Introduction
Non cash asset pension scheme funding is an increasing popular pension management strategy, whether held as security by trustees as a contingent payment or paid directly into the scheme. According to PWC, a fifth of the FTSE 100 are now using noncash assets and £8bn of the total £20bn pension fund contributions made last year, or 40%, were from such assets. Special purpose vehicles form an integral part of this as the assets, or rights to the assets, must be transferred to a separate vehicle over which the pension fund has ownership or control rights. The structure of the special purpose vehicles, alongside the asset valuation and necessary contracts and accounting requirements, is therefore a key component requiring specialist knowledge and advice.

Examples
Tangible assets such as property were initially most commonly used. In 2009, Sainsbury’s contributed £750m of property assets to its underfunded pension scheme. In 2010 Marks & Spencer's contributed £300m of property assets to its scheme and John Lewis £95m to its scheme.

Other assets have also been used; ITV used part of its digital channel operator SDN and Diageo contributed £500m of whisky stock to its scheme. In 2009 Interserve used 13 public finance investment (PFI) contracts worth £61.5m as contingent assets to help reduce its £250m pension deficit. John Lewis contributed its 29% share holding in Ocado, and engineering firm GKN contributed a mix of assets valued at £331m including its trademark.

Intangible assets such as contracts, trademarks, copyright and patents are more and more being seen as an attractive option for both companies and trustees. They are often a company’s most important and valuable asset, they can be separated relatively easily, they can be valued reliably, there is an active market for them, they are less likely to be encumbered with existing loan facilities and therefore are often an unleveraged asset.

Motivation
There are several reasons why companies and trustees are turning to contingent asset financing. The biggest motivation is that pension deficits have never been bigger due to a fall in asset values and rise in liabilities. Meeting increased cash contribution requirements impacts cash flow significantly. Contributing assets in temporary lieu of cash helps maintain the company’s liquidity whilst still enabling the pension fund to meet its ongoing obligations.

Another reason is to prevent overpayment. As pension fund deficits are arguably artificially high, meeting the current cash contributions may result in the scheme being overfunded when normal economic conditions return. It is possible to extract assets from a pension fund if structured properly but can be difficult to extract cash surpluses. Using SPVS in this way therefore helps preserve unnecessary cash payments. This was the motivation for Diageo’s scheme which would have been at risk of having a pension surplus. Contributing whisky stock prevents locking up unnecessary amounts of cash in the pension fund.

Companies whose pension funds are not in deficit are also being attracted to contributing tangible and intangible assets as it is an effective way of preserving cash as well having creating tax benefits through efficiently set up SPV structures.

Structure/solution/SPV
The basic premise is for the intangible assets to be valued and transferred to an SPV which the pension fund has rights over in event of default. The company then pays a royalty to continue to use the asset – like in a license agreement. The pension fund deficit is reduced by the value of the assets and so the annual cash contributions are lowered.

Off-shoring IP in SPVs is nothing new, having been used by many companies for years to improve operational and tax efficiencies. The same principles exist for transferring IP to SPVs for pension scheme management purposes.

Several structures currently exist. Scottish LLPs are often seen as the most attractive structure to house the assets because SLPs have a separate corporate identity separate from the company thereby avoiding classification as a collective investment scheme. This also enables the company to receive an accelerated tax benefit from contributing the value of the asset which would be significantly more than the usual cash contribution. If the asset is valued at several hundred million pounds – as in many of the examples above – then this can be a considerable tax benefit and one that is only possible if the correct SPV and structure is implemented.

Another way of structuring the SPV arrangement is to have two SPVs. The corporate pays the royalty to the LLP 1 and a guaranteed profit share similar to a bond coupon is paid to the scheme often leaving headroom between the underlying value of the royalty/brand and the coupon. This provides additional security to the pension scheme and trustees.
 
The circumstances of each company are different and therefore require a unique approach and use of SPVs. As these schemes are still relatively new there are many opportunities to establish different models, utilising the different benefits of SPV options.

Benefits
There are many benefits of these schemes to both the corporate and trustees. These advantages need to be considered when arranging the SPVs to ensure the benefits can be realised.

For corporates and trustees there is an immediate reduction in the pension deficit. This can have a positive impact on the share price and improve the company’s borrowing facility. As cash contributions are reduced, cash flow can improve significantly as deficit payments are spread over a longer period and ongoing contributions are lowered. There is an acceleration of corporation tax relief due to the payment of the lump sum value of the asset being transferred. As the deficit is reduced there is also a lowering of the Pension Protection Fund (PPF) contributions which can be high for companies with large deficits. There can also be commercial benefits as the company is now forced to pay to use an asset it was historically using for free. Additionally, using intangible assets takes advantage of a previously unleveraged asset which is an efficient use of the company’s resources.

There are also many benefits to trustees of pension schemes. Having ownership or control rights over the intangible assets in the SPV greatly increases their security in event of default. If the company goes into administration, whereas previously it would have been left with nothing, now the pension fund owns a valuable asset which it can sell. There is added protection as the value at which the intangible asset was transferred to the SPV would have been at a significant discount to its going concern market value. This is the same principle the banks lend against and provides an additional level of security to the pension scheme. The value of the intangible asset is monitored continually to ensure its value is being maintained. Arrangements can also be put in place to alter the terms of the deal should certain warning signals be triggered.

Another benefit to the trustees is that it leaves the sponsor company in a much healthier situation, more likely to be able to fulfil its ongoing obligations. There is, however, a balancing act to consider between owning or having rights over an asset whilst sacrificing cash contributions in the short term. The cash funding requirements of the scheme have to be fully considered.

To ensure value can be maintained in event of default it is important that the appropriate mix of intangible assets is bundled together. For instance, a fashion label’s trademark may be extremely valuable and marketable just by itself, but with supply contracts, distribution agreements, design copyright, customer databases, access to the archive and relevant domain names, it becomes much more valuable. Bundling these intangible assets together provides a greater level of security, supports a higher value and makes it easier to sell. This identification process is a critical part of the valuation.

Intangible asset suitability is not just confined to consumer facing lifestyle brands, as GKN demonstrated by using its trademark. Most organisations rely on intangible assets, whether these are software, domain names, patents, database, trademarks, copyright, technology or contracts. These can all be valued reliably, there is an active market for them and can be separated for transfer into the SPV.

Conclusion
SPVs play a pivotal role in contingent asset pension scheme funding. And even more so with intellectual property as it can be moved into different vehicles and jurisdictions relatively simply. With the extent of company pension deficits exceeding £50bn from the FTSE 100 alone and noncash funding forecast to increase from £8bn to £10bn next year, according to PWC, schemes such as these will prove an increasingly popular pension and asset management strategy.

Stuart Whitwell, joint managing director of Intangible Business, the brand valuation consultancy. www.intangiblebusiness.com