Pensions have long been a challenge for dealmakers, as well as those who need to manage risks post transaction. The U.K. in particular is a market with substantial pension commitments with defined benefits (DB) obligations adding complex issues when buying or selling UK businesses.
While companies bear the financial risks, U.K. DB plans are managed by appointed trustees who have a fiduciary duty to act in members’ best interests. Oversight is provided by the U.K.’s Pensions Regulator (TPR), whose primary goal is to protect workplace pensions.
On 1 October 1, 2021, TPR gained new powers, which represent perhaps the most significant shift in pension rules applicable to M&A in the region since TPR came into existence over 15 years ago. Additional requirements are expected to follow in April 2022[1]. The changes are aimed at safeguarding benefits but introduce new considerations for both buyers and sellers of businesses with U.K. pension obligations.
Global dealmakers need to consider the impact and options at the earliest opportunity, so to avoid potentially significant financial and reputational risks.
Broadly, TPR’s new powers mean:
Ensure a robust corporate governance structure for pensions, with clear responsibilities for monitoring, identifying and responding to corporate activity, taking specialist advice as appropriate.
Don’t wait for a deal to materialise, as it may be too late. Build awareness within your management team so that those who are closest to early-stage discussions know actions are needed from outset. And maintain that awareness.
A reasonableness requirement applies to the way TPR uses all of its discretionary powers. A clear audit trail, setting out the reasons for a particular course of action, the options considered and their impact on the pension scheme will support this defence should the need arise.
TPR will take a risk-based approach. A strategic plan for identifying and managing down the risks associated with the pension plan and the level of any underfunding will support M&A readiness. Options include plan design changes, investment and insurance solutions.
Clearance is a voluntary process enabling M&A participants to get assurances from TPR that it will not use certain powers in relation to a specified event. When TPR was first set up, the number of clearance applications averaged over 220 a year. In 2019 the number had fallen to just three, as companies had become more familiar with where the boundaries sat. However, it is expected that the number will rise considerably during 2022 as dealmakers will be nervous about if and how TPR will use its new powers.
Early and transparent engagement with trustees will usually support the deal process as well as your reasonableness defence. To support early engagement, we are seeing more formal information-sharing protocols being put in place between trustees and employers. TPR supports this.
The new rules also mean trustees must be notified of certain corporate activity before a binding agreement is reached. TPR’s expectation is that this needs to be early enough for the trustees to understand, take advice and respond. The timing of when to commence this engagement will be an important consideration for sellers as well as buyers and will depend on the deal specifics.
Trustees will, of course, likely feel emboldened by TPR’s new powers when building their own arguments for additional security for the pension plan. A thought-out strategy for engaging with the pension trustees and TPR will therefore be an essential component of a successful deal.
Trustees may also be nervous about how the new powers could impact on them personally, particularly if they are relatively new to the role or are having to manage potential conflicts of interest (for example, if they also hold a decision-making role within the business). The appointment of an independent professional trustee can help to manage such concerns.
We are supporting a large number of organisations with their response to the new TPR powers and reporting requirements. We expect the response companies take will evolve over time, as more guidance is published and a clear picture of market practice emerges. However, corporate activity can happen at any time and, with the new powers effective from October 1, 2021, it is important for organisations who have (or who may acquire) U.K. pension obligations to develop their own response, to effectively manage the increased risks and ensure any future corporate activity runs smoothly. Commonly, the first step in this process is an awareness, education and planning discussion.