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Non-cash Funding Solutions


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Non-cash Funding Solutions

  1. 1. Redington13-15 Mallow StreetLondon EC1Y 8RDT. 020 7250 funding solutionsJeremy Lee – RedingtonNobby Clark – HSBC Pensions Solutions Group25 November 2010
  2. 2. Agenda1. What’s the alternative?2. A brief history3. Recent transactions4. Issues to consider5. HSBC case study6. Looking ahead7. Questions
  3. 3. 3What’s the alternative?Contingent assets• Guarantees• Security• Escrow• Letters of CreditBusiness assets• Direct transferAsset-backed• Priority ofcashflows• Security overassetsCash
  4. 4. Common features of recent asset-backed structuresCorporatePension schemeSPV• Income generating• Unencumbered• Tax deduction – viapension scheme?1. Corporate placesasset in SPV• Typically “rent”• Market rates2. Income from assetreceived by SPV• Share of profits and interestin SPV• Fixed period• Multiple coverage by “rent”• Not direct pass through3. Scheme’s interest paysincome• Valuation -ongoing/distress• Covenant assessment• Shortfall at end4. Scheme also has securityover [some] assets in the SPVNote: This is intended as an overview only. Individual objectives and circumstances will alter the structuring.4
  5. 5. Non-cash funding – a brief history20102008200620042002Sponsors fear trappedsurplusSmarter use of balancesheetTPR/PPF brings focuson contingent assetsLetters of credit(National Grid)CorporateguaranteeSponsor affordabilitytestedEscrow(Marconi)Banks developproductsLP/trust structures(M&S, Sainsbury’s,Diageo)Super-security(KKR/Boots)LeveragedtransactionsAccelerated cash(Somerfield) Business assets(John Lewis, Uniq?)Insurance vehiclesMarketdriversPopularsolutions5
  6. 6. 02004006008001000120020072008Jun09Jul09Aug09Sep09Oct09Nov09Dec09Jan10Feb10Mar10Apr10May10Jun10Jul10Aug10Sep10Oct10Nov10Valueoftransaction(£inmillions)Asset backed Business assetUniq?Recent activity using asset-backed structures and business assets6Source: Annual Reports, press releasesNote: Tesco has raised funds via sale and leaseback of properties through a 50:50 JV with the pension schemeUniq is subject to review by The Pensions Regulator£1,760mM&S1M&S2GKNLloydsJohnLewisITVM&S3JSainsburyDiageoWhitbreadHSBCPhilipsUniq?CostainInterserveJohnLewisTesco1Tesco2Tesco3Travis Perkins
  7. 7. 7Issues to considerKey issues to considerFunding deficit reductionImpact on recovery planGreater securityCorporate accounting treatmentManaging future surplusAsset concentration / Employer-related investmentsSupport investment strategyUnrecognised value?Asset valuation – ongoing/distressTax treatmentTrustee education / ComplexityLegal advice
  8. 8. M&S: Because there is no Plan BDate Market value ofpropertyAnnual cash How long for? Final lump sum? NPV of cash2007 £1.1bn £50m 15 years No £500m2008 £400m £22m 14 years No £200m2010 - £36m 15 years(from 2017)Up to £350m in2031£300m0204060801001202007200820092010201120122013201420152016201720182019202020212022202320242025202620272028202920302031£mUp to £350mSource: Annual Reports, press releases8Date Market value ofpropertyAnnual cash How long for? Final lump sum? NPV of cash2007 £1.1bn £50m 15 years No £500m2008 £400m £22m 14 years No £200mDate Market value ofpropertyAnnual cash How long for? Final lump sum? NPV of cash2007 £1.1bn £50m 15 years No £500mDate Market value ofpropertyAnnual cash How long for? Final lump sum? NPV of cash
  9. 9. 9Impact on recovery plans0 5 10 15 20 25Average Recovery PlanLloydsITVWhitbreadDiageoGKNJ SainsburyTravis PerkinsJohn LewisM&SYearsComparing the length of the payment schedulesSource: Annual Reports, press releases, TPR Recovery Plan analysisNote: Payment schedules are for the asset-backed payments only
  10. 10. 10Greater security0%10%20%30%40%50%60%70%80%90%100%Lloyds Whitbread GKN John Lewis M&S J Sainsbury DiageoValue of pension scheme interest as proportion of totalassets in structureSource: Annual Reports, press releasesNote: Asset-backed structures only and where sufficient information is available
  11. 11. 11Reducing the IAS 19 deficitCompany IAS 19 Plan Asset?M&S YLloyds YJohn Lewis NGKN YWhitbread NITV NJ Sainsbury YDiageo N/KTravis Perkins YSource: Annual Reports, press releasesNotes: Asset-backed structures only
  12. 12. 12Managing future surplusesCompany Ability to manage surplusM&S Final payment up to £350mLloyds NoJohn Lewis Final payment between £0.5m and £99.5mGKN Future surplus can be used to offset service costWhitbread Final payment up to £110mITV Final payment up to £150mJ Sainsbury Final payment up to £600mDiageo Final payment up to £430mTravis Perkins NoSource: Annual Reports, press releasesNotes: Asset-backed structures only
  13. 13. 0% 5% 10% 15% 20% 25% 30% 35% 40% 45% 50%Uniq?TescoPhilipsInterserveHSBCJohn LewisCostainM&SGKNJ SainsburyWhitbreadDiageoTravis PerkinsITVJohn LewisLloydsValue of structure as proportion of total scheme assets13Asset concentrationAsset-backed structuresBusiness assetsSource: Annual Reports, press releasesNotes: For Tesco, we have assumed 50% of the MV of properties placed into the JV, although it is not clear what the value isUniq is subject to review by The Pensions Regulator
  14. 14. 14Issues to considerKey issues to considerFunding deficit reductionImpact on recovery planGreater securityCorporate accounting treatmentManaging future surplusAsset concentration / Employer-related investmentsSupport investment strategyUnrecognised value?Asset valuation – ongoing/distressTax treatmentTrustee education / ComplexityLegal adviceKey issues to considerFunding deficit reductionImpact on recovery planGreater securityCorporate accounting treatmentManaging future surplusAsset concentration / Employer-related investmentsSupport investment strategyUnrecognised value?Asset valuation – ongoing/distressTax treatmentTrustee education / ComplexityLegal advice
  15. 15. 15Global Banking and MarketsAlternatives to Cash Funding HSBC Case StudyNobby Clark – November 2010
  16. 16. 16HSBC Bank (UK) Pension SchemeHSBC’s track record in managing riskHSBC has been actively engaged with its defined benefit pension schemes on risk management since 2004As a regulated financial, we were able to make a direct comparison between the risks being run within the HSBC Bank(UK) Pension Scheme and within HSBC Global Markets– Pension Scheme was running approx 3 times as much risk as the Trading Books– Trading books had 400 traders with position limits / stop loss limits and management oversight and intervention– Historically, Pension Scheme Trustees met quarterly and the interface with the Sponsor was primarily handled by HRSenior management decided that, although capital treatment and disclosure may vary between Pension Scheme andBank it did not want to take risk in the Pension Scheme that it wouldn’t take directly on balance sheetA strategy was developed and approved by HSBC senior management and the TrusteeThe strategy was based on Group ALM Policy and involved interest rate and inflation swaps and reducing theSchemes exposure to equitiesAlthough exposures were thought of as direct exposures the strategy recognised the role of Trustees and theiradvisers (see HSBC Annual Report)HSBC recognised and accepted that increased contributions would be required if the strategy was implementedHSBC risk management actions pre-dated the Basel 2 capital framework which required increased capital to be heldagainst pension riskWhilst the key driver was managing economic risk the changing capital framework was expected to reward sound riskmanagement
  17. 17. 17Financial Sector Considerations - CapitalCurrent FSA RequirementsPillar 1 - Funding– A firm must deduct and IAS19 surplus from Pillar 1 capital resources, as the surplus is not available to absorb losses– A firm must deduct either the IAS19 deficit or the Deficit Reduction Amount (DRA)– The DRA equals the next 5 years of contributions. HSBC has generally elected the DRA for stability reasonsPillar 2 – Risk of Increased funding– The FSA provides Banks with guidance that it will review Bank internal calculations vs the potential increased funding requirementat a 99.5% 1 year VaR levelPossible changes to FSA regulations– The DRA “filter” is expected to be removed. This will increase the volatility of the capital required to support a DB PensionScheme. For some schemes the quantum may increase tooObservationsThe pension capital regime differs from banking and trading book capital regimesIt is quite reasonable that it should differ – we have yet to see a pension scheme that manages its balance sheetexactly like a bank doesOther supervisors differ in the filters that they allow for Pillar 1 capital, and in whether they require risk capital to beheldBasel 3 does not require pension risk capital to be held
  18. 18. 18Financial Sector Considerations - LiquidityThe importance of liquidity to financial institutions – particularly banks / near banks / shadow banks – washighlighted early on in the financial crisisCharacteristics that expose them to liquidity risks include:– Their central role in the economy, particularly if deposit-taking– Their high levels of leverage– Their role in providing maturity transformation“Liquidity regulation and supervision should be recognised as of equal importance to capital regulation”*Global regulation is now falling into place for internationally active banks, driven by the Basel Committee:Liquidity Coverage Ratio– 2011 Observation, 2015 Implementation– LCR = Value of unencumbered high quality liquid assets / cumulative cash outflow over 30 day stress periodNet Stable Funding Ratio– 2012 Observation, 2018 Implementation– NSFR = Available stable funding (liabilities >1Y or stable deposits) / Required stable funding– Requires stable funding for all but the most liquid assets– Proposals for the precise mechanism and initial calibration expected by end 2010Pension assets do not count towards liquidity ratios* The Turner Review, March 2009
  19. 19. 19HSBC Bank (UK) Pension SchemeThe 2008 funding agreement
  20. 20. 20HSBC Bank (UK) Pension SchemeAsset transfer summaryProcessSponsor and Trustee agreed a conventional cash recovery plan in February 2010The long track record of productive engagement on risk management created an environment where both parties wereprepared to commit resource to a difficult transaction that could improve both of their positionsThe Bank identified assets from around the Group balance sheet that it wished to be part of the transferThe Bank and Trustee analysed the portfolio carefully to establish suitability, market and intrinsic valueThe transfer was agreed and closed in June 2010Trustee benefitsThe Trustee gained immediate increased security for membersThe assets are plan assets which cannot be construed as employer-relatedThe Trustee benefits from the illiquidity premium that is priced into the assets, and from the Sponsor covenantSponsor / Bank benefitsRetained beneficial interest in illiquid assets that the Bank did not want to sell to the marketExpected asset performance should reduce the deficit fasterPillar 1 capital improvement – offset by increase in Pillar 2 Pension Risk Capital requirement
  21. 21. 21DisclaimerThis document is issued by HSBC Bank plc (“HSBC”). HSBC is authorised and regulated by the Financial Services Authority (“FSA”) and is amember of the HSBC Group of companies (“HSBC Group”).HSBC has based this document on information obtained from sources it believes to be reliable but which have not been independently verified.Any charts and graphs included are from publicly available sources or proprietary data. Except in the case of fraudulent misrepresentation, noliability is accepted whatsoever for any direct, indirect or consequential loss arising from the use of this document. HSBC is under no obligation tokeep current the information in this document. You are solely responsible for making your own independent appraisal of and investigations intothe products, investments and transactions referred to in this document and you should not rely on any information in this document asconstituting investment advice. Neither HSBC nor any of its affiliates are responsible for providing you with legal, tax or other specialist adviceand you should make your own arrangements in respect of this accordingly. The issuance of and details contained in this document, which is notfor public circulation, does not constitute an offer or solicitation for, or advice that you should enter into, the purchase or sale of any security,commodity or other investment product or investment agreement, or any other contract, agreement or structure whatsoever. This document isintended for the use of clients who are professional clients or eligible counterparties under the rules of the FSA only and is not intended for retailclients. This document is intended to be distributed in its entirety. Reproduction of this document, in whole or in part, or disclosure of any of itscontents, without prior consent of HSBC or any associate, is prohibited. Unless governing law permits otherwise, you must contact a HSBC Groupmember in your home jurisdiction if you wish to use HSBC Group services in effecting a transaction in any investment mentioned in thisdocument. Nothing herein excludes or restricts any duty or liability of HSBC to a customer under the Financial Services and Markets Act 2000 orthe rules of the FSA.This presentation is a “financial promotion” within the scope of the rules of the FSA.HSBC Bank plcAuthorised and regulated by the Financial Services AuthorityRegistered in England No. 14259Registered Office: 8 Canada Square, London, E14 5HQ, United KingdomMember HSBC GroupDISCPRES011107
  22. 22. Looking ahead22Property Machinery InventoryDebtor books Brands Intra-group loansPFI contracts Intellectual PropertyOther intangibleassets
  23. 23. Disclaimer For professional investors only. Not suitable for private customers.The information herein was obtained from various sources. We do not guarantee every aspect of its accuracy. The information is for your private information and is for discussion purposes only. A variety ofmarket factors and assumptions may affect this analysis, and this analysis does not reflect all possible loss scenarios. There is no certainty that the parameters and assumptions used in this analysis can beduplicated with actual trades. Any historical exchange rates, interest rates or other reference rates or prices which appear above are not necessarily indicative of future exchange rates, interest rates, or otherreference rates or prices. Neither the information, recommendations or opinions expressed herein constitutes an offer to buy or sell any securities, futures, options, or investment products on your behalf.Unless otherwise stated, any pricing information in this message is indicative only, is subject to change and is not an offer to transact. Where relevant, the price quoted is exclusive of tax and delivery costs.Any reference to the terms of executed transactions should be treated as preliminary and subject to further due diligence .Redington Ltd are investment consultants regulated by the Financial Services Authority. We do not advise on all implications of the transactions described herein. This information is for discussion purposesand prior to undertaking any trade, you should also discuss with your professional tax, accounting and / or other relevant advisers how such particular trade(s) affect you. All analysis (whether in respect oftax, accounting, law or of any other nature), should be treated as illustrative only and not relied upon as accurate.©Redington Limited 2010. All rights reserved. No reproduction, copy, transmission or translation in whole or in part of this presentation may be made without permission. Application for permission shouldbe made to Redington Limited at the address below.Redington Limited (reg no 6660006) is registered in England and Wales. Registered office: 13-15 Mallow Street London EC1Y 8RDTHE DESTINATION FOR ASSET & LIABILITY MANAGEMENTContactsDirect Line: +44 (0) 20 3326 7111Telephone: +44 (0) 20 7250 3331Redington13-15 Mallow StreetLondon EC1Y 8RDJeremy Lee FIAVice President | Investment