Mind the pensions gap

In light of Duke Street’s recent run in with the UK Pensions Regulator, buyout firms face the prospect of being forced to make up pension shortfalls, write Richard Garvan and Andrew Patten.

The UK’s Pensions Regulator has shown a new-found willingness to use its powers by forcing Duke Street Capital to pay £8 million (€10.4 million; $14 million) into the Focus DIY pension fund. This is despite the fact Duke Street sold its interest in the business to Cerberus Capital Management almost a year ago.

While details have not been made public, the settlement appears to have been in response to a threat by the Regulator to issue a Financial Support Direction (FSD). The Regulator can look back at actions over 12 months for FSDs, which it can use to require a company to put financial support in place for its pension scheme (for example, a parent company guarantee).   An FSD can be issued if there is a single person who can make up the difference between a company’s resources and 50 cent of its share of its pension scheme’s buyout deficit. 


In this case, the payment to the scheme was probably linked to the 2005 sale by Focus of the Wickes group, which was followed by a significant return of capital to shareholders (including Duke Street) and a highly leveraged refinancing. Focus’ financial position subsequently deteriorated and the deficit of its scheme increased from £26 million to around £32 million. In 2007 it was sold to Cerberus for £1.

The Regulator’s apparent change in approach is a reaction to what the government sees as new ways in which companies may try to cut under-funded pension schemes adrift, leaving the Pensions Protection Fund to pick up the shortfall. Of particular concern are situations which reduce the asset base of the pension scheme’s sponsor company and business models where a pension scheme is run for profit using a high-risk investment strategy.

Factors which may have attracted the regulator’s interest to Focus are: the sale of a major part of the business, the return to investors and the refinancing; the weakened covenant of the sponsor company, as shown by Focus’ eventual sale to Cerberus; and lack of clearance from the Regulator (although the sale and refinancing may have been too early for Duke Street to apply).

The first two issues are not unique to Focus and a sale is not a factor needed for issue of an FSD. If highly geared companies start to struggle in a downturn, the Regulator may well be able – and now willing – to intervene. As a result, companies and major shareholders will need to give greater consideration to the effect that transactions have on a company’s strength and its ability to support its  pension schemes. Potential investors and purchasers will also need to check more carefully that nothing has been done to the detriment of schemes in previous years. Failure to do this will potentially increase the risk of intervention by the Regulator.

The Regulator’s powers are being widened to give it scope to take into account wider group assets when imposing FSDs. Despite government assertions to the contrary, this strengthens the case for seeking clearance that the Regulator will not impose an FSD because of action to be taken by a company. A significant consideration for the Regulator is whether a scheme’s trustees approved the transaction in question, so early engagement with trustees will also be increasingly important.

In the present economy the Regulator is likely to have hard decisions to make between not stifling the business activities of companies and investors and using its enhanced powers to ensure sufficient protection for pension scheme members. Only time will tell how the Regulator will use its extended powers and the effect these will have on business and investment activities.

Richard Garvan is a banking & finance partner and Andrew Patten a pensions partner at law firm Denton Wilde Sapte.