The Pensions Regulator (TPR) has expressed concern that a Melrose Industries takeover of GKN is likely to have a "detrimental impact" on the GKN defined benefit (DB) scheme.
In a letter to the Work and Pensions Committee (WPC), published 6 March, the watchdog's chief executive Lesley Titcomb outlined that, in any major corporate transaction, "we expect the companies involved to identify if there is potential material detriment to a pension scheme and explain how they will mitigate against that detriment."
Titcomb continued: "We would expect sufficient mitigation to be agreed with scheme trustees to ensure that a pension scheme is not placed in a worse position by any takeover."
She was responding to a letter from WPC chairman Frank Field, sent last month, which asked about TPR's assessment of the covenant impacts of GKN and Melrose's respective plans, as well as its involvement with the firm's trustees and its boards.
Titcomb added that TPR appreciated that a takeover situation like this can bring uncertainty to members of GKN's DB schemes: "The watchdog is working with trustees of these schemes to support them as they seek to secure the best possible outcome for its members in the event of a takeover."
TPR called for Melrose to put the deal through the authority's voluntary clearance system, a process which allows companies to seek the watchdog's approval ahead of corporate activity, warning: "In the absence of clearance, our anti-avoidance powers remain available for us to use in respect of any significant corporate action, if the necessary criteria are met."
The watchdog's letter also confirmed it had initiated contact with trustees of both firms of 15 January, and added it is in regular communication with the firm's by phone and by email.
A Melrose spokesperson said: "We imagine TPR will want to look carefully at the downgrade of GKN by ratings agency Moody's, which is concerned at GKN's hasty and ill-considered plans to demerge the business or sell chunks of it to overseas buyers.
"We believe our covenant will be materially stronger, even before such risky action by GKN."
PP has contacted the GKN trustees, but they have not yet responded.
Titcomb's letter was published as the Business, Energy and Industrial Strategy Committee (BEISC) held an evidence session over the proposed £7.4bn takeover, with representatives of both GKN and Melrose, including GKN group finance director Jos Sclater, and its chief executive Anne Stevens, testifying.
Speaking at the evidence hearing, Sclater defended the position of GKN's two DB schemes, which had a combined £1.1bn deficit on a gilts-flat basis as of October last year.
"The scheme went into deficit because interest rates have gone against all pension schemes, not just ours, and because there's a liability that interest rates go down and returns get worse," he said.
"Unfortunately, as investment returns have dropped, the deficit has gone up and actually because of that we've been keen to grow company because as our pension schemes have grown, we wanted to outgrow the pension scheme by growing the company; which we've done successfully.
"The good news is last year we made £680m of profit which is enough to cover contributions to pension scheme."
Melrose proposed a strategy for the GKN schemes, including a plan to sell its £1bn powder metallurgy business, but GKN's board rejected the takeover offer while the schemes' trustees warned Melrose about the pension funding position.
While the trustees originally questioned the ability of Melrose to protect the long-term interests of its members, the company's announcement to potentially split the business has raised different challenges from a covenant protection perspective.
GKN's DB pension schemes have closed both to new members and to future accrual. Collectively, they have around 32,000 members, of which 17,000 are current pensioners.
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