UK/GLOBAL - Discussion around Accounting Standards Board (ASB) proposals for pensions accounting reforms really began in earnest last week, and what an uphill struggle it seems ASB officials face. Whereas talk so far has been in part about the way these reforms connect to those set out by the International Accounting Standards Board (IASB), a public discussion meeting in London hosed by the ASB revealed the bigger challenge for the local organisation is how the ASB balances the needs of pensions accounting with the information needs of the wider investor community, particularly when everyone involved also believes the ASB's dismissal of regulatory considerations is wrong.

The platform speakers selected reflect the scale of the problem. How do you rectify the reporting needs of pension managers with regulatory requirements, accounting ‘preparers' and analysts? ASB chairman Ian Mackintosh noted at this discussion on the financial reporting of pensions no standard is suitable for every pensions scheme. But the difficulty it now faces is how to ensure reporting of pensions management can be compared on a global scale, and in today's environment covers the delivery of schemes "not pigeonholed as defined benefit or defined contribution".

In reality, some of the issues concerning definition of schemes may already have hit a wall at the IASB as it has postponed the decision to define hybrids of DB and DC until a later date. Nonetheless, analysing the technical accounting of pensions appears to be a welcome discussion as those involved in the pensions market have argued for some time existing accounting does not reflect the true status of pension schemes and the long-term focus therefore needs to be reviewed.

All of the views expressed at the meeting were stressed as personal comments and not necessarily those of the companies and organisations they represented. So it was especially interesting to hear Gary Hibbard, global head of pensions at BP plc, describe the task set in reviewing accounting as "Herculean", in part because the UK's ASB is attempting to build standards reflecting the global market, when its international affiliate, the IASB, is not looking at the impact its rules will have on DB schemes.

One element yet to be rectified, for example, is the use of the ‘corridor approach' which is only used by 10% of UK schemes but is widely used in the Netherlands, and is therefore causing a stir should it be abolished. His main concern, however, is he does not believe the ASB should operate a bottom-up approach of tinkering with rules when the IASB and US' Financial Accounting Standards Board (FASB) are looking to converge standards. Rather, the top-down view is more important and the conceptual framework should be completed first - a view shared later in the meeting by fellow platform presenter Tony Sykes, audit partner at KPMG.

The meeting also revealed there are widely differing opinions on whether a risk-free rate of accounting should replace the existing use of the AA-rated corporate bonds discount rate. Hibbard believes a nil rate is not a more abject measure, as currently proposed, because nil rate would effectively need to calculate liabilities at a set date in time - requiring a spot rate - and at buyout level. They should therefore incorporate regulatory requirements - something the ASB said it did not believe should be part of its consideration, according to Hibbard.  At the same time, he noted many sponsors face a problem with the current regime as their own credit rating can be higher than the "local nil risk rating" or bonds applied to pension liabilities.

It is the issue of risk-free rates which could see most attention before the ASB completes its review, as most speakers disagreed as to which method was most appropriate. Joanne Segars, chief executive of the National Association of Pension Funds (NAPF) suggested its discussions have so far found there is no definite consensus on whether to stay with the existing system, whether to move to gilts, though there does appear to be more support for shifting to a "swaps plus" spot rate as this appears to carry a better level of risk recognition against liabilities and assets.

She argued the risk-free rate "fails to take into account the opportunities available to employers to mitigate scheme liabilities by changing terms or closing DB schemes altogether" and does reflect the likely gains assets could make through higher return investments.

Moreover, she also presented figures suggesting were liabilities calculated against gilts, the assets required would climb substantially. A young scheme at 29 years from maturity with payable benefits of £100m (€125m), for example, would see liabilities double to £200m under accounting rules, while a medium scheme of 23 years faces an increase to £160m and a mature scheme would have a 25% increase on liabilities to £125m.

In contrast, however, were liabilities calculated on a ‘swap plus' rate, it would place the mark-to-market reported liabilities closer to the actual liabilities fund would face, suggested Segars - a view shared by Crispin Southgate, director of Institutional Investment Investors (IIS).

Figures presented by Segars but produced by Punter Southall for the NAPF suggest were liabilities reported at swaps + 1.5%, this would be the equivalent of calculating risk of the pension fund against the spot value of AA-rated bonds. The actual liability to schemes is starkly different to the current rate, however, as young schemes would be able to calculate assets at swap+1.64, while medium schemes would see displayed liabilities drop to swap+1.47 and mature schemes fall further to swap+1.14.

Sykes - speaking in his own opinion and not his firm's but using research he conducted among 12 large UK companies - has found there is widespread concern among financial report preparers that the conceptual and theoretical proposals from the ASB are not necessarily practical when applied. A poll of those people found 11 of those 12 preparers are opposed to ASB proposals for discount rate being moved to a risk-free rate. "IAS19 + ASB proposals are divorced from reality" was just one comment from one of those firms, while others suggested "some risk should be reflected in the rate used" while stronger opinions argued "a risk-free rate would create a systemic accounting defect, even where, for funding purposes, the technical provision matches the assets."

Southgate was sceptical in some respect about ASB's need to change the way the risk-free rate is displayed - even though he has been campaigning for some time for improved reporting - liking it to a doctor altering a patient's records when ill: "We are talking about accounting, not funding, so let's not get them mixed up. If you change a doctor's records, the patient does not feel better," he argued. However, he did think there was more apparent liquidity in ‘swaps plus' rates than government bonds, suggesting there is a more implicit future stream over 3-6-month LIBOR - the rate most pension funds will likely hold assets at when needing to liquidate assets for a member's retirement income.

There appeared initially to be support for ASB proposals to remove future salary increases from consideration of pensions accounting, when the ASB argued this is not a contractual or salary obligation. That said, companies told Sykes and his team "whilst contractually they may not be committed, companies typically have a constrictive obligation based on past practice" whereas others felt "salary increases should be excluded if the liability is being looked at on inflation since they do not represent current commitments".

"[Hibbert] made the point that while the majority of the IASB agree salary increases should not be reflected, because deferred members are required to measure inflation raises, this is inconsistent," said Sykes.

At the same time, companies are not inclined to be as dismissive of regulatory requirements as the ASB, noted Sykes, because regulations tend to also sets out financial obligation on the sponsors and the trustees. Southgate pointed out as an analyst the regulatory obligations in reporting do matter and should therefore be reported in pensions accounting because they could have a material impact on any company's future potential revenue.

Issues raised in this meeting and so far highlighted here only touch the surface of comments made, as disclosure and presentation also play key roles in the production of company accounting. But what this meeting perhaps showed - and was later acknowledged by ASB's Mackintosh - is matters concerning pensions accounting are not easily resolved. The idea of removing reported smoothing may eventually go, with general support, but whereas ASB officials thought there was also consensus for removing the need to consider future salary increases in accounting disclosure, this meeting showed even pension funds and sponsors cannot agree whether this would be wise.

What it did indicate, however, is more companies are more aware of the reporting and regulatory implications of overseas regimes, even though the ASB is traditionally UK-centric. It will therefore be very interesting to ASB officials and UK pension funds to discover what continental Europeans think of the current IASB and ASB proposals, when they meet next week to discuss suggested reforms.

What do you think, as a European investor, of ASB proposals for reform of pensions accounting? If you have any comments you would like to add to this or any other story, contact Julie Henderson on + 44 (0)20 7261 4602 or email julie.henderson@ipe.com

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