The UK’s Pensions Regulator appears to have hardened its stance on the need for private equity firms undertaking leveraged buyouts to address the pension scheme deficits of target companies.
Specifically, the regulator has advised pension scheme trustees in target companies that they are entitled to request payments in excess of any deficit that exists when pension accounting standard FRS 17 is applied to the scheme.
According to Rosalind Connor, a pension specialist in the London office of law firm Jones Day, private equity buyers have not tended to agree to excess payments in such circumstances on the understanding that the Regulator would be unlikely to intervene in trustees’ favour.
However, the new guidance stresses that this is not the case. Even where the scheme is well funded according to FRS 17, the guidance from the Regulator is that trustees are entitled to ask for substantial payments. Although a buyer can legally refuse to agree to this at the time of the deal, it will subsequently be forced to renegotiate with the trustees when the scheme undergoes its tri-annual valuation. At this point, the Regulator can impose its own verdict on the required size and timescale of pension payments should the new owners fail again to meet the trustees’ demands.
Says John Broome Saunders, actuarial director at BDO Stoy Hayward Investment Management: “Today’s announcement is clearly designed to increase the size of… lump sum contributions. This shifting of the goalposts may well be motivated by the Regulator’s desire to dip its hand further into the apparently deep pockets of the private equity houses, for the benefit of scheme members.”
However, Connor points out that another factor is growing concern that the FRS 17 valuation methodology tends to underestimate the true size of deficits with its reliance on highly volatile market-based assumptions. In the recent negotiations between a private equity consortium and the trustees of J Sainsbury, the firm’s pension deficit based on accounting principles was less than £500 million. But the trustees insisted on a £2 billion payment based on the cost of buying individual annuities for pension scheme members in the open market should the scheme be wound up by the buyers.
The Regulator’s guidance is not restricted to private equity firms, but leveraged buyouts are a particular cause of concern given the perceived high risk of the company ending up in difficulty as a result of its debt burden.