It is perhaps not surprising that with cash being so tight, companies are scouring their asset base to find unencumbered bits of something that they can offer to their pension fund trustees in lieu of a big cheque.
As Gavin Bullock, pensions partner at Deloitte explains, the idea of asset-backed structured partnerships between the company and the scheme trustees tends to be very popular with finance directors since it has instant treasury and tax benefits.
“For a start, it frees up cash for more profitable ventures and uses inside the business. For a second, there can be some interesting tax advantages,” Bullock says. Once the asset is invested in the special-purpose vehicle then the company has access to accelerated tax relief, which is attractive to finance directors – provided there are profits to set off against it.
Since Marks & Spencer did the first groundbreaking deal in 2007, a number of asset-backed funding deals have come through. In fact, 2010 has seen a rash of them, with assets, from whisky stocks to property, being offered to trustees (see table, page 34).
Moreover, asset-backed arrangements have benefited from what amounts to a blessing from The Pensions Regulator (TPR), which is putting increasing pressure on trustees to seek contingent assets from employers where they can.
Where these assets are associated with a revenue stream, such as a property that has rental income associated with it, they can go a good way to plugging the scheme deficit. Bullock says that the average so far is for these schemes to fill in for about 50 percent of the deficit. And it can work for smaller companies too.
A survey by KMPG on asset-backed funding points out that another benefit for companies going down this route is that it can materially stretch out the time frame TPR is prepared to allow for scheme recovery plans.
“Data from TPR suggests that the average recovery plan for conventional cash contributions is around eight years, whereas the asset-backed funding structures have an average term of 17 years,” the report’s authors say.
The reason for this more relaxed attitude on the part of TPR is obvious. With high-quality assets in place, the whole position of the scheme looks a great deal better to everyone, from the trustees to TPR. According to KPMG, more than £4bn of asset-backed contributions have been made so far to UK pension schemes, and trustees have been granted security over nearly £9bn of assets.
Mike Smedley, pensions partner at KMPG, points out that FTSE-100 companies pumped a record breaking £11bn in their schemes in 2009, the vast bulk of which was cash. That created real challenges and a non-cash solution is clearly very attractive, he says.
Martin Potter, a consultant at Hymans Robertson, points out that one of the stumbling blocks in the way of companies going ahead with asset-backed structures in the past has been the rule that prevents trustees from investing more than five percent of their fund in the sponsoring company. However, this barrier has now been effectively overcome through the use of Scottish limited partnerships (SLP).
Under Scottish law, an SLP is very clearly a legal entity able to enter into contracts. The position of a partnership under UK law is far less certain when it comes to contracts. This is important because as the SLP is a separate, arms-length structure, the five percent rule falls away.
“What is critical about the choice of assets to go into the SLP is that they have to be unencumbered, and they have to have a clear value in themselves that means that they would not become valueless if the sponsoring company failed,” says Potter. “Provided the assets meet this rule and the trustees can be confident both that the value of the assets will hold up and that they can get hold of the assets left in the partnership if the company folds up, then a deal can be done,” he says.
Potter adds that company bankers tend to be comfortable with these arrangements.
“They see these deals as evidence that the companies are getting on top of worryingly large deficits in a manner that does not strain cash resources,” he says.
Another interesting feature of the asset-backed approach, Potter says, is that these deals are pretty neutral from the perspective of users of the company’s accounts. Bullock agrees. “From an accounting perspective there is very little change in terms of presentation in your consolidated accounts, before and after the deal,” he says. “There is full awareness in the market as to what has been done, but the assets and the pension fund are still within the consolidated accounts.”
So far the deals done have been in the hundreds of millions of pounds range. Bullock says it is feasible that deals will come down in scale to the point where a £10m deal might be doable. However, he says there is a limit to the degree to which an asset-backed funding approach can become an off-the-shelf solution.
“These are complicated deals and by their nature they are bespoke,” he says. “That makes them quite expensive.”
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