Scottish, Scotland referendum - flags on mugs, isolated on white

As the 18 September 2014 referendum on Scottish independence approaches, many of the key economic issues surrounding the move to independence are coming under increasing scrutiny.

Whilst much of the debate has centered on the cost of funding pensions in an independent Scotland, we consider the possible impact on those companies who currently operate in both countries and who make no distinction between where their workers are located.

Cross border provisions

An occupational pension scheme with members employed in an independent Scotland (assuming Scotland is successful in its bid to join the EU) will have to comply with the regulatory provisions governing cross border pension schemes.  As will a Scottish scheme with members in the remaining part of the UK.

One of the main requirements of the provisions is that cross border schemes are fully funded at all times.  As such, in the event Scotland becomes an independent state, all UK-based defined benefit pension schemes with active members employed in Scotland (and possibly deferred members – the law in this area is not clear) will need to be fully funded on an ongoing basis, meaning the sponsoring employer must ensure that the scheme has sufficient assets to cover its liabilities at all times, rather than the employer and the trustees being able to agree a recovery plan for making good any funding deficit over time.  The same would be true of a Scottish based scheme with members in the UK.

It was widely expected that the European Commission would relax these requirements, but it chose not to do so.

At a time when for many employers the cost of providing final salary pensions is proving challenging, those employers with active (or deferred) members employed in Scotland (or Scottish employers with employees elsewhere in the UK) will be increasingly concerned at the potential cost to their business of a ‘yes’ vote later this year.

Scheme funding arrangements

Many sponsoring employers are looking to enter into complex asset backed funding arrangements under which business assets are used to generate cash which is then paid to the pension scheme as a regular income stream.

These arrangements typically involve the asset being held by a Scottish Limited Partnership (SLP) to provide the necessary degree of separation needed to avoid falling foul of legislation prohibiting pension schemes from investing more than 5% of the value of its assets in its sponsoring employer.

One of the reasons an SLP works for these purposes is that it is an ‘unincorporated body constituted under the laws of a territory within the UK’ and, unlike an English partnership, has its own legal personality.  Therefore a pension scheme investing in the SLP is not investing in ‘shares’ in a company associated or connected to the employer, as defined in the legislation.

In the event that Scotland becomes an independent country then the SLP would be deemed a non-UK body and so it is possible that it might no longer be used as a structure for these purposes. Trustees entering into these arrangements therefore need to make sure there is a ‘Plan B’.

For those employers who have already entered into such an arrangement, the existing documentation is likely to include a ‘change in law’ provision that will set out the consequences of Scottish independence. Whilst each arrangement will be different, this provision may require, for example, that the arrangement is unravelled and the SLP payments are repaid.

PPF protection

In the event an independent Scotland becomes a member of the EU, European regulation will require that it establishes its own version of the Pension Protection Fund (PPF).  However, whilst at present the risks are spread across the UK and across a large number of defined benefit schemes, the number of such schemes in an independent Scotland will be much fewer.

It would be for the Scottish Government to determine the details such as the level of compensation to be provided and how this will be funded, but there will inevitably be some increased uncertainty for employers, trustees and scheme members.  Given that there would be less pooling of risk, it seems likely (assuming Scotland wished to replicate the PPF compensation structure) that there would be an increased cost to the schemes and their sponsoring employers.

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This blog is intended only as a synopsis of certain recent developments. If any matter referred to in this blog is sought to be relied upon, further advice should be obtained.