TPR publishes new guidance on asset-backed contributions

Introduction

On 19 November 2013, TPR published new guidance on asset-backed contributions (ABCs). These are also commonly referred to as asset-backed funding (or special purpose vehicle) structures and pension funding partnerships (PFPs). It is aimed at trustees who are considering a proposal to enter such an arrangement.

Key points

Whilst recognising the potential advantages of ABC arrangements for employers and pension schemes in terms of funding and security, TPR expects trustees to examine ABC proposals “critically and carefully”.
Trustees should consider whether there are any less risky alternatives to support the Scheme.
Trustees should ‘unpack’ the ABC arrangement to identify the extent to which the value attributed to the ABC in the Scheme’s accounts is reliant on future payments.
All ABC arrangements should include a separate underpin to protect the scheme’s position should the arrangement be declared void or there is a change in the law.

What is an asset-backed contribution?

An ABC is a contractual agreement between a DB pension scheme and the sponsoring employer’s group, under which the employer or another group company agrees to transfer an asset to a ‘special purpose vehicle’. The pension scheme then receives part of the income stream generated by the asset for a specified period and may have a legal claim to the asset if a certain event, such as the insolvency of the sponsoring employer, occurs.

The guidance

TPR’s risk expectations

TPR expects trustees to ensure that they properly understand the risks and benefits of any proposed ABC arrangement by undertaking a robust evaluation, considering available alternatives (even where these are not proposed by the employer) and obtaining “extensive legal, actuarial, asset valuation and covenant advice”.

TPR identifies the following key risks:

An inflexible schedule of payments, delaying full funding – TPR is concerned that schemes may receive lower annual payments under an ABC than under an appropriate recovery plan, with the result that trustees are reliant on the ABC continuing for a longer period to achieve full funding. In addition, an ABC may limit trustees’ funding options, for example, because the capitalised income stream from the ABC may eliminate the scheme’s deficit on a technical provisions basis, leaving the trustee unable to agree higher payments under a recovery plan even where they are affordable and appropriate.
Weak underlying assets or limited legal claims on those assets.
Masking the scheme’s overall risk profile – the future payment stream may be capitalised and treated as an asset on day one improving the scheme’s funding level but the scheme is still reliant on the employer group making the future payments to meet this target.
Weakened covenant – trustees’ access to an asset could be reduced by its transfer to an ABC and / or the employer’s covenant could be damaged by the operation of the ABC arrangement.
Illegality of the structure – TPR notes that investment in ABCs could breach the statutory restrictions on employer-related investment.
Costs and complexity.

Trustees’ assessment

As part of their evaluation of an ABC arrangement, trustees should consider whether there are any suitable alternatives (for example, an appropriate recovery plan). In addition, while appropriate considerations will vary, TPR expects trustees to take the following factors into account as a minimum:

The period and amount of payments by which the scheme’s deficit (ignoring any immediate capitalisation of payments) will be met under the proposed ABC and how these compare to a standard recovery plan.
Where the ABC involves a longer (or more back-end loaded) payment period than would be available under an appropriate recovery plan, whether the potential value of and access to the underlying asset justifies such a payment plan.
Whether the ABC provides access to any assets which are not currently owned by the sponsoring employers (or otherwise available to the scheme) and therefore do not already form part of the covenant on which the scheme can rely. Trustees should also consider whether these assets could be provided to the scheme by way of a contingent asset arrangement, such as security over the asset.
Whether entering into an ABC fetters the trustees’ ability to negotiate increased deficit repair contributions in future.
Whether an ABC could restrict the trustees’ ability to carry out de-risking exercises such as buy-ins, buy-outs and longevity swaps.

Underpin

Tying in with good governance and risk management principles, TPR expects ABC arrangements to include an underpin to protect the scheme’s position in the event that, for example, the courts find that ABCs are void for illegality or there is a change in the law. The underpin should be “robust and certain” and cover:

Any repayment to the scheme of monies previously received under the ABC but returned, and
Future payments (reflecting the fact that the scheme would lose the income stream, as well as any security afforded by the ABC).

The underpin should not be an “agreement to agree” an alternative funding plan and should be in a separate agreement to prevent any illegality of the ABC structure endangering the underpin itself.

Assessing the scheme’s risk profile

TPR is concerned that an ABC can make it appear as if the scheme has more assets than it does and is therefore less dependent on the sponsor than is actually the case.

For this reason, it considers trustees should “unpack” the ABC arrangement and clearly identify the extent to which the value attributed to the ABC in the scheme’s accounts is reliant on payments being made in the future, as well as assessing the likelihood that those payments will be made in relevant scenarios. Trustees should carefully consider whether any reliance should be placed on those future payments.

Reporting

TPR expects trustees to explain a decision to enter into an ABC to scheme members “in the next available communication”. This communication should be clear about the funding implications, the extent to which the scheme remains reliant on the sponsor/group, and why this arrangement benefits the scheme.

Trustees must also report any investment in an ABC to TPR.

TPR’s approach

TPR does not approve or advise on ABCs. However, where appropriate, it will challenge a decision by trustees to enter into an ABC and, if it has concerns about an arrangement, may even look to its regulatory powers.

When considering an actuarial valuation, TPR will evaluate any ABC arrangement and trustees should be able to “clearly demonstrate” why they were satisfied it was the right option for their scheme.

What is the aim of the guidance?

TPR recognises that ABC arrangements can help employers to meet their funding obligations and may improve a scheme’s security. However, it is keen to ensure that trustees fully understand the risks, costs, and complexity involved, and obtain appropriate advice so that they can make an informed decision.