Pensions and the regulator – does he need more power?

August 2016 | LEGAL & REGULATORY | BANKRUPTCY & RESTRUCTURING

Financier Worldwide Magazine

Save for the ongoing debate about the financial consequences that may ensue following the UK’s decision to leave the European Union, perhaps the most emotive stories to have featured in the financial press in the UK over the last few months have been those about the collapse or potential closure of businesses employing thousands of men and women. Two of the most prominent examples are the untimely demise of retailer BHS and, the possible closure of Tata’s steelworks in Port Talbot, Wales. In both cases (and of course there are also other examples), the presence of significantly underfunded final salary pension schemes, and concerns about the fates of workers, former workers and dependants who have been relying on those pension schemes for financial support during their retirements, has not only added to the agonies of closure, but also created significant stumbling blocks to the possibility of mounting rescue operations for the beleaguered businesses.

Of course, this is completely understandable – it is one thing to seek the support of potential rescuers for a business teetering on the edge of financial ruin, and quite another to also expect those rescuers not only to take responsibility for the business itself, but also to shoulder the burden of hundreds of millions of pounds-worth of accrued pension liabilities.

Unsurprisingly, much attention has been paid by legal and other experts in the corporate, insolvency and pension arenas to the possible ways of separating businesses from their pension schemes and their liabilities in rescue scenarios. Methods of achieving this do exist, though they generally result either in the pension scheme being wound-up in deficit, with scheme members suffering cut-backs in their pension benefits or (in the event of really serious underfunding) with the scheme falling into the ambit of the Pension Protection Fund (PPF). This would put even further financial strain on that body, and many pension scheme members seeing even greater benefit cut-backs.

In either case, identifying or implementing ways of addressing the problems posed by the pension scheme, and negotiating with the relevant pension authorities (primarily the Pensions Regulator and sometimes the PPF itself), take time and money. Both of these are often in short supply in the midst of a rescue attempt, and this alone can sometimes be sufficient to stymie a rescue attempt.

Also understandable is the anger that is frequently felt when a business fails, leaving an underfunded pension scheme in its wake. There are often calls for the ‘authorities’ (which in the UK primarily means the Pensions Regulator) to take action, particularly if it is felt that owners (or former owners) of the insolvent business did not do enough to support the pension scheme, or even improperly took advantage of the business, at the expense of the pension scheme in the months or years preceding the collapse. There have recently been calls in the press for reviews of the scope of the Regulator’s powers in this regard, with suggestions that his powers need to be strengthened. That is certainly a debate that should be had, but as a starting point we should surely be asking what exactly his existing powers permit him to do, particularly with regard to pursuing owners and former owners? And the answer to that is quite a lot actually.

The Regulator already has a collection of powers under existing pension legislation (commonly called his ‘moral hazard powers’). They enable him, in certain circumstances, to require that owners and former owners of employers operating final salary pension schemes, and those parties currently or formerly ‘associated or connected’ with such owners (for example, holding companies) make financial contributions to the scheme. This is even the case if those parties do not sponsor or participate in the pension scheme themselves. He also has widespread investigatory powers. The terms ‘associated’ and ‘connected’ have the same meaning in relation to moral hazard as they do within the insolvency arena, and so there are various ways that association and connection can be established.

In extreme cases, the contribution required by exercise of a moral hazard power could be equal to the scheme’s full funding deficit. These powers primarily take two forms; the power to issue contribution notices (CNs) and the power to issue financial support directions (FSDs). Broadly speaking (inevitably legal small print adds complexity), CNs can be issued if (in the reasonable opinion of the Regulator) an employer or associated/connected party has done something (or failed to do something) causing ‘material detriment’ to the pension scheme (so that its ability to pay benefits is threatened) or if the result of the act or failure is evasion of a form of statutory debt (a ‘section 75 debt’) which can arise, e.g., on employer insolvency or scheme wind-up at a time of scheme underfunding.

Therefore, there has to be ‘wrongdoing’ on the part of the CN recipient. In the case of FSDs however, there need not be wrongdoing as such. An FSD is an order from the Regulator to put in place ‘financial support’ (e.g., by means of a payment or guarantee) to a pension scheme. This can be ordered against an employer or connected party (but, unlike the case of a CN, usually not an individual) if a particular test assessing the respective financial strengths of the employer, its wider corporate group and the scheme itself is passed.

Consequently, even if the employer or associated/connected party has behaved impeccably, it could potentially be an FSD recipient. Once again, the Regulator must believe it reasonable to issue the FSD, and the result of an FSD could be that the recipient is obliged to fund the scheme’s deficit.

The key point to note is that the moral hazard powers can be exercised retrospectively, even if at the time of exercise the recipient is no longer associated or connected to the employer and pension scheme, for example, because the employer has been sold to a third party. There must, however, have been a state of association/connection at the time of the event or effective date of the financial test. In the case of a CN, the look-back period is six years, and it is two years in relation to FSDs. Thus (provided the other grounds for issuing a CN or FSD as the case may be exist), the fact that a former owner of a pension scheme disposed of the employer and severed its link to the employer and the pension scheme in the process, does not mean the former employer has necessarily escaped the scope of the Regulator and his moral hazard powers.

Should the moral hazard powers be extended? There is certainly an argument that the discussion needs to be had. The Regulator’s powers are already widespread, and there could be concerns that widening them further may have a detrimental effect on legitimate corporate activities and business transactions generally. One area that might be considered worthy of review is that of reporting to the Regulator; at present, despite his widespread investigatory powers, there is no automatic requirement to inform of prospective acquisitions or disposals. Some commentators have already called for a system whereby the Regulator is warned if a disposal is proposed involving significantly underfunded or otherwise potentially vulnerable pension schemes, and the recent sagas of BHS and others could well lead to reform in this area of pension regulation, even if the moral hazard powers themselves remain as they are.

Wyn Derbyshire is a partner at gunnercooke LLP. He can be contacted on +44 (0)7494 433 779 or by email: wyn.derbyshire@gunnercooke.com.

Wyn Derbyshire

gunnercooke LLP