New U.K pensions regulator affects U.S. corporate activity.
For years, the UK has applied a very light touch to the regulation of company pension plans. More than three decades after the establishment of the Pension Benefit Guarantee Commission in the United States, this has changed. Six months into the new regime, the consequences are being felt acutely in the UK transactions market. Now the ripples of UK pensions regulation are beginning to cross the oceans and widely affect company pension plans around the globe.
The problem stems from the cumulative changes made to protect UK employees and retirees during the last 25 years of the Twentieth Century. While corporations protested, there was no obvious pain because corporate UK had taken a big bet on the stock market--and been handsomely rewarded. As a consequence, several UK governments, prodded by the European Union, were able to push through changes now seen as burdensome upon UK industry.
The perfect storm of falling stock values, lower interest rates, and increased life expectancy resulted in large deficits in many UK pension plans--proportionately more damaging than the United States. The situation was made worse in 2003 when the UK government announced it was piercing the corporate veil in order to ensure groups stood behind the pension promises of their companies. As a result, the UK pensions regulator is insisting that, as long as underfunding persists, pension plan trustees act as unsecured creditors in negotiating funding with their sponsoring employers. What do these developments mean?
The regulator has identified three key areas where trustees should seek to intervene and maximize their funding at the expense of the sponsoring employer:
1. Change in priority
2. Change in control structure
3. Repayment of capital or subordinated debt
For U.S. groups this has a number of implications. For example, the simple act of granting security over assets owned by a company sponsoring a pension plan will subordinate the position of the pension plan trustees. Such activity now requires consultation with the trustees, who are expected to negotiate improved funding terms in return for the reduction in their security.
When businesses are bought or sold, the change in ownership will result in the pension trustees being in either a stronger or weaker position, depending on the relative financial strengths of purchaser and vendor as well as the financial structure of the deal.
Dividend payments from the UK--and indeed the EU--to the U.S., for example driven by section 965 of the Internal Revenue Service (added by the American Jobs Creation Act of 2004), result in a weakening of security from the perspective of pension trustees. Trustees must be consulted and, crucially, are expected to negotiate increased funding in return for their approval to the dividend payment.
Many U.S. managers have expressed surprise, and sometimes more than a little outrage, at having to consult with UK pension trustees on their dividend policy. "What has dividend policy got to do with funding the UK pension plan?" But this is the new reality in the UK. With no equivalent of the PBGC for so many years, employees and retirees of insolvent companies have lost too much on their pension entitlement. More recently, with such massive underfunding, the losses have been huge in a number of cases. Concluding that it could not afford to allow this to persist, the UK government established a Pension Protection Fund (PPF), which provides security along the lines of the PBGC. (For general information about PPF, please see visit the Fund's website at http://www.pensionprotectedfund.org.uk/.)
But the cost of this security is high and is to be funded by UK corporations. In its efforts to keep costs down, the regulator is insisting that underfunded pension plans be restored to financial health much more swiftly than in the past. Trustees have been given the tools to intervene in corporate activity and are beginning to use them--sometimes with relish.
So what is to be done by US management? Five golden rules:
1. Identify pension underfunding in the UK and develop strategy to rectify.
2. Identify corporate activity that impacts on UK pension trustees as unsecured creditors.
3. Acknowledge pension trustees as legitimate stakeholders and develop strategy to deal with them.
4. Understand the regulator's requirements and develop strategy to meet them.
5. Review corporate advisers for expertise and experience in this new environment.
NEVILLE MCKAY is a partner in the Human Resource Services practice of PricewaterhouseCoopers LLP's London office.
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|Date:||Nov 1, 2005|
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