The two UK pension schemes of Anglo-Dutch steelmaker Corus have become key players in a closely watched bidding war THE BIDDING WAR between India’s Tata Steel and Brazil’s Companhia Siderugica Nacional (CSN) for Anglo-Dutch steelmaker Corus Group typifies the shifting balance of ownership between mature western economies and emerging markets. Less obviously, the takeover battle highlights the new, critical role played by pension trustees and their advisers in corporate finance. Under the terms of its £4.1 billion offer to Corus shareholders, made on 20 October, 2006, Tata proposes to buy out shareholders and holders of £800 million Corus debt using £1.8 billion in cash combined with £3.3 billion of debt to be issued by a new holding company, Tata Steel UK. It soon emerged that the Corus pension trustees had demanded and won important additional security pledges from Tata Steel in return for acquiescing to the bid. According to Ray Hill, chairman of the multi-union committee at the Corus steelworks in Scunthorpe and a trustee of the British Steel Pension Scheme (BSPS), “We are a professional trustee board and we take our legal commitments and responsibilities very seriously. We are independent and we act in the best interests of our members, be they paid, families, deferred or contributing members.” According to the Corus 2005 accounts, the two UK schemes, BSPS and Corus Engineering Steels (CESPS) have IAS19 liabilities of £8.9 billion and £826 million respectively. The 166,000 member British Steel scheme is open to new members and has a funding ratio of 100%, while the closed CES scheme is only 76% funded. A third scheme, Stichting Pensionfonds Hoogovens (SPH) with £3.6 billion of liabilities, is separately incorporated under Dutch law and has been extensively liability- matched (see Life & Pensions, August/September 2005, p20). In a preliminary meeting with a sub-group of trustees, Tata offered to eliminate the CESPS deficit with an upfront payment of £126 million, and increase the contribution rate on the BSPS scheme from 10% to 12%. In 2005, Corus made £93 million of pension contribution payments. However, with 86% of BSPS members retired or deferred, such gestures are largely cosmetic in the light of the volatility within the scheme, combined with a potential deterioration of sponsor status. With Corus facing challenges producing cheap steel in the face of emerging market competition, the trustees were aware that such deterioration might be inevitable if fresh capital were not found. But even with the business synergies between Tata Steel and Corus, the trustees were concerned by the role of ‘non-recourse fi nancing’ that was a centrepiece of the offer. Corus currently has recourse to reduce divi-dends paid to shareholders or sell assets in order to meet pension obligations if necessary. Crucially, the new Tata holding company will not have legal recourse to the Indian parent company – 33% owned by Tata & Sons, a $47 billion diversifi ed family-controlled conglomerate – should Corus have problems meeting its liabilities. Faced with a quadrupling of debt, its holders having a superior claim on Corus’s assets, the trustees were presented with a clear reduction in sponsor quality. In a series of meetings that took place in October, they expressed these concerns. In a joint statement, the respective trustee chairmen of BSPS and CESPS, Bob Avis and Ian Cooper, said: “The trustees’ objectives were to protect the position of both schemes and to put in place additional security measures to address the fi nancing structure of the takeover arrangements.” Mindful that the UK Pensions Regulator’s clearance process could be invoked to block any deal, Tata and its advisers, ABN Amro and Deutsche Bank, worked to mollify the trus-tees. According to sources close to Tata, the two UK schemes have been promised senior creditor rights over Tata Steel UK, which means their claim on assets is superior to that of subordinated creditors expected to provide the bulk of financing. In the event of insolvency, these rights still leave the pension schemes below senior bank lender Credit Suisse, which is also advising Corus. But in a full trustee meeting that took place in October, Tata representatives made additional ‘non-economic’ pledges to the trustees, focusing on the business as a going concern. According to Ray Hill, “We agreed a satisfactory memorandum of understanding with Tata, based on information provided by Tata and Corus.” The trustees – consisting of union representatives such as Hill in addition to Corus executives – decided not to approach the Pensions Regulator. “We are very pleased with the constructive nature and outcome of discussions with Tata Steel,” the trustees said in their joint statement. “We greatly appreciated the help from our team of independent advisers in the process.” For Tata, the granting of seniority to the trustees will have to be paid for. When the use of a special purpose vehicle to refi nance Corus was announced in October, it caused credit default swap spreads referenced to Corus debt to widen dramatically – refl ecting an anticipation of increased borrowing cost. Subordinating the new debt to pension scheme liabilities is likely to increase borrowing costs even further. The secret ALM study Life & Pensions has learned that secret discussions between the scheme trustees and their advisers to de-risk the £9 billion schemes may have been factored into Tata’s thinking well before the bid became public. Together, BSPS and CESPS have 50% of assets invested in equities. Although this equity content is far lower than some UK schemes, the scheme does not have a good match between assets and IAS19 liabilities. Moreover, the accuracy of the PMA92 life expectancy tables currently used by the Corus schemes’ actuary are subject to debate. Although Tata will reduce the current IAS19 deficit at the time of takeover, it is the future expected deficit that concerned Tata, which began planning its takeover bid early in 2006. Aside from significant longevity risk, a source of this future deficit was volatility due to the mismatch between assets and liabilities, expressed as a value-at-risk (VaR) parameter. As confidential discussions commenced between the board members of Tata and Corus, Tata’s two adviser banks began a due diligence process for their client, which involved pension experts at the two banks. In some takeover bids, notably Philip Green’s approach to Marks & Spencer, trustees have resisted providing any confidential information about pension scheme policy. But current and former senior Corus executives, and union representatives among the trustees were keenly aware of the business reasons behind the takeover, and were persuaded to co-operate in order to safeguard member benefits. It may have helped that the chairman of the BSPS trustee investment committee, Paul Strickland, is also Corus’ head of corporate finance. As part of the due diligence process, it emerged that some time in 2006, BSPS and CESPS had jointly engaged Watson Wyatt to perform an asset liability management (ALM) study. This study had led to a de-risking plan being adopted by the trustees, summarised by certain parameters. The ALM study was ongoing at the time of the due diligence process and the parameters may have since changed. According to sources close to Tata, the trustees have decided to reduce the 95% VaR of the schemes by 50% over a three year period. The 50% equity allocation would be reduced to 30%, the sources suggest. These changes are likely to be accompanied by a shift to a liability-driven benchmark, with possible use of swap hedges. However, sources point out that the fund already has a considerable holding in index-linked gilts and may rather be looking to diversify into alternative assets. The new investment plan remains secret and is not reflected in the two schemes’ publicly available statement of investment principles (SIP). The trustees and Watson Wyatt declined to comment. While the VaR parameter simply provides the trustees with a worst-case funding threshold at a particular level of confidence, the Watson Wyatt study had particular significance for Tata as potential sponsor. According to sources close to Tata, the advisory team used a form of tail VaR, whereby once the VaR threshold had been crossed, the deficit would be crystallised at buy-out levels, far above the current IAS19 valuation. This meant that Tata was highly averse to the threshold being crossed. Whatever the exact parameters involved, Tata Steel gained enough confidence from the de-risking plan under consideration by the investment committees to offer the security the trustees wanted when negotiations took place in October. Enter the Brazilians This carefully crafted agreement was thrown into confusion on 17 November when the £4.3 billion CSN bid was announced. In a short stock exchange announcement, CSN – which is advised by Lazard and Goldman Sachs – said it, “Intends to match the terms of the agreement reached with the trustees of Corus’ pension funds.” The financing of the bid is expected to follow a similar non-recourse structure to the Tata offer. However, observers point out that the two bidders are very different from the pension scheme perspective. While not legally obliged to provide additional equity should Corus’ position deteriorate, Tata Steel can draw upon the extensive $47 billion financial resources of the Tata group and is expected to protect its investment in the event of a downturn. CSN, by contrast, is already heavily in debt, has extensive capital expenditure requirements and is constrained from new share issuance. It is controlled by Vicunha, the family foundation of Brazilian tycoon Benjamin Steinbruch, who is also CSN’s chairman. By contrast with the Tata group, Vicunha lacks operating assets and itself has $400 million in debt. Although terms of its Corus offer had not been finalised when Life & Pensions went to press, CSN is thought to be contributing only £1 billion in cash, relying on £4 billion of debt to make up the balance of Corus’ enterprise value. The credit markets have already reflected this fact by pricing the CDS spreads of CSN identically to that of Corus, whose debt is rated at the speculative BB- level. According to Ray Hill, the CSN offer to match Tata’s commitment to the Corus schemes is unlikely to be sufficient.“It would be reasonable to offer more,” Hill told Life & Pensions, adding that no detailed offer was yet on the table. Sources close to CSN insist that the trustees do not have the right to derail the bid, because schemes will be fully funded by CSN. But this may be an optimistic view. The Corus trustees might insist on a more conservative valuation of pension liabilities with the help of the Pensions Regulator, which requires funding to be ‘scheme specific’. While CSN is thought to have already approached the regulator, Tata chairman, Ratan Tata, has approached the UK establishment at a higher level. On 17 November, Tata visited London to announce his participation in a panel of economic advisers to UK chancellor Gordon Brown. Corus shareholders will have an opportunity to consider both bids on 20 December. The mystery of Corus longevity figures Life expectancy is likely to prove a key variable in the future of the two Corus UK pension schemes. According to the Corus 2005 annual report, a triennial valuation was recently performed on the two schemes by actuarial consultants Watson Wyatt. “The assumptions adopted are in line with the PMA92 mortality table and refl ect steel industry mortality experience,” the report stated. “This indicated that today’s 60-year old member is likely to live to 82 years of age.” The PMA92 tables for males, and equivalent PFA92 tables for females, were fi rst drawn up by the UK Actuarial Profession in 1992 and have become a standard valuation tool for pension scheme actuaries. The tables express the probability (as observed in 1992) that a person born on a given year will live to a given age. Although the PMA92 tables refl ected increasing longevity up to 1992, subsequent rapid and largely unexpected improvements in life expectancy have not been taken into account. Some companies have adopted modifi ed forms of PMA92 to refl ect this. For example, chemicals group ICI, which also did its triennial valuation in 2005, switched to the PMA92C05MC tables for males. This valuation takes into account the so-called ‘medium cohort’ effect, whereby people born between around 1920 and 1940 have experienced particularly high mortality improvements. ICI also anticipates that mortality will continue improving in the future. The difference between the adjusted and unadjusted form of PMA92 can have a profound impact on pension liabilities. When ICI made the adjustment, it reported an actuarial loss of £500 million. Some observers suggest that if Corus made the same adjustment, its total pensions liabilities could increase by as much as £1 billion. In Corus’ defence, it can be argued that its steelworks (both active and defunct) are sited in low life expectancy areas of the UK, such as south Wales and north east England. According to data from the UK Offi ce of National Statistics, healthy life expectancy at birth in south Wales is over 14 years less than in the longest-lived areas of the UK....
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