Moral Hazard: Proposed Extension Of Pensions Regulator's Powers.

The UK government has published consultation on controversial changes to the moral hazard powers of the Pensions Regulator. Some of these changes took effect from 14 April 2008, when an initial announcement was made. A statement has been issued by the Pensions Regulator limiting the retrospective application of the new provisions. The proposals have caused great concern in the private equity and venture capital industry with suggestions that many deals have been put on hold because of fears of the extent of the new powers. Draft legislation is not expected until the autumn.

What is moral hazard? The powers to issue contribution notices and financial support directions were first introduced in April 2005. The main purpose is to prevent employers walking away from occupational pension scheme debts. Notices and directions issued by the Regulator can require the immediate payment of up to the full deficit in the pension scheme on an annuity buy out basis. They can be issued against a wide range of individuals or bodies including employers, companies connected or associated with an employer (including directors and controlling shareholders).

Contribution notices The main changes are in relation to contribution notices. Prior to 14 April 2008, the Regulator could issue a contribution notice where it was of the opinion that the recipient was a party to an act, the purpose of which was to prevent recovery of a debt owed to the pension scheme or, otherwise than in good faith, to prevent such a debt becoming due. The government is concerned that there remain certain actions which could be taken to the material detriment of pension scheme members which could not be subject to a contribution notice.

The main proposals are:

A new power for the Regulator to issue a contribution notice where the effect of an act is materially detrimental to a pension scheme's ability to pay benefits. The important change here is that the Regulator will look at the effect of an act rather than the intent.

The good faith requirement will be removed, so that a contribution notice may be imposed in any circumstances where an action has the effect of preventing a statutory debt to a pension scheme becoming due.

A new statutory defence which will apply where a party can demonstrate that he could not reasonably have foreseen that his actions would have a materially detrimental effect of the security of members' benefits.

The Regulator's statement

On 25 April 2008 the Pensions Regulator issued a statement setting out how it would apply its new powers, pending the introduction of the final legislation later this year. It will not apply the new tests listed above in the meantime unless one of the following actions or situations is present:

The employer or pension scheme is moved to another jurisdiction.

The operating company is split from the pension scheme without appropriate mitigation.

Assets are split from the operating company without appropriate mitigation for the pension scheme.

Scheme assets and liabilities are transferred to another scheme which does not have adequate employer support.

The pension scheme is being run for profit without adequate account of the interests of the members.

A business model in which risk is borne predominantly by scheme members but high investment returns would benefit investors.

Where none of these factors is present then the Regulator will continue to operate its powers largely as before.

Nabarro comment

We welcome measures to protect pension scheme members from unwarranted risk. However, this should not be at the expense of legitimate corporate activity, nor create regulatory uncertainty. One concern is that in concentrating only on the effect of an action and not the intention, parties may incur contribution notices as a result of the unforeseen consequences of a transaction. It may not always be possible for a party to make this assessment before the transaction takes place – although the statutory defence will be of some comfort.

Interested parties are likely to lobby strongly in the consultation as many organisations are concerned about these changes. In particular they may seek to hard-code the circumstances in which the Regulator can operate the new legislation (perhaps in line with the current Regulator's statement). Without this there will be huge uncertainty going forward, giving the Regulator wide scope to act in circumstances it deems "reasonable".

One consequence of these changes is likely to be a larger call on the Regulator's clearance procedure, rather than risk a contribution notice. The Regulator has confirmed that it does not envisage any fundamental change to its approach to the operation of its powers, and specifically to its operation of the clearance procedure.

Any company or organisation connected with a defined benefit occupational pension scheme which is involved, or intending to be involved, in any of the situations listed in the Regulator's statement should give urgent consideration to the new provisions and consider whether a clearance application should be made.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

Ms Susan Jones

Nabarro

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