Plugging the gaps

At a time when borrowing continues to be difficult and many businesses seem to have reached the limit on the amount of hard assets that are already pledged as security to banks, the last year or so has seen more companies turning to innovative funding solutions aimed at tackling their pension deficits.

Controlling pension scheme deficits continues to be a major challenge for UK companies. Traditionally, companies have sought to reduce their deficits by using straightforward cash contributions and/or contingent asset arrangements to fund their schemes. But over the last few years companies have pledged a widening variety of assets to their pension schemes, such as real estate and other tangible assets to their schemes in order to conserve cash. Examples include:

• Marks and Spencer transferred real estate worth approximately £1.1bn in three separate tranches: 2007, 2008 and 2010.
• John Lewis transferred real estate worth some £150m with trustees receiving an income stream over 21 years followed by a final one-off payment of between £0.5m and £99m, depending on the scheme's funding level at the time.
• Sainsbury's transferred real estate worth some £750m with trustees receiving an income stream over 20 years followed by a final one-off payment to remove any remaining deficit up to a maximum of £600m.
• Whitbread transferred real estate and other assets worth some £228m with the trustees receiving an income stream over 15 years followed by a bullet payment to remove any remaining deficit up to a maximum of £110m.
• Travis Perkins transferred 16 freehold properties with the trustees receiving an income stream over a period of 20 years.

The UK Pensions Regulator now accepts less traditional assets as being suitable for pension fund investment: PFI contracts (Interserve), loan notes (Lloyds), shares in a broadcasting subsidiary (ITV) and in one case even barrels of whisky (Diageo) have been used to back innovative funding solutions.

However, with an increasingly large proportion of an average UK company's value being typically made up of intangible assets, the increased pledging of a company's intellectual property to a pension scheme is inevitable.

Intellectual property means a range of legal rights including (among others) copyright, patents, trademarks, design rights, know-how, domain names and databases. Many of them are registrable. This is a huge resource, which, if tapped correctly, can help reduce spiralling pension deficits.

A company's bundle of intellectual property assets, once identified, can be readily valued. Like most assets, the valuation process will be influenced by market conditions, competition levels, potential acquirers and exit strategies, consumer behaviour and industry threats.

How does it work?

The principle is simple: a company transfers its intellectual property to a special purpose vehicle (SPV) or partnership. Typically the assets are held to act as collateral and generate royalty income (payable by the corporate sponsor). This income is used to deliver a pattern of payments over a set period (typically ten to 15 years) to the pension scheme which can be a mixture of a regular payment stream and/or lump sums. The SPV will usually be bankruptcy-remote, thus providing increased security to the trustees in the event of the insolvency of the corporate sponsor.

This structure can be to circumvent pension rules concerning employer-related investment (ERI). The general rule is that trustees must make sure that not more than five per cent of the value of scheme assets is invested in ERI. Putting in place a SPV, for instance, allows the assets or rights to be held in a separate corporate entity from the corporate sponsor and avoids breaches of the ERI restrictions under pension legislation.

Using intellectual property to plug scheme deficits can be significantly more attractive to both pension scheme trustees and corporate sponsors. The main advantages are shown in the box.

Future focus

In May this year TUI Travel, the tour operator, agreed a deal with the trustees of its pension schemes that used the value of its Thomson and First Choice brands to cut the pension fund's deficit. Similarly GKN, the multinational engineering company headquartered in Redditch, has also pledged royalty income from the use of some of its trademarks to plug the deficit in its scheme.

The ball is well and truly rolling, and more and more British companies are likely to focus on their intellectual property portfolios to fund their ailing pension schemes.