31 Mar 2019

A regulatory intervention report published by the Pensions Regulator confirms that it is increasingly using its powers to protect defined benefit (DB) pension plans and taking a tougher regulatory approach. 

The report sets out why the Regulator decided to intervene, after using its information-gathering powers, when a flexible apportionment arrangement (FAA) was used to avoid a statutory debt on the sponsoring employer becoming due after a decision was made to substitute the UK principal employer of the Martin Currie Retirement and Death Benefits Plan with another non-UK employer. 

Background 

In response to changes to the capital requirements of regulated financial businesses (which require employers to reserve for the full accounting deficit of any DB plan they sponsor), the Plan's principal employer, Martin Currie Investment Management Ltd (MCIM), asked the trustees of the Plan to agree to the replacement of MCIM with the group's parent company as the principal sponsoring employer. The parent company, Martin Currie Holdings Limited (MCHL), is a company based in Bermuda and not subject to the same capital requirements. It was proposed that any debt triggered on MCIM on ceasing to be the principal employer would be apportioned to MCHL under a FAA. 

The trustees accepted a mitigation package in return for agreeing to the FAA, which included:

  • MCHL becoming a statutory employer and taking responsibility for the debt triggered on MCIM under the employer debt legislation
  • a guarantee in favour of the Plan, provided by MCIM, up to the lesser of £26m or 110% of the Plan's Pension Protection Fund (PPF) liabilities, and
  • the benefit of a potential 'earn-out' payment following the acquisition of MCIM by Legg Mason Inc. (LM), contingent on future business performance 

The Regulator's intervention 

The Regulator's main concern with the FAA was around the replacement of the Plan's principal employer with a non-UK registered company. This type of substitution is considered by the Regulator to be 'materially detrimental' to a plan. 

A material detriment arises when the Regulator is of the view that an act, or failure to act, impacts on the likelihood of members receiving their benefits under a plan. If there is a material detriment, it can exercise its regulatory powers to protect members' benefits, which may take the form of a contribution notice (broadly requiring a cash payment to be made to the plan from the employer or a connected or associated person, which may include individuals). 

In this case, although the Regulator had no immediate concerns regarding the solvency of the Martin Currie Group, it was concerned that the change in jurisdiction of the principal employer could result in the Plan being ineligible for the PPF if MCHL was to suffer an insolvency event in the future. 

The Regulator also raised concerns over:

  • Whether the actions and decisions taken by some of the trustees called into question their independence and impartiality. A number of the trustees had personal conflicts - they were shareholders in the Martin Currie Group and there could have been a perception that they had an interest in pushing through the mitigation package to clear the way for the LM sale 
  • The overall mitigation package accepted by the trustees. The level of protection offered by the guarantee was inadequate in comparison to the Plan's previous position (where the Plan had a full, uncapped section 75 debt claim against MCIM as a statutory employer) and the trustees had no guarantee an earn-out payment would be paid

After coming to the conclusion that the FAA was materially detrimental, the Regulator gave the parties time to agree additional support. The additional support was implemented by a second FAA and included:

  • the Plan reverting to having a UK sponsoring employer as principal employer
  • enhanced employer covenant protections including a section 75 guarantee from MCHL, an additional guarantee from the wider group for 110% of the PPF benefits (uncapped), the earn-out payment being retained and other unspecified restrictions being put in place to protect the position of the Plan, and
  • appointing a new independent trustee - all conflicted trustees involved in the decisions regarding the first FAA stepped down 

The Regulator granted 'clearance' in respect of the second FAA after it concluded that the mitigation package was sufficient to address its concerns and resolved not to impose a contribution notice in relation to the first FAA. 

What impact does this have for trustees and employers of DB plans?

The report shows that the Regulator is taking a tougher approach to the regulation of commercial activity involving a DB plan. Whilst the legislative conditions appear to have been met for entering into a FAA and there were no immediate concerns of insolvency, it is important to note that the Regulator still intervened, holding that the original FAA was materially detrimental. 

The FAA had been notified to the Regulator as legally required by the notifiable events regime. The Government has recently proposed strengthening this regime by extending the notifiable events which are required to be reported. The Government also intends to legislate for the introduction of a "declaration of intent", to be provided by employers to trustees and the Regulator when proposing corporate restructurings. These changes can be seen as intended to help the Regulator to take a tougher, more proactive approach and to receive information so as to have the opportunity to act (if necessary) to ensure adequate support for pension plans. 

In practice, many trustees and employers are communicating with each other in advance of restructuring exercises and taking steps to ensure that members' benefits are protected. Therefore, it is more a case of the Government enshrining these actions in legislation and prescribing the procedure to be followed.  

Steps to minimise the risk of the Regulator using its moral hazard powers  

Employers and trustees should:

  • Determine whether the commercial activity, including any corporate restructuring not directly affecting a DB plan, has the potential to have a materially detrimental effect on the employer covenant and, if so, consider whether any mitigation on offer is appropriate
  • Appropriately manage conflicts of interest. The Regulator is more likely to question decisions reached when there is no evidence that conflicts have been identified and managed 
  • Be aware that the Regulator is going to review any agreements reached when entering into a FAA and will raise questions if it has concerns. The parties should therefore keep appropriate records of the negotiations between them in case the Regulator makes enquiries.