Pensions World

James Berkley, PricewaterhouseCoopers, on protecting your scheme in a corporate transaction

Post-credit crunch, much has changed in the type and structure of corporate transactions. The Pensions Regulator’s approach has also evolved. Protecting your scheme has become more complex.

More corporate transactions mean it is ever more important that trustees know how to protect the scheme’s position. Three simple steps will help.

1. Quantify the detriment (if any)

The Pensions Regulator’s requirement for trustees to identify if a transaction is “materially detrimental” (June 2009 Clearance Guidance) is undefined and subjective, involving consideration of a wide range of complex factors.

More importantly, trustees are now required to determine how detrimental a transaction is and agree mitigation commensurate with this – gone are the days when identification of a “Type A event” typically meant seeking half of the FRS17 deficit up front with the remainder paid over an accelerated period.

Answering this requires understanding the commercial rationale for the transaction and quantifying the change in a number of key areas before and after the transaction, for example:

• the scheme’s access to value
• the employer’s profitability and cash generation
• the amount that the scheme would receive in an insolvency.

In most cases, multiple impacts will need to be considered together.
A helpful way of doing this is to consider how they impact the employer covenant and as a result how this changes the funding target.

For example, if you had an employer covenant pre-transaction that led you to a deficit of £10m and post-transaction you have a weaker employer covenant, that will lead to a change in the level of prudence needed in the assumptions and therefore a deficit of £18m. The minimum mitigation you are looking for is the £8m increase in deficit.

2. Identify a range of mitigation options

In the example above, a one off payment of £8m should return the scheme to the same position it was in pre-transaction. The remaining £10m deficit still needs to be paid off and in some cases a fundamental change in the risk profile of the employer may require this to be accelerated over a period shorter than the existing recovery period.

However, a cash only solution often is not possible and the trustees should also consider a wide range of alternative options that could mitigate the transaction, in particular any options that are valuable to the scheme and easy for the company to give. This may include guarantees, security, negative pledges or legal commitments. A package of options that returns the covenant to its initial strength could reduce (or negate) the need for any cash funding.

3. Decide upon your preferred negotiation strategy

In our example above, the trustees “need” to receive value of £8m to mitigate the impact of the transaction. There is nothing to stop them asking for more and it is usual that there is some movement from both sides away from their respective opening positions. Having a clear strategy is key. Consider the following points:

• What will be your opening demand from the company? How will you justify this demand? How and when will you step down from this position to arrive at a consensual and acceptable answer?
• Think about tactics – is it best to make the first offer/demand or wait for the other side to do this? Balance letter writing with face to face meetings, and know when to include or exclude your advisers.

Above all, be firm but fair in your negotiations and avoid getting entrenched in one position – a short term gain at the expense of your relationship with the employer is unlikely to be beneficial in the long term.