BT’s defined benefit scheme has seen its accounting deficit drop by £1.8bn over the past quarter after investing in the bonds of its own sponsor, but some experts have questioned whether the move has any meaningful impact on member security.
The telecoms giant issued £2bn of sterling-denominated long-dated bonds to the BT Pension Scheme in May via its €20bn Euro Medium Term Note Programme, with maturities between 2033 and 2042. Half of the bonds are index-linked.
As a result, a trading update on Friday revealed that the scheme’s accounting deficit dropped to £4.6bn gross of tax, almost entirely driven by the new assets given to the scheme. Its actuarial deficit is likely to be much larger, having been measured at £11.3bn as at June 30 last year.
BTPS remains an unsecured creditor to BT whether or not it holds its bonds
John Ralfe, independent consultant
The company has also promised cash funding for the scheme, and is due to pay in £1.25bn over the next 12 months.
SLP avoids self-investment regs
The structure of the deal has avoided strict controls on scheme investment in a sponsoring employer, brought in by the Pensions Act 1995 in response to the Maxwell scandal.
No more than 5 per cent of a scheme’s assets may be invested in the sponsoring employer, and investment in “an employer-related loan” is expressly prohibited. Bonds share many features of loans but also have key differences - for example, the BTPS may choose to sell some of its holdings in its sponsor on the open market.
John Ralfe, an independent pensions consultant, said: "The Pensions Act 1995 prohibits schemes making employer-related loans. It isn't clear how BTPS has managed to square this circle."
In fact, the bonds are held for the scheme in a Scottish Limited Partnership to avoid being classed as self-investment, and also amount to around 4 per cent of the scheme’s assets.
Guidance from the Pensions Regulator explains that scenarios most likely to breach employer-related investment rules are those where the loan is made from existing scheme assets, unlike BT's bond gift.
The regulator's approach to ERI used as a funding mechanism also takes into account the impact on member security, and the level of traditional cash funding ued alongside the employer asset.
The bond issuance has improved BT’s deficit as disclosed under IAS19, although this may be of as little pertinence to investors in the telecoms company as it is to scheme members.
“It would be the funding deficit that analysts pay attention to, “said Hargeaves Lansdown senior analyst Laith Khalaf, calling the accounting deficit “a fairly fanciful figure” that “tells you more about bond yields” than the scheme’s true health.
He said it was unclear whether the move was positive for shareholders, as the company’s pension debt could be argued to have been alleviated solely by increasing the group’s cash debt.
Are members better off?
It is also unclear whether the scheme’s new assets represent any meaningful improvement in security for the 297,454 members of the BTPS (as at the end of June last year).
Both the bonds issued to the scheme and the scheme’s claim on BT’s assets under an insolvency scenario, known as a section 75 debt, are unsecured claims.
Ralfe called the move a “sleight of hand” that has no impact on the security of members’ pensions.
“BTPS remains an unsecured creditor to BT whether or not it holds its bonds,” he said. “BT should sell the bonds publicly and inject the £2bn proceeds into BTPS to genuinely reduce the deficit."
The pension scheme has confirmed that it will sell no more than £600m of the bonds in aggregate, and the trustee has previously called the assets a “valuable investment opportunity”.
BT has also pledged a number of protections for its scheme’s funding level, including promising to make additional payments to the scheme if annual dividends and share buybacks exceed 10 per cent and £200m respectively.
No more than £1.5bn of claims will be granted seniority to the pension scheme unless the deficit drops below £2bn at a triennial valuation.
Do not write off alternative funding
Donald Fleming, a restructuring advisory partner at professional services firm RSM and chair of the Employer Covenant Working Group, said it was not possible to gauge whether the scheme will benefit without doing a complicated estimated outcome analysis.
He said the move highlighted the importance of trustees employing integrated risk management, given the potential for “a concentration of risk through the covenant”.
However, he added that trustees should not necessarily reject such proposals from employers.
“Cash is always the best thing but in the real world it might not be achievable,” he said. “Trustees should be willing to engage on properly thought out proposals. But they do need, with their advisers, to assess what these things mean, and from a risk perspective how do these change the balance of risks in the scheme.”
WTW slip impacts accounts
BT’s trading update also announced that its improved funding ratio had also been offset by the correction of a £500m calculation error made by its actuary, Willis Towers Watson.
“We have received certified assurance from the actuary that their quantification of their error is accurate and that there are no other errors as at 31 March 2018,” the trading update read. “The correction, which amounts to less than 1% of the total pension liabilities of just over £57bn, has no effect on... the 2017 triennial funding valuation of the BT Pension Scheme, associated cash contributions or pension scheme members.”
