Post on 11-Jun-2015
Redington13-15 Mallow StreetLondon EC1Y 8RD
T. 020 7250 3331www.redington.co.uk
Non-cash funding solutions
Jeremy Lee – RedingtonNobby Clark – HSBC Pensions Solutions Group
25 November 2010
Agenda
1. What’s the alternative?
2. A brief history
3. Recent transactions
4. Issues to consider
5. HSBC case study
6. Looking ahead
7. Questions
3
What’s the alternative?
Contingent assets
• Guarantees
• Security
• Escrow
• Letters of Credit
Business assets
• Direct transfer
Asset-backed
• Priority of cashflows
• Security over assets
Cash
Common features of recent asset-backed structures
Corporate
Pension scheme
SPV
• Income generating• Unencumbered• Tax deduction – via
pension scheme?
1. Corporate places asset in SPV
• Typically “rent”• Market rates
2. Income from asset received by SPV
• Share of profits and interest in SPV
• Fixed period• Multiple coverage by “rent”• Not direct pass through
3. Scheme’s interest pays income
• Valuation -ongoing/distress
• Covenant assessment• Shortfall at end
4. Scheme also has security over [some] assets in the SPV
Note: This is intended as an overview only. Individual objectives and circumstances will alter the structuring.
4
Non-cash funding – a brief history
20102008200620042002
Sponsors fear trapped surplus
Smarter use of balance sheet
TPR/PPF brings focus on contingent assets
Letters of credit(National Grid)
Corporate guarantee
Sponsor affordability tested
Escrow (Marconi)
Banks develop products
LP/trust structures (M&S, Sainsbury’s,
Diageo)
Super-security(KKR/Boots)
Leveraged transactions
Accelerated cash(Somerfield) Business assets
(John Lewis, Uniq?)
Insurance vehicles
Mar
ket
dri
vers
Po
pu
lar
solu
tio
ns
5
0
200
400
600
800
1000
12002
00
7
20
08
Jun
09
Jul 0
9
Au
g 0
9
Sep
09
Oct
09
No
v 0
9
Dec
09
Jan
10
Feb
10
Mar
10
Ap
r 1
0
May
10
Jun
10
Jul 1
0
Au
g 1
0
Sep
10
Oct
10
No
v 1
0
Val
ue
of
tran
sact
ion
(£
in m
illio
ns)
Asset backed Business asset
Un
iq?
Recent activity using asset-backed structures and business assets
6
Source: Annual Reports, press releasesNote: Tesco has raised funds via sale and leaseback of properties through a 50:50 JV with the pension schemeUniq is subject to review by The Pensions Regulator
£1,760m
M&
S 1
M&
S 2
GK
N
Llo
yds
Joh
n L
ewis IT
V
M&
S 3
J Sa
insb
ury
Dia
geo
Wh
itb
read
HSB
C
Ph
ilip
s
Un
iq?
Co
stai
n
Inte
rser
ve
Joh
n L
ewis
Tesc
o 1
Tesc
o 2
Tesc
o 3
Travis Perkins
7
Issues to consider
Key issues to consider
Funding deficit reduction
Impact on recovery plan
Greater security
Corporate accounting treatment
Managing future surplus
Asset concentration / Employer-related investments
Support investment strategy
Unrecognised value?
Asset valuation – ongoing/distress
Tax treatment
Trustee education / Complexity
Legal advice
M&S: Because there is no Plan B
Date Market value of property
Annual cash How long for? Final lump sum? NPV of cash
2007 £1.1bn £50m 15 years No £500m
2008 £400m £22m 14 years No £200m
2010 - £36m 15 years(from 2017)
Up to £350m in 2031
£300m
0
20
40
60
80
100
120
20
07
20
08
20
09
20
10
20
11
20
12
20
13
20
14
20
15
20
16
20
17
20
18
20
19
20
20
20
21
20
22
20
23
20
24
20
25
20
26
20
27
20
28
20
29
20
30
20
31
£m
Up to £350m
Source: Annual Reports, press releases8
Date Market value of property
Annual cash How long for? Final lump sum? NPV of cash
2007 £1.1bn £50m 15 years No £500m
2008 £400m £22m 14 years No £200m
Date Market value of property
Annual cash How long for? Final lump sum? NPV of cash
2007 £1.1bn £50m 15 years No £500m
Date Market value of property
Annual cash How long for? Final lump sum? NPV of cash
9
Impact on recovery plans
0 5 10 15 20 25
Average Recovery Plan
Lloyds
ITV
Whitbread
Diageo
GKN
J Sainsbury
Travis Perkins
John Lewis
M&S
Years
Comparing the length of the payment schedules
Source: Annual Reports, press releases, TPR Recovery Plan analysisNote: Payment schedules are for the asset-backed payments only
10
Greater security
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
Lloyds Whitbread GKN John Lewis M&S J Sainsbury Diageo
Value of pension scheme interest as proportion of total assets in structure
Source: Annual Reports, press releasesNote: Asset-backed structures only and where sufficient information is available
11
Reducing the IAS 19 deficit
Company IAS 19 Plan Asset?
M&S Y
Lloyds Y
John Lewis N
GKN Y
Whitbread N
ITV N
J Sainsbury Y
Diageo N/K
Travis Perkins Y
Source: Annual Reports, press releasesNotes: Asset-backed structures only
12
Managing future surpluses
Company Ability to manage surplus
M&S Final payment up to £350m
Lloyds No
John Lewis Final payment between £0.5m and £99.5m
GKN Future surplus can be used to offset service cost
Whitbread Final payment up to £110m
ITV Final payment up to £150m
J Sainsbury Final payment up to £600m
Diageo Final payment up to £430m
Travis Perkins No
Source: Annual Reports, press releasesNotes: Asset-backed structures only
0% 5% 10% 15% 20% 25% 30% 35% 40% 45% 50%
Uniq?
Tesco
Philips
Interserve
HSBC
John Lewis
Costain
M&S
GKN
J Sainsbury
Whitbread
Diageo
Travis Perkins
ITV
John Lewis
Lloyds
Value of structure as proportion of total scheme assets
13
Asset concentration
Asset-backed structures
Business assets
Source: Annual Reports, press releasesNotes: For Tesco, we have assumed 50% of the MV of properties placed into the JV, although it is not clear what the value isUniq is subject to review by The Pensions Regulator
14
Issues to consider
Key issues to consider
Funding deficit reduction
Impact on recovery plan
Greater security
Corporate accounting treatment
Managing future surplus
Asset concentration / Employer-related investments
Support investment strategy
Unrecognised value?
Asset valuation – ongoing/distress
Tax treatment
Trustee education / Complexity
Legal advice
Key issues to consider
Funding deficit reduction
Impact on recovery plan
Greater security
Corporate accounting treatment
Managing future surplus
Asset concentration / Employer-related investments
Support investment strategy
Unrecognised value?
Asset valuation – ongoing/distress
Tax treatment
Trustee education / Complexity
Legal advice
15
Global Banking and Markets
Alternatives to Cash Funding HSBC Case Study
Nobby Clark – November 2010
16
HSBC Bank (UK) Pension SchemeHSBC’s track record in managing risk
HSBC has been actively engaged with its defined benefit pension schemes on risk management since 2004
As a regulated financial, we were able to make a direct comparison between the risks being run within the HSBC Bank
(UK) Pension Scheme and within HSBC Global Markets
– Pension Scheme was running approx 3 times as much risk as the Trading Books
– Trading books had 400 traders with position limits / stop loss limits and management oversight and intervention
– Historically, Pension Scheme Trustees met quarterly and the interface with the Sponsor was primarily handled by HR
Senior management decided that, although capital treatment and disclosure may vary between Pension Scheme and
Bank it did not want to take risk in the Pension Scheme that it wouldn’t take directly on balance sheet
A strategy was developed and approved by HSBC senior management and the Trustee
The strategy was based on Group ALM Policy and involved interest rate and inflation swaps and reducing the
Schemes exposure to equities
Although exposures were thought of as direct exposures the strategy recognised the role of Trustees and their
advisers (see HSBC Annual Report)
HSBC recognised and accepted that increased contributions would be required if the strategy was implemented
HSBC risk management actions pre-dated the Basel 2 capital framework which required increased capital to be held
against pension risk
Whilst the key driver was managing economic risk the changing capital framework was expected to reward sound risk
management
17
Financial Sector Considerations - Capital
Current FSA Requirements
Pillar 1 - Funding
– A firm must deduct and IAS19 surplus from Pillar 1 capital resources, as the surplus is not available to absorb losses
– A firm must deduct either the IAS19 deficit or the Deficit Reduction Amount (DRA)
– The DRA equals the next 5 years of contributions. HSBC has generally elected the DRA for stability reasons
Pillar 2 – Risk of Increased funding
– The FSA provides Banks with guidance that it will review Bank internal calculations vs the potential increased funding requirement
at a 99.5% 1 year VaR level
Possible changes to FSA regulations
– The DRA “filter” is expected to be removed. This will increase the volatility of the capital required to support a DB Pension
Scheme. For some schemes the quantum may increase too
Observations
The pension capital regime differs from banking and trading book capital regimes
It is quite reasonable that it should differ – we have yet to see a pension scheme that manages its balance sheet
exactly like a bank does
Other supervisors differ in the filters that they allow for Pillar 1 capital, and in whether they require risk capital to be
held
Basel 3 does not require pension risk capital to be held
18
Financial Sector Considerations - Liquidity
The importance of liquidity to financial institutions – particularly banks / near banks / shadow banks – was
highlighted early on in the financial crisis
Characteristics that expose them to liquidity risks include:
– Their central role in the economy, particularly if deposit-taking
– Their high levels of leverage
– Their role in providing maturity transformation
“Liquidity regulation and supervision should be recognised as of equal importance to capital regulation”*
Global regulation is now falling into place for internationally active banks, driven by the Basel Committee:
Liquidity Coverage Ratio
– 2011 Observation, 2015 Implementation
– LCR = Value of unencumbered high quality liquid assets / cumulative cash outflow over 30 day stress period
Net Stable Funding Ratio
– 2012 Observation, 2018 Implementation
– NSFR = Available stable funding (liabilities >1Y or stable deposits) / Required stable funding
– Requires stable funding for all but the most liquid assets
– Proposals for the precise mechanism and initial calibration expected by end 2010
Pension assets do not count towards liquidity ratios
* The Turner Review, March 2009
19
HSBC Bank (UK) Pension SchemeThe 2008 funding agreement
20
HSBC Bank (UK) Pension SchemeAsset transfer summary
Process
Sponsor and Trustee agreed a conventional cash recovery plan in February 2010
The long track record of productive engagement on risk management created an environment where both parties were
prepared to commit resource to a difficult transaction that could improve both of their positions
The Bank identified assets from around the Group balance sheet that it wished to be part of the transfer
The Bank and Trustee analysed the portfolio carefully to establish suitability, market and intrinsic value
The transfer was agreed and closed in June 2010
Trustee benefits
The Trustee gained immediate increased security for members
The assets are plan assets which cannot be construed as employer-related
The Trustee benefits from the illiquidity premium that is priced into the assets, and from the Sponsor covenant
Sponsor / Bank benefits
Retained beneficial interest in illiquid assets that the Bank did not want to sell to the market
Expected asset performance should reduce the deficit faster
Pillar 1 capital improvement – offset by increase in Pillar 2 Pension Risk Capital requirement
21
Disclaimer
This document is issued by HSBC Bank plc (“HSBC”). HSBC is authorised and regulated by the Financial Services Authority (“FSA”) and is a member of the HSBC Group of companies (“HSBC Group”).
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DISCPRES011107
Looking ahead
22
Property Machinery Inventory
Debtor books Brands Intra-group loans
PFI contracts Intellectual PropertyOther intangible
assets
Disclaimer For professional investors only. Not suitable for private customers.
The information herein was obtained from various sources. We do not guarantee every aspect of its accuracy. The information is for your private information and is for discussion purposes only. A variety ofmarket factors and assumptions may affect this analysis, and this analysis does not reflect all possible loss scenarios. There is no certainty that the parameters and assumptions used in this analysis can beduplicated with actual trades. Any historical exchange rates, interest rates or other reference rates or prices which appear above are not necessarily indicative of future exchange rates, interest rates, or otherreference rates or prices. Neither the information, recommendations or opinions expressed herein constitutes an offer to buy or sell any securities, futures, options, or investment products on your behalf.Unless otherwise stated, any pricing information in this message is indicative only, is subject to change and is not an offer to transact. Where relevant, the price quoted is exclusive of tax and delivery costs.Any reference to the terms of executed transactions should be treated as preliminary and subject to further due diligence .
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Telephone: +44 (0) 20 7250 3331Redington
13-15 Mallow Street
London EC1Y 8RD
Jeremy Lee FIA
Vice President | Investment Consulting
jeremy.lee@redington.co.uk
www.redington.co.uk
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