Corporate transactions: Is compulsory clearance ahead?
Increased regulatory powers over UK corporate transactions could harm sponsors; The regulator would need enhanced powers to process applications efficiently
The interaction between corporate transactions and defined benefit (DB) pension schemes, the effectiveness of the current clearance process, and the Pensions Regulator’s ability or willingness to intervene have been the subject of discussion for several years in the UK.
This debate has recently intensified as a result of several high-profile controversies, such as over British Steel, BHS and Bernard Matthews. Following a parliamentary inquiry into DB pension schemes, which made several recommendations, the government published a Green Paper on the security and sustainability of DB pension schemes in February. The official discussion document aims to identify issues undermining confidence in the current DB pensions system in the UK and to consider possible solutions.
Among the potential solutions discussed is the introduction of a requirement for proactive compulsory clearance by the Pensions Regulator of certain corporate activities in limited circumstances. The advantages of this proposal are that it would give the regulator (and trustees) advance warning of transactions that could be detrimental to a DB pension scheme.
It would also provide an opportunity to secure mitigation of that detriment, rather than the regulator having to rely on its retroactive anti-avoidance powers. Ultimately, members’ rights would be more likely to be safeguarded.
Yet, from a commercial perspective the downsides to implementing the proposal are self-evident. The proposed clearance requirements are likely to stifle legitimate business activities and ultimately negatively impact the UK economy. They could deter investors who might otherwise have invested in companies with DB pension schemes.
If this proves to be the case, some of these companies might end up with a higher insolvency risk because of difficulties in securing investment. The restructuring of stressed businesses would also be more difficult, potentially resulting in a higher number of insolvencies. Ultimately, instead of protecting members’ benefits (which should be the key objective in any revised clearance process), there could be a higher number of members not receiving their full benefit entitlements.
There could also be a greater strain on the Pension Protection Fund. This is the opposite scenario to what the government intends.
Redesigning the current clearance framework to avoid these types of scenarios would be a challenge. Perhaps the greatest hurdle would be defining clearly the types of transactions that would have a detrimental impact on DB schemes because this would depend on many factors. These include the nature of the transaction, the funding position of the scheme and the strength of the existing employer covenant.
Regulator would need greater resources
Compulsory clearance would require greater resources at the regulator in order process the clearance applications promptly. This raises the question of who would pay for these resources.
Providing the regulator with additional resources so it can engage with a wider range of schemes under its existing powers is another option discussed in the Green Paper. In this context, the government suggests that such resources could be paid for by increasing the general levy paid by pension schemes or by charging for certain regulatory services (such as clearance).
The government explicitly recognises the risks that compulsory clearance would bring and the challenges it and the pensions industry would face in designing a framework that minimises these risks. Unsurprisingly, it is not persuaded, currently, that compulsory clearance would be an appropriate option to take forward, but views are sought.
There may well be other ways of tackling the issue of the potentially detrimental impact of corporate activity on DB pension schemes that are not covered in the Green Paper.
An alternative to the compulsory clearance proposal might be to require parties to a transaction to notify the regulator and the trustees of the proposed transaction, but without the regulator’s approval having to be sought.
As with compulsory clearance, this option would give the regulator (and the trustees) advance warning of transactions that may be investigated further. But there should be no delay in the transaction because there would be no need to obtain regulatory approval.
The downside of this approach would obviously be that the regulator would not be able to ensure that the transaction, proceeded on terms that protected the pension scheme. However, by having advance notice of the transaction the regulator and the trustees would have an opportunity to be involved with and influence the transaction negotiations.
In addition, if the transaction proceeded on terms that were not satisfactory in the regulator’s view, it would still be able to use its anti-avoidance powers.
Moreover, a notification regime could apply to a far wider range of transactions than a compulsory clearance regime as the concerns regarding the potential stifling of legitimate business activities would not apply.
Designing an appropriate notification framework would not be simple. For example, it would still be necessary to decide which transactions would be within the scope of the notification obligation, and how far in advance of a transaction notification would need to be made.
However, it would be significantly less complex and far easier to achieve than designing a compulsory clearance framework.
While a compulsory clearance requirement or a pre-notification requirement would both ensure that the regulator was made aware of proposed corporate activity, they would not address several other difficulties that such activity can create for DB pension schemes.
Assessing the implications of a proposed transaction for a pension scheme requires skills that trustees may not possess. Trustees therefore need access to appropriate professional advice, but many smaller schemes do not have the resources to obtain this advice. A professional trustee can help to fill a skills gap but, again, schemes or employers may be reluctant to bear the cost of appointing one.
Corporate transactions in particular acquisitions will often result in the sponsoring employer or its corporate group taking on significant additional bank debt.
This will usually be secured by a fixed or floating charge over some or all of the sponsoring employer’s assets.
As a result, the bank is placed at the head of the queue of creditors in the event of the employer’s insolvency. Trustees rank, for most purposes, as unsecured creditors and are therefore likely to make only limited recoveries from an insolvency.
There is little that trustees can do to improve recovery prospects in an insolvency unless they are also able to take security over employer assets. The extent to which this is possible will depend on several factors. These include whether any suitable assets are available, whether the consent of any other security-holders is required and whether the employer is willing to grant security.
The Green Paper was closed for comment on 14 May and at the time of writing the government had not indicated when it plans to respond. However, whenever the government does react it seems unlikely that it will decide to proceed with introduction of a compulsory clearance requirement.
It remains to be seen whether it will introduce an alternative means of mitigating the potentially detrimental impact of corporate transactions on DB pension schemes.
Ian Wright and Jay Doraisamy are partners at Mayer Brown International