Soaring pension fund liabilities hurting cash flow at U.K. corporations
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August 23, 2016 01:00 AM

Soaring pension fund liabilities hurting cash flow at U.K. corporations

Sophie Baker
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    U.K. corporations are facing a “cash flow drain” as the post-Brexit interest rate cut and additional quantitative easing is set to inflate pension fund liabilities, warned Fitch Ratings.

    The U.K.’s vote to leave the European Union, decided in a referendum June 23, led to a cut in U.K. interest rates by the Bank of England to 0.25%, from 0.5%. The central bank also announced additional quantitative easing in the form of corporate bond purchases.

    These measures are expected to inflate liabilities for U.K. companies with defined benefit plans, and “any substantial increase in pension contributions to plug such shortfalls could create a cash flow drain for U.K. corporates,” said Fitch in a news release Tuesday. However, Fitch added that “rising liabilities and deficits will start to go into reverse as the real interest rate rises in the longer term.” Fitch said there is a strong chance the real interest rate will rise over the medium to long term as monetary policy “eventually” normalizes.

    The ratings agency expects pension fund deficits to deteriorate further this year, as monetary policy changes hit yields on high-quality corporate bonds — which are used to determine the U.K. pension fund discount rate. “A declining discount rate generally inflates defined benefit schemes’ liabilities and assets, but liabilities are more sensitive due to the longer duration of pension payments,” said Fitch.

    The Pensions Regulator’s stance will also be important for trustees of pension funds once the U.K. enters Brexit negotiations. “To date this has been a long way from the unambiguous message of forbearance many corporates could have hoped for. The regulator has indicated it wants trustees and sponsors to focus on the longer term, but also to assess how the referendum result will affect employer covenants in the event of deteriorating business prospects,” said Fitch.

    In the same release, Fitch cited the government’s Work and Pensions Committee, which has launched a consultation looking at DB funds. Considerations include the balance between meeting pension fund obligations and ensuring the viability of the employers that sponsor these funds. “We believe this is likely to be reflected in tighter rules on pre-clearing M&A rather than a blanket tightening of funding requirements. The cash impact on corporates will also be affected by the three-year timetable for most funding reviews,” noted Fitch. While this move will limit the immediate impact of widening liabilities, it may also delay benefits from future improvements, Fitch warned.

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