Employers are increasingly using reservoir trusts to increase the funding and security of defined benefit schemes, in a desire for less complicated asset-backed structures in light of recent regulatory scrutiny.
The recent rise in popularity of asset-backed funding structures has centred around the use of Scottish limited partnerships, but experts say reservoir trusts are gaining popularity due to the less complex nature of the arrangement.
The prediction is that they’ll be looked at increasingly, due to the fear around trapped surplus
Jennifer Chambers, Burness Paull
Late last year, the Pensions Regulator released guidance on asset-backed contributions, advising trustees not to rely too heavily on the underlying asset and that the income stream should not give a "distorted view of the scheme's funding position and its overall risk profile".
The Financial Reporting Council has also warned that structures that artificially inflated solvency could be a cause for investigation.
A reservoir trust is a funding deal established between an employer and scheme, typically as part of a recovery plan. The employer places cash into the trust to be gradually paid into the scheme to improve its funding level, or to be invested on the scheme’s behalf.
The trust provides security for the scheme, which can receive the funds in the event of the company becoming insolvent. It also prevents lost surplus for the employer, which can receive the money if the scheme becomes fully funded or enters a buyout.
Jennifer Chambers, senior associate at law firm Burness Paull, said: “There has been an increased focus, they're being looked at and the prediction is that they’ll be looked at increasingly, due to the fear around trapped surplus.” This is surplus assets that cannot be transferred back to the employer.
Chambers said the trusts may be particularly appealing to financial services companies, as it would still sit on their balance sheet and ease the burden of tougher capital requirements. “We’ve had a couple of queries from the big accounting firms,” she said.
One of the appeals of reservoir trusts is simplicity. Setting up an SLP can be a complicated process compared with setting up a trust, said Stuart O’Brien, partner at law firm Sackers.
An SLP is typically used to house a company asset, and to get around the limit on how much a pension fund can invest in its sponsor. “A reservoir trust is just money put in then invested… it’s used as a way of funding the pension scheme using conventional assets,” said O'Brien.
O’Brien reported that one of his clients had already implemented a reservoir trust and another was examining the possibility.
But despite the rising interest in trusts, SLPs still account for the vast majority of asset-backed funding arrangements. “The aim is broadly the same – to improve the funding of the scheme without trapping cash inside,” said Alan Collins, director at consultancy Spence & Partners.
The use of asset-backed funding structures has grown considerably in the past few years. A survey this year by consultancy KPMG found 23 new asset-backed contributions had been announced in 2013, compared with seven the year before.
