By Fraser Smart
In the UK a single amber light means stop if it’s possible to safely do so. Although there are many who wrongly believe it means proceed with caution.
An asset-backed contribution structure (ABC) is a contractual arrangement between the trustees of a defined benefit 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 generated by the asset for a specified period. The special purpose vehicle is for legal reasons, typically a Scottish Limited Partnership. The Pensions Regulator has seen an increase in the use of asset-backed contribution structures to fund defined benefit arrangements. Recent research suggests that 80% of ABCs were used to fund shortfalls of less than £100m during 2013.
While obviously concerned about the increased use of ABCs, the regulator has stopped short of giving them the red light. Instead, it has issued guidance to trustees and their advisers saying innovative funding mechanisms, such as ABCs, may help an employer to fund their scheme and can, in certain circumstances, improve a scheme’s security by providing access to valuable assets that were previously out of reach.
However, it is important that trustees considering investing in an ABC fully understand the risks, complexity and costs involved, and obtain appropriate advice, so that they can make an informed decision – in other words proceed with caution. The regulator defines appropriate advice as legal, actuarial, asset valuation and covenant advice. Also, it is at pains to point out that ABCs could be classed as ‘employer-related investments’ and could breach the statutory restrictions set out in the Pensions Act 1995. Although ABCs claim to exploit a loophole in the legislation, this has yet to be tested in the courts.
On the positive side there is the indication that an ABC may be appropriate if it gives the scheme access to an asset or assets, which are not currently owned by a sponsoring employer and, therefore, not already part of the company covenant. But there is a long list of reasons why an ABC may not be appropriate, for example, the costs involved, the fact that the scheme may receive lower on-going payments from an employer under a recovery plan in the absence of an ABC, and the risks that are involved should the employer or ABC fail.
The regulator makes it clear that trustees entering an ABC are expected to inform the members in the next available communication. That communication must be clear on the details and risks associated with the ABC and state why this arrangement benefits the scheme. Trustees are also expected to inform the regulator about an ABC and do not need to wait for the annual scheme return to do this. If the regulator has concerns over an ABC it will consider its full range of powers. Trustees will be expected to clearly demonstrate to the regulator how they concluded that entering an ABC was in the best interest of the scheme’s beneficiaries.
So, while ABC’s have not been given a red light, they have not been given a green one either. Does this particular amber light mean stop if it’s possible to do so safely, or proceed with caution?
Fraser Smart is managing director, Europe at Buck Consultants
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