UK - Financial restructurings at companies trying to avert insolvency could have a major impact on UK pension schemes, according to Punter Southall.

The consultancy's caveat comes at the same time as Gazelle Pensions Advisory warned that the gradual erosion of the sponsor covenant's strength - rather than company insolvency - that posed the greatest risk to corporate schemes.

According to Punter Southall, current economic conditions will trigger corporate restructuring over the course of this year as companies try to avoid insolvency, financial distress or significant deterioration in trading performance.

This, in turn, might involve moving key assets out of the sponsoring employer and weakening the pension scheme - even if the legal structure is unchanged, and the positions of the scheme and its sponsoring employer(s) within the corporate hierarchy remain the same.

"For instance," the company said in a note, "if the restructuring involves transferring some profitable contracts from the employer to another group entity, with the remaining business of the employer becoming significantly less profitable, the ongoing support for the scheme will be weaker going forward."

Similarly, if the restructuring involves the employer taking on more secured debt, the scheme's potential recovery as unsecured creditor in the event of the employer's insolvency will become weaker.

The consultancy also argued that companies with defined benefit (DB) schemes might be particularly vulnerable to material changes in the strength of the employer covenant.

Decision-makers would do well to take that into consideration, said Lorant Porkolab, head of the covenant advisory team at Punter Southall.

"Many restructurings affect the legal shape of the business," he said. "It is critical for trustees to understand where this leaves the pension scheme and its sponsoring employer.
"Restructuring can involve moving key assets out of the sponsoring employer and weaken the covenant support available to the pension scheme. This can also happen even if the legal position remains the same."

According to Porkolab, both employers and trustees should prepare to work together on mitigation to put the scheme back in the same place it was before the restructuring.

"It is important that everyone be pragmatic and commercial throughout the process," he added. "Benefits from properly restructuring a business will ultimately bolster the covenant support available for the pension scheme."

Porkolab's view was not shared by Gazelle, with the advisory arguing that mergers, restructurings and takeovers would have "fundamentally changed" the strength of the covenant.

Examining changes at FTSE 100 companies as listed in 1985, Gazelle chairman Simon Willes said: "It is not clear that the current pension regulatory framework, which has striven to improve the protection of pension schemes on default, effectively deals with the risks to pension scheme funding posed by corporate activity and change.

"The transaction clearance regime originally showcased is voluntary and appears to be now largely ignored by companies and their advisers.

"If regulation is about ensuring pensioners do receive pensions from defined benefit schemes, then elevation of the status and ranking of pension schemes from long-term unsecured creditors is central to the debate."