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Corporate Finance: 2023 promises increased corporate engagement in DB schemes

‘A look ahead to 2023’ download our full report below

The events of Q4 2022 have been a timely reminder that, no matter how well funded their defined benefit (DB) pension scheme, pensions risk is still very much a risk to the business (the sponsoring employer) that sits behind it.

While it is public knowledge that some household names have had to provide emergency liquidity support, many more businesses have had to educate themselves about LDI at short notice and be on standby to prevent a fire sale of scheme assets.

Alex Beecraft, Director

Heading into 2023, as the dust settles on a turbulent period, management teams will need to take a keener interest in how trustees (and their advisors) run their DB schemes. We expect three main areas of focus:

1. Revisiting journey plans and investment strategies

While many schemes will have seen a material reduction in their liabilities due to higher interest rates, reducing LDI leverage ratios to ease collateral concerns could weigh on efforts to rely on investment returns to reach an end game.

But businesses must ensure their trustees recognise that reducing growth assets alone will not reduce risk but will re-profile it by extending the timeframe to reaching full funding. A better approach would be to choose an investment strategy that recognises the corporate
sponsor’s ability to support risk-taking (i.e. strength of its employer covenant) and to allow an end game to be reached sooner.

This could mean creating company-led liquidity facilities to free up investible capital in the scheme, while maintaining sufficient liquidity in the collateral waterfall. Reviews on
scheme journey plans and investment strategies should also include a ‘health check’ on existing LDI mandates to understand where issues arose in the recent crisis, and ensure they are fit for purpose going forwards.

2. A wider range of covenant risk solutions will come into focus

While improved funding levels could increase the scope for insurance de-risking transactions, insurer capacity may be limited by the availability of capital and people. Many schemes will also need significant preparatory work to be ‘match-fit’ for an insurance transaction.

Some may question the role of herding behaviours in the recent LDI crisis that, while intended to reduce schemespecific risks, ultimately led to a systemic market risk. This should be a check on selecting an insurance end game by default, without scrutinising the risks included and the
alternatives that are increasingly available.

Insurance may not be the right solution for all businesses, with structured ‘run on’ or ‘alternative capital solutions’ likely to gain more attention with businesses that are looking to optimise their cost/risk trade off.

3. A return in deal activity will test the new notifiable events regime

Finally, we expect the recent slowdown in activity to reverse in the new year for two main reasons. Substantial dry powder combined with a weakened Sterling will make UK assets more affordable to overseas buyers, while over-leveraged corporates may look to non-core
asset disposals to support deleveraging prompted by increased finance costs.

The Department for Work & Pensions’ new Notifiable Events regime could be immediately tested, if implemented as drafted in the recently completed consultation process. Moreover, the Pensions Regulator’s ability to gauge where its scrutiny of the covenant impact and treatment of DB schemes is most warranted and can be most constructive will be important.

At the same time, a rise in corporate distress should be expected in sectors requiring discretionary consumer spend, and those reliant on imports and/or overstretched supply chains. Here, it will be essential for all stakeholders to engage quickly and pragmatically to maximise the
value that can be recovered. As ever, early engagement with the DB scheme will be key and will allow time for exploration of consensual and/or solvent scheme outcomes, even where the business cannot continue.

Overall, 2023 promises to see a substantial increase in engagement from businesses in their DB schemes.

A look ahead to 2023

A year of reflection, consolidation and recasting strategies.

A look ahead to 2023

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