Could the 2021 “dividend bubble” be about to burst?

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After dividend levels were depressed during the Pandemic, the first half of 2021 has seen a recovery in payouts, with some high profile firms announcing large dividends in recent months. Whereas dividends paid by FTSE 100 companies dropped from around £110bn in 2019 to just over £70bn in 2020, announcements so far in 2021 suggest much of that fall could be recovered this year. And there have been similar positive noises from companies outside of the FTSE100 regarding the level of proposed dividend payouts.

However, analysis by consultants LCP suggests that the pace of recovery in dividends could be slowed as a result of increased powers for the Pensions Regulator (‘TPR’) which are due to come in to force from 1st October 2021.

These will take TPR’s benchmarking of shareholder dividends (and other forms of ‘covenant leakage’, including executive remuneration) to a new level for corporates which sponsor DB pension schemes. This will impact all sponsors of DB schemes, not just the largest FTSE 100 blue chips whose dividend announcements make it into the news around this time of year.

The new powers for TPR have come about as a result of the Pension Schemes Act 2021, which was designed to strengthen the rules around the funding of company pension schemes in the wake of high profile cases such as BHS and Carillion. 

Under the new rules, company directors and others involved could face a legal challenge if a dividend payment leads to a ‘material reduction’ in the recovery that a DB pension scheme can expect to get in the event of a hypothetical insolvency. 

According to LCP, where directors of companies with a DB scheme wish to pay dividends, and where the DB pension scheme has a deficit on the relevant measure (which most will because the relevant measure is by reference to the solvency deficit), directors will wish to analyse the impact of dividends on the DB scheme at an early stage of discussions. This will be relevant for all corporates which sponsor DB pension schemes, not just the largest FTSE 100 blue chips. And is relevant for intra group and special dividends, as well as ongoing ‘regular’ dividends paid out to investors.

Such an approach demonstrates that the DB pension scheme was considered as part of the directors’ decision making (should TPR come knocking in the future) and also sets out the basis for conclusions on whether any mitigating measures could be appropriate to manage the risk of regulatory intervention for a dividend. Such regulatory intervention could include the requirement for the sponsor, or director, to make a one-off cash payment to the Scheme (a ‘Contribution Notice’). 

There are two important features of the new law which mean that even robust employers with a pension fund surplus in their accounts cannot afford to ignore it:

  • The test applies to companies whose DB pension scheme is in deficit relative to the cost of buying out all its liabilities with an insurance company; this is a tougher measure than the deficit measure used in company accounts and can mean that a scheme which shows a surplus in the accounts can still be caught by the new rules.
  • The test applies *if* the company were to go bust, and is not based on the likelihood of this happening; if a dividend makes it less likely that a deficit would be covered *if* the company went bust, then action could still be taken even if the company was widely regarded as being in good health.

Whilst firms with a DB scheme deficit will not be banned from paying substantial dividends, they may in some cases be expected to take other mitigating measures to provide security to the pension scheme (such as giving the pension scheme priority claim on certain company assets). Alternatively they may decide to pay a lower dividend in order to avoid a ‘material’ risk to the pension scheme’s position, and to manage the risk of regulatory intervention.

Finally, it is worth noting that the impact of the new powers for the Regulator extends beyond companies’ dividend policies and all company boards will now have to document how they considered the pension scheme impact across a wide range of corporate decisions (including refinancing and Group restructuring).

Commenting, Laura Amin, principal at LCP said:

“Government and regulators are keen to avoid a repeat of scenarios where a company goes bust leaving a hole in the pension scheme after a period when large dividends have been paid to shareholders. The new powers for The Pensions Regulator (‘TPR’) will raise the bar on TPR’s benchmarking of dividends and may lead to more frequent regulatory intervention. We expect the new powers to generate much debate in the early days of these new TPR powers coming into force from 1 October this year and it may be challenging for company directors to understand where the new boundaries lie. At the very least, company boards will have to think much more carefully when setting their dividends about the impact on the position of their pension scheme, whilst schemes will be in a stronger position to press for greater security if a large dividend payment goes ahead. It’s important to note that the impact of the new powers for the Regulator extends beyond dividend policy and all company boards will now have to document how they considered the pension scheme impact across a wide range of corporate decisions (including refinancing and Group restructuring)”

New TPR powers: what do you need to do now?

New TPR powers: what do you need to do now?

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