BVCA and Pensions Regulator hash out the issues

The chief executive of the British Private Equity and Venture Capital Association (BVCA), Simon Walker, last week met with David Norgrove, the chairman of the Pensions Regulator, to discuss some of the recent changes to the Regulator’s powers that were announced in April. The major takeaway from the meeting: private equity funds in the UK should start thinking about pension issues earlier, as uncertainty regarding the current scope of regulatory powers is causing a slowdown in the investment process.

A recent survey by the European Private Equity and Venture Capital Association (EVCA) showed that around a quarter of private equity funds raised in 2008 came from pension schemes. As many companies are dealing with large pension deficits, firms are warier of investing in businesses with defined pension benefit schemes in place, especially in the UK where the Pensions Regulator is tasked with policing pension schemes and their beneficiaries.

Since it was established in 2005, the Regulator has been given the ability to investigate pension schemes and employers and issue warnings or fines – also known as “contribution notices” – in order to minimise the likelihood of schemes going into deficit and requiring some form of compensation under the Pensions Protection Fund (PPF), said Wyn Derbyshire, a partner in the employment and pension group of SJ Berwin. Its new powers include an increased ability to issue contribution notices in the event that a materially detrimental effect has occurred on a scheme’s ability to provide benefits, and a longer time period during which the Regulator may consider whether to issue an order for employers or connected parties to put in place financial support for underfunded schemes.

During the meeting, Norgrove said the changes were designed to keep businesses from circumventing the protections provided for defined benefit pension schemes, including instances where a scheme is separated from its sponsor employer or an employer improperly seeks to profit from the scheme itself. However, as the possibility of resulting penalties can prove unsettling when planning transactions, Derbyshire says the Regulator has also put in place a “clearance” process.

“Clearance is essentially a process under a situation in which you engage the Pensions Regulator and say ‘this is what we are planning, can you tell us whether what we are planning to do would trigger a contribution notice or a financial support direction (similar in some ways to contribution notices)?’,” he said. “It is a voluntary process but if when planning a transaction you suspect there may be an aspect or aspects that might lead the Regulator to issue a contribution notice or a financial support direction, you would usually give at least some thought to the desirability of seeking clearance.”

But although Norgrove stated that “those who play by the rules … have nothing to fear from the new powers”, there remains uncertainty about their scope and practical application. “Where there are concerns would be, for example, the legislation still has one or two areas where the wording is not clear,” Derbyshire said. “For example, the Regulator was given very wide-ranging powers to interpret the legislation. So for example, financial support directions are issued when it is “reasonable” to do so, so a lot of it goes down to the judgment of the Regulator.”

Continued uncertainty over when a transaction may or may not be caught up in the Regulator’s powers could leave deals vulnerable to attack for up to 24 months, while funds may reject more complex investment structures that could come with pension concerns. The investment process may also slow as managers seek clearance to assure themselves that they will not get in trouble later, which is why, Derbyshire says, they need to start early on their pensions due diligence.

“When you go for clearance, the Regulator is not going to roll over and say that is all right,” he said. “He will sometimes say the pension scheme is going to be worse off, perhaps because there is a debt restructuring or something similar related to the transaction, and he will look for mitigation designed to address the financial damage caused by the event in question. That usually involves some sort of cash payment or variation in funding plan or some sort of guarantee in favour of the pension scheme. That means when planning a transaction all sorts of these variables need to be thought about early on because it can take some time to nail all these things down.”