New rules could put UK dividend recovery at risk

New rules could put UK dividend recovery at risk

The pace of dividend recovery for UK companies could be put at risk due to new pension rules coming into force on October 1, LCP has warned.

Dividend levels were depressed during the pandemic but the first half of 2021 has seen a recovery in payouts, with some high-profile companies announcing large dividends in recent months.

According to Link Group’s UK dividend monitor, UK dividends jumped 51 per cent in the three months to June this year, as businesses began to reinstate payments to shareholders. This compared with a drop of 49 per cent in the third quarter of 2020 as companies tightened their belts due to Covid-19.

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However, LCP warned the pace of recovery in dividends could be slowed as a result of increased powers for the Pensions Regulator, which are coming into force on October 1.

The new rules, stemming from the Pension Schemes Act 2021, will beef up the watchdog’s scrutiny of shareholder dividends — and other forms of “covenant leakage”, including executive remuneration — to a new level for sponsors of defined benefit pension schemes, LCP stated.

The consultancy warned company directors and others involved could face a legal challenge if a dividend payment leads to a “material reduction” in the recovery that a DB pension scheme can expect to get in the event of a hypothetical insolvency. 

As a result, LCP is advising companies to include the impact on their pension scheme in their dividend discussions, since this will demonstrate that the DB scheme “was considered as part of the directors’ decision making”, should “TPR come knocking in the future”.

The consultancy noted while companies with a DB scheme deficit will not be banned from paying substantial dividends, “they may in some cases be expected to take other mitigating measures to provide security to the pension scheme, such as giving the scheme priority claim on certain company assets”.

Alternatively, they may decide to pay a lower dividend in order to avoid a “material” risk to the scheme’s position, and to manage the risk of regulatory intervention, LCP said.

At the end of July, there were 2,600 DB schemes in deficit and 2,718 schemes in surplus in the UK, with a funding ratio of 103.5 per cent, data from the Pension Protection Fund 7800 Index showed.

Laura Amin, principal at LCP, noted that “government and regulators are keen to avoid a repeat of scenarios where a company goes bust leaving a hole in the pension scheme after a period when large dividends have been paid to shareholders”.

She said: “­­The new powers for TPR may lead to more frequent regulatory intervention. We expect the new powers to generate much debate when they come into force from October 1 and it may be challenging for company directors to understand where the new boundaries lie.”

Amin noted at the very least, “company boards will have to think much more carefully when setting their dividends about the impact on the position of their pension scheme, while schemes will be in a stronger position to press for greater security if a large dividend payment goes ahead”.