The PPF, onerous terms and ISDAs: from hedgehogs to elephants

Robert Tellwright

Last October, Chris Jackson posted on this blog about how the PPF’s power to disclaim onerous terms was concerning some banks which held derivative contracts with pension scheme trustees (see link).  The PPF has taken some welcome steps to address these concerns.  But are we ignoring an elephant in the room?   

The PPF has recently published guidance which says that it will not ordinarily disclaim terms that have been negotiated at arms’ length by trustees, even if the trustees negotiated a poor deal.  It will only be interested in terms which are “substantially unfair or manifestly prejudicial”.  It goes on to say, in very reassuring tones,  that it would not expect to use its power to enable an ‘out of the money’ derivative to be terminated.  So far so good for the banks. 

In relation to ISDAs, the guidance also recommends that banks and trustees include an “Additional Termination Event” in their ISDA contracts, which will allow the bank to terminate the contract upon the PPF approving a valuation showing that the scheme is definitely “PPF-bound”.  However, this Additional Termination Event would not bite if the PPF has, before this time, issued a deed to the bank confirming that it will not exercise its powers to disclaim the terms of the ISDA. 

The overall reaction to this proposal has been positive, and there seems to be a general consensus that the PPF’s recommendations provide a pragmatic solution for banks and trustees alike.  But are we ignoring an elephant in the room?  When I discussed this with a contact at one bank, she told me she would be more comfortable inheriting the PPF as a counterparty if the PPF follows this procedure and confirms it will not disclaim any of the ISDA terms.  But that is not to say the bank would be 100% comfortable with the PPF becoming the counterparty per se

The bigger issue for some banks (not considered in the PPF’s guidance) is whether they want ISDA contracts which they have negotiated with pension scheme trustees to pass to the PPF at all, irrespective of the PPF’s stance on disclaiming onerous terms.  Credit departments may well take the view that the PPF has bitten off more than it can chew in terms of its liabilities, and that as the Fund matures it will become a less desirable counterparty.  Banks may also be concerned that if the PPF was ever to become insolvent, their claims for outstanding balances under these ISDA contracts would rank alongside the claims of the PPF’s unsecured creditors – including the beneficiaries entitled to PPF compensation.  When banks enter derivative contracts directly with the PPF, they are in a position to assess and form a view on these perceived risks at the outset, but they will not have this luxury where the PPF steps into the shoes of an existing trustee counterparty.   

While these concerns subsist, it is possible that banks will want to reserve the right to pull the plug on ISDA contracts where the scheme is headed for the PPF, irrespective of the PPF’s reassurances on onerous terms.  If this turns out to be the case, trustees and the PPF should watch out for this particular “elephant” looming large over their hedges.

Robert Tellwright is an associate at Allen & Overy LLP.

Comments published on Pensions Talk do not necessarily reflect the views of Allen & Overy or its clients.

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