoidance powers ­ Financial Support
Directions (FSD) and Contribution Notices (CN).

An FSD requires financial arrangements to be put in place to support an
employer’s pension liabilities, where the employer is insufficiently resourced.
A CN requires an amount, up to the full buyout debt, to be paid to a scheme. The
regulator can issue a CN against a company or related party, where it is of the
opinion that one of the main purposes of the act was to avoid a pension debt.

Parties can seek clearance for specific actions to obtain assurance that the
regulator will not use its anti-avoidance powers.

Key changes
The main change that is causing concern in the market is the extension of the
circumstances in which the regulator can issue a CN. The regulator’s powers are
significant and far reaching, and therefore need to be given due respect.
However, a CN can currently only be issued where there is deliberate avoidance
of a pension debt. This focus on intent has been widely accepted by the market.

Under the proposed changes, the regulator can force companies and related
parties to make additional pension payments if an event is subsequently deemed
to be materially detrimental to a pension scheme’s ability to pay members’
benefits, even if it was unintended.

Companies currently involved in a range of normal corporate activities will
need to think differently, including whether to seek clearance from the
regulator. This means additional cost and risk at a time when the market is
already experiencing difficulties in obtaining financing.

The government has stated that the particular focus of its attention is
business models that may sever the link between the pension scheme and the
employer in order to operate schemes for a profit. However, under the proposed
changes the regulator could potentially use these expanded powers in wider
circumstances. There is therefore market concern that, despite the government’s
and the regulator’s assurances, the changes might frustrate legitimate corporate

The government is currently consulting on the proposed changes (until 20 June
2008) before releasing the draft legislation giving effect to them. While
changes will certainly be made, their final form, and to what extent any
limitations may be imposed on them, is still unclear and will remain so,
potentially for several months. In the meantime, businesses are left wondering
how to obtain certainty over actions without unnecessary cost.

It is important that the regulator and the government protect pension
benefits. But it is questionable whether such significant changes are needed as,
given recent agreements reached between the regulator and market participants,
it appears the regulator’s existing powers are working well.

The proposed changes are already impacting on business. In some cases deals
are being put on hold until there is more certainty over the changes. But not
just deals are being affected. One of our clients looking to sell assets in
order to undertake further capital investment in its core business now has no
alternative but to seek clearance from the regulator for this capital
expenditure. The company’s advisers were unable to give any certainty that such
an action would not fall foul of the new powers.

We expect to see a significant increase in the number of clearance
applications in cases where previously this would not have been necessary.
However, clearance takes time and may delay corporate action by six-to-eight
weeks, and nearly always results in additional cash contributions.

The changes are also impacting on legitimate cost reduction or restructurings
of businesses. The proposed changes impact the balance of powers between the
company, its lenders and pension trustees.

As a result we have seen a number of cases where restructuring plans are
being reconsidered because potential additional pension costs would undermine
the deal and the value that it would preserve. This is particularly problematic
in the case of a struggling business, where lenders are having to reconsider the
actions they may take to support the business.

Seeking advice
It is clear that the changes are forcing companies to develop more formal
strategies for managing pensions during a wide range of corporate activities.
Companies are seeking help on assessing how the changes will be viewed by
pension trustees, and how to communicate the merit of corporate actions. They
need to document why corporate actions are positive for the company and its
ability to support its pension arrangements, and then present this in an
appropriate way to pension trustees.

In the meantime, we and many of our corporate clients continue to question
whether such far-reaching changes are appropriate to address a perceived risk
that may already be adequately covered by the existing regulator powers.

Lee Jagger is head of corporate pensions at KPMG UK

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