Royal Bank of Scotland (RBS) has signed an agreement to inject up to £3.5bn into its main defined benefit (DB) pension scheme, in preparation for ring-fencing legislation.
The bank said on Tuesday that it had agreed with the trustees of the main section of the Royal Bank of Scotland Group Pension Fund (the main scheme) to make a £2bn contribution in the second half of the year, with further contributions of up to £1.5bn tied to any dividend payments or share buybacks to follow after 2020.
In addition, the trustee will take on a lower risk long-term investment strategy by reducing exposure to quoted equity, while increasing its exposure to assets with more certainty over cashflows. The extra funding is expected to compensate the trustee for any associated loss of employer covenant, due to the new requirements and restrictions of the ring-fencing legislation.
The bank's chief financial officer Ewan Stevenson said the deal was an important milestone for the bank's shareholders towards the resumption of capital distributions. "With these proposed payments, together with the one-off contribution into the fund in the first quarter of 2016, we will have substantially addressed the historical funding weakness that existed in the fund and brought clarity to future funding arrangements", he said.
From 1 January 2019, UK banks will need to segregate their retail business from their investment business, to prevent another financial crisis. This will demand significant changes to the structure of RBS's existing DB pension schemes, because from 2026 it will not be possible for any of the entities inside the ring-fence to participate in the same DB pension scheme as entities outside the ring-fence. The bank said it is developing a strategy for this, which will require the agreement of the trustees.
The trustee estimates as at 30 June 2017 the main scheme had a surplus of £1.7bn under the technical provisions assumptions agreed for the 31 December 2015 triennial valuation. However, a 25 basis point reduction in the technical provisions discount rate would reduce the surplus position by around £2.4bn. The scheme's next valuation is 31 December 2018.
Commenting on the announcement, Lincoln Pensions managing director Richard Farr said: "This is another pertinent example of pensions obligations taking their rightful priority in the allocation of employer cash resources.
"The key question will be how appropriate is the payment to the actual deficit and risk the scheme is running compared to the dividend yield being demanded by the market."
The bank operates several DB schemes; at the end of 2017, all the schemes reported a total funding surplus of £263m, compared to a £87m funding deficit in 2016, on an actuarial basis.
The five largest schemes, which represent around 98% of RBS's pension liabilities are: the main scheme, the AA section of The Royal Bank of Scotland Group Pension Fund, the Ulster Bank Pension Scheme, the Ulster Bank Pension Scheme, and the Royal Bank of Scotland International Pension Trust.
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