New Delhi: In the April-June quarter, Tata Steel Ltd noted that the employee pension fund of its British unit, the erstwhile Anglo-Dutch steel company Corus Group Plc., lost Rs5,352 crore because of its exposure to equity and other financial markets.
In the aftermath of what has been a sharp decline in global stock markets since then, it is likely that the fund took more hits.
This ripple effect on one of India’s blue chip companies is yet another illustration of the impact the global markets crisis will have on Indian entities even as stock markets rebound after governments pumped in hundreds of billions of dollars in liquidity.
While the performance of the fund for the July-September period will only be revealed when the company discloses the numbers, Tata Steel’s pension liabilities to Corus employees include defined benefit plans, where a company guarantees a certain level of pension payment regardless of the returns on investment.
This means that an erosion in pension funds’ “surplus” forces Tata Steel to offset the erosion in employees’ pension from its balance sheet.
However, this offset will not be reflected in Tata Steel’s profits because the company, which had followed Indian accounting rules in 2007 when the pension fund recorded an increase in its surplus, reversed its stance in 2008 and decided to adopt British accounting standards instead. British standards do not require Tata Steel to deduct pension fund losses from profits.
The Corus pension funds had an asset base of Rs1.2 trillion. The size of Tata Steel’s consolidated balance sheet on 31 March was Rs92,161 crore. Corus’s income also accounts for about 74% of Tata Steel’s consolidated total income.
Indeed, in its annual report for 2007-08, Tata Steel noted that “the market value of pension assets and liabilities is significantly greater than the net assets of Corus and therefore, any change can have a material impact on Corus’s financial statements as well as impacting the level of company pension contributions.”
A Tata Steel spokesman requested that Mint send detailed questions to the company, promising a response. Eventually, Tata Steel declined to reply to the questions and cited the so-called silent period ahead of the scheduled announcement of its second quarter results on 24 October.
Tough buy: Workers at the Corus steel plant in Ijmuiden, Netherlands. Tata Steel’s pension liabilities to Corus employees include defined benefit plans, where a firm guarantees a level of pension payment. Paul O’Driscoll / Bloomberg
Mint has no independent way of ascertaining the impact of eroding stock markets during the July-September quarter, or beyond, on the Corus pension fund investments.
According to Andrew Watchman, executive director, international financial reporting at Grant Thornton International Ltd, typically when share prices fall, defined benefit schemes slip into deficit.
Watchman, who addressed a workshop in New Delhi on international financial reporting standards (IFRS), said in the UK, companies sometimes move pension schemes to stand-alone firms to insulate themselves from fluctuations unrelated to their main business.
While the precise details of Tata Steel’s liabilities on pension contributions weren’t available to Mint, the causes for the problem are discussed in the 2008 annual report of the British Steel Pension Scheme (BSPS).
BSPS represents steel workers and negotiated with Tata Steel to operationlize its commitments to Corus employees.
According to the BSPS report, a key principle underlying pension fund investments is to beat inflation. Therefore, the bulk of the resources are to be invested in “real assets such as equities, index linked securities, and property, which can be expected to give an investment return which keeps pace with inflation.”
On 31 March, the net assets of BSPS were £9.3 billion (about Rs81,300 crore), of which 40.8% was parked in index linked securities, 24.1% in fixed income securities, 9.3% in the UK equities and 4.3% in property. The accounting guidelines for pension liabilities in the UK, which follows IFRS, and India differ.
In India, an erosion in pension funds’ surplus is deducted from the profit in the profit and loss account. IFRS allows companies to deduct from the reserves and surplus in the balance sheet, thereby insulating that year’s profits of steel operations.
In 2007-08, in favourable market conditions, Corus’ pension funds registered “actuarial gains”. Tata Steel chose to reflect the gains in its consolidated financial statement and announced a net profit of Rs12,321.76 crore on income of Rs1.31 trillion. By June, when the company announced its first-quarter financial results, turmoil had gripped global financial markets and Corus’s pension funds had shown a deficit of about Rs5,352 crore, more than the company’s consolidated profit before tax of Rs4,807.61 crore.
This time, Tata Steel changed its accounting principle and chose to follow the IFRS standards that was earlier followed by Corus.
Consequently, the deficit in pension funds was not reduced from profit. It also recast its profit for the previous financial year to bring it in sync with the switch. In the notes to its accounts, Tata Steel said it chose to switch to IFRS to account for pension in the manner allowed by Indian accounting standards (AS 21).
“Given the large share of Tata Steel UK in the consolidated Tata Steel results, and the potential volatility caused by periodic changes in the assumptions underlying the computation of pension liabilities, it is not considered practicable to adopt a common accounting policy for accounting for the pension liability of the company and Tata Steel UK Ltd (erstwhile Corus),” the notes to the company’s financial statements for the April-June quarter said.
Tata Steel’s exposure to a defined benefit pension plan overseas hasn’t been a major factor on company ratings given by analysts.
“They have enough cushion,” said Rakesh Arora, steel analyst at Mumbai-based Macquarie Securities Ltd. His firm has an outperformer rating (expected stock return to exceed 10%) on Tata Steel based on expectations for core operations. Tata Steel is the fourth largest payer of Indian advance taxes, paid by companies on the basis of their estimated profit for the year.
According to data compiled by the finance ministry, Tata Steel paid an advance tax of Rs1,356 crore for the period 1 April-15 September of the current financial year, an increase of 104% over the corresponding period of the previous year.
It was the second highest growth rate recorded among the top 20 taxpayers during the period.
Tata Steel shares closed on Tuesday at R304.80 a share on the Bombay Stock Exchange. The shares are well off their 52-week high.