The new pension accounting rule FRS 17, set to become mandatory next year, could curtail some U.K. companies' ability to fund themselves in the debt capital markets, say analysts. The new rule, which requires companies to account for their pension fund liabilities on balance sheet, could make companies appear over leveraged--especially those with pension liabilities larger than the market value of the company. Companies with large pension liabilities need to show investors that they have a feasible plan to fund them, otherwise it could impact their cost of capital, warned one analyst. Many of these deficits look awful until the company explains how they will be funded, says Crispin Southgate, fixed-income strategist at Merrill Lynch in London. "Investor relations strategies are key," he says. But some companies may be in for trouble, if they do not have a game plan. "It will impact their cost of capital, especially if the deficits are big and horrible, and justifiably so," he says.
Other analysts are warning investors to be on the lookout for balance sheet surprises related to FRS 17 over the next year. Even though FRS 17 has already been spurring pension funds to dump equities and shift into bonds to match liabilities, which has been supporting the long-end of the sterling curve, the new accounting may make new corporate funding at the long-end prohibitive. With the pension liabilities on balance sheet, the extra risk could mean less long-dated corporate issuance, even though demand for exactly that kind of paper will remain high from pension funds.