The UK opposition Labour party’s bombshell announcement it would nationalise BT’s Openreach network and provide free full-fibre broadband to every home and business in the country took everyone by surprise.
Much has been written about the political and competition problems of nationalising Openreach, but what about BT’s huge pension scheme? Could pensions be an expensive stumbling block to Labour’s ambitions?
BT has the UK’s largest company pension scheme with £63bn of liabilities — three times the company’s £20bn market capitalisation — and a £5.5bn deficit, at September 30. It was closed to employee members in 2018, and now has almost 300,000 members in three sections.
However much BT wants to reinvent itself as a 21st century company, it has a very 20th century pension problem round its neck.
And despite the risk posed to BT by the sheer size of pensions, it continues to run a major asset and liability mismatch. Of the scheme's £57.5bn assets, about £20bn remain in equities, infrastructure, and property, the same value as its market capitalisation.
Adding to the size and complexity, a Crown guarantee was issued at privatisation in 1984. If BT ever goes bust, the government would meet its pension obligations.
Nevertheless, compared with all the other issues, pensions are the easy bit in any nationalisation. How so?
Openreach Ltd — run at arms-length from BT following pressure from the telecoms regulator Ofcom — would be sold to the government in exchange for cash or gilts. The pension scheme would stay with BT, which would pay all future deficit contributions, and the Crown guarantee would remain in place for all members.
To compensate for the loss of Openreach, which is a major part of overall profit and cash flows, BT would make a one-off pension contribution from the sale proceeds. There are many examples of this — including Pearson selling the Financial Times to Nikkei in 2015, and Invensys, the engineering group, selling its rail division in 2013.
How much of the sale proceeds BT would pay is governed by a legal agreement with the pension trustees from 2008, renewed every three years. Under this agreement, disclosed in its annual report, BT commits to pay into the pension scheme a third of any “net cash proceeds” from disposals over £1bn in any year.
A recent note from independent boutique New Street Research put Openreach’s economic value at £16.5bn, so the pension contribution would be about £5bn — higher or lower proceeds meaning a higher or lower pension contribution.
As well as making the pension contribution, and keeping a war chest for investment or acquisitions, BT would almost certainly want to pay a big chunk back to shareholders as a special dividend.
Although BT has agreed to “consult” the pension trustees over any special dividend, they have no legal powers to stop it. But to compensate for the increased credit risk, and as a matter of realpolitik, the pension trustees would expect a further deficit contribution over and above the £5bn.
“Corporate events”, including a special dividend, do not have to be agreed with the Pensions Regulator, but it has a voluntary “clearance” mechanism, and will agree not to use its “anti-avoidance” powers in the future — de facto approval. After agreeing the size of the further contribution with the trustees, BT would want to get clearance to copper-bottom a special dividend.
Meanwhile, UK pension regulation remains weak and inconsistent. The Pensions Act 2004 does not require deficits to be measured on a consistent basis against bonds, or require companies to inject cash over a set time. Instead, there is a DIY funding standard different for each scheme.
The Pensions Regulator has made things worse. Over the years it quietly dropped important guidelines; allowed companies, including Trinity Mirror, to extend their deficit payments; and bent its own rules to keep large schemes going as zombies without company sponsors — Trafalgar House, Polestar and Kodak.
When Kodak eventually entered the Pension Protection Fund this year the PPF hit was about £1.5bn — its largest by a country mile — and £600m more than if the regulator had followed its own rules.
John Ralfe is an independent pension consultant
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