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Commerce · VII.08 · MMXXVI · daylight
WORKBOOK — THE CORPORATE EXECUTIVE
Chapter VII.08 · The Long View and the Discount Rate
For the person who signs the provision, chairs the committee that sets the hurdle rate, or owns a liability that will outlive their tenure by eighty years. The language here is the firm's, without apology, because the firm's own numbers already support most of the move.
THE PREMISE, STATED COMMERCIALLY
You carry at least one obligation that will still be running when nobody in the building was born. Decommissioning. Closure and aftercare. Land remediation. A tailings facility. A defined-benefit scheme. A warranty on a structure. A regulatory undertaking with no end date.
Three things are true about how that obligation appears in your accounts, and all three are commercial rather than ethical.
One: the provision is a discount rate, and so is the funding ratio. IAS 37 measures a provision at the present value of the expenditures expected to settle it and requires the rate to be disclosed. The asset side has no equivalent discipline. When your papers say "sixty percent funded", nobody has stated the rate that produced the denominator, and the number is unusable.
Two: your successor has a standing, correct incentive to reprice you down. If you use a horizon-indexed declining schedule, a successor applying the same table from their own present will value your year-200 commitment at 64.5 percent of what your plan promised. They are not cheating. This is measurable and it is in the chapter.
Three: past a certain horizon a rate stops carrying information. At the Green Book's own floor of one percent, a pound in year 300,000 is worth ten to the minus 1,296. Where your duty runs that long — and for some of you it does — the instrument is a standard, not a price, and the commercial consequence is that your optimisation problem changes shape from maximise NPV to meet the standard at least cost, which is a cleaner brief and usually a cheaper one.
The commercial prize. Two things. A credit committee and a rating agency will price a disclosed, covenanted, externally trusteed obligation materially better than an undisclosed provision of the same size, because the first is a known and the second is an unknown. And where the duty is regulated, the regulator's published minimum is a free, defensible floor that removes the largest internal argument you have.
PART ONE — DISCOVERY
Days 1–30: find what you already carry, and what already holds
Exercise 1.1 — The outliving register (one day, with the controller)
List every obligation whose final cash flow falls after the last date on your current long-range plan. For each: the duty in one sentence, the end date, the undiscounted total, the current provision, the rate used, and where the money is.
You will find three things and they are the same three every time. Some obligations have no end date recorded at all. Some have a provision and no segregated asset. And at least one has an asset pot whose adequacy nobody has tested against the undiscounted schedule.
Exercise 1.2 — The commitments that already held (half a day)
Appreciative, and it is not decoration — it locates your internal precedent. Find three commitments this organisation has kept for more than fifteen years through at least one change of leadership. A site rehabilitation programme. A pension covenant. A community agreement. A long supply relationship with a capital commitment inside it.
For each, write what held it: a contract, a trustee, a regulator, a published number, a physical fact, a covenant, a person's reputation. That list is your organisation's actual repertoire of commitment devices, and it is almost always longer than anyone expects.
Exercise 1.3 — Pull the external floors (half a day)
Wherever you are regulated, somebody has already published a minimum you can adopt for free. In the United States, 10 CFR 50.75 sets formula minima — a January 1986 base of $105m for a large PWR, $135m for a BWR, escalated — and requires a public funding-status report every two years. France requires dedicated, segregated assets under the law of 28 June 2006. Never construct an authority where you can cite one.
PART TWO — THE ARITHMETIC
Days 31–45: three computations and a board-ready page
Exercise 2.1 — Invert every funding ratio (two days)
For each obligation on the register, do this and only this:
- Write the liability undiscounted, by calendar year, to its end.
- Take the pot as reported.
- Solve for the real return that makes the pot equal the schedule's present value.
- Pull the fund's trailing twenty-year realised real return.
- Subtract.
The worked shape, at UK national scale: £130bn undiscounted across 120 years is £1.0833bn a year. A pot of £15bn needs an annuity factor of 13.846, which implies 7.22 percent real, forever. At a realised four percent the required pot is £26.84bn.
assets, GBP bn implied real return, forever
10.00 10.83%
15.00 7.22%
20.00 5.41%
26.84 4.00%
40.00 2.58%This is the single highest-return day of analysis available to a finance function this year, and it requires no new data.
Exercise 2.2 — Show the ratio's own sensitivity (half a day)
Same liability, five rates, and watch the funding ratio move without anything physical changing:
rate present value of the duty 'funded' by GBP 15bn
0.0% GBP 130.00 bn 11.5%
1.0% GBP 75.51 bn 19.9%
2.0% GBP 49.14 bn 30.5%
3.5% GBP 30.45 bn 49.3%
5.0% GBP 21.60 bn 69.4%A 4.27-times swing. Put this table in the paper. It is what retires the funding ratio as a governance number, and it retires it without anyone having to be accused of anything.
Exercise 2.3 — Price the successor's reprice (half a day)
If you use a declining schedule, compute your own exposure. On the Green Book table, a year-200 benefit stands at £6,207 today; from year 30 the plan's own continuation value is £17,423 and a successor re-applying the table gets £11,244 — 64.5 percent, a 1.550-times over-statement. At year 75 it is 41.6 percent.
Then publish your schedule in calendar form beside the horizon form: the forward rate this plan commits successors to, for named date ranges. A successor may still depart from it. They will have to do so visibly, which is the entire mechanism.
PART THREE — DESIGN
Days 46–60: the instrument
The structure: a segregated long-horizon obligation trust with a published implied-return covenant and a restatement gap.
| Term | Setting |
|---|---|
| Vehicle | Irrevocable trust, external corporate trustee, single permitted use |
| Assets | Off the sponsor's balance sheet; investment policy set by the trustee |
| Liability schedule | Undiscounted, by calendar year, to the end of the duty |
| Headline disclosure | The implied required real return, on the first page |
| Covenant | Implied required return ÷ trailing 20-year realised real return ≤ 1.0 |
| Top-up trigger | Ratio above 1.0 for three consecutive years |
| Term | The life of the duty, never the life of the licence or the lease |
| Security | The corpus, then the top-up covenant |
Why the trust and not a bigger provision. A provision is an estimate the issuer controls, and every estimate the issuer controls is discounted by the reader. A trust with an external trustee and a single permitted use is an observable. The rating and credit consequence of moving from the first to the second is the commercial case, and it is usually larger than the cost of funding.
Why the implied return and not the funding ratio. The implied return can be compared to the fund's own history. A funding ratio can be compared to nothing. That difference is why the ratio survives in board packs and why it should not.
Where to reach for a standard instead. Where the duty runs past a few thousand years — deep disposal, certain geotechnical closures, some sequestration undertakings — price stops carrying information and the correct instrument is a performance constraint with a compliance test. Precedent: EPA's Yucca Mountain standard, extended to one million years after NRDC v. EPA (2004), expressed as 15 millirem a year to year 10,000 and 100 millirem median thereafter. A dose ceiling, no rate. Your finance function's job then is least-cost compliance, which it is very good at.
The six devices, and what each costs you. Choose deliberately; do not collect.
| Device | Cost to the firm |
|---|---|
| Entrench in the constitution or articles | Unavailable in a crisis, which is the point and the price |
| Published formula + independent scorekeeper | Holds by reputation; the first defector destroys it |
| Irrevocable external trust | The rate is relocated into an assumed return, not eliminated |
| Counterparty with money at stake | Priced into your cost of capital; they may outlive you by less than the duty |
| Physical irreversibility | The option to change your mind |
| A standard instead of a price | Unpriceable, so untradeable — robust and occasionally very expensive |
PART FOUR — DESTINY AND DELIGHT
Days 61–90: make it survive you
The three that make it hold.
Put the implied required return on the face of the accounts. An assumption that must be disclosed is an assumption that must be defended. Under IFRS S2 the long-horizon narrative and its quantitative effects are disclosable, which means this arithmetic now has an external audience — an opportunity, because a number that must be published is a number that gets built.
Make the reporting biennial, public and formulaic. This is what the NRC regime gets right. A licensee cannot drift, because it must file against a figure it did not choose and a schedule it cannot move.
Separate the party that benefits from the party that owes. Germany's operators paid €24.1bn into KENFO in 2017 and the state took the disposal duty, because a utility is not an institution anyone should rely on to exist a century from now. Trust law has known this for four hundred years and corporate finance keeps rediscovering it.
And here is how it fails, from the record. The US Nuclear Waste Fund collected one mill per kilowatt hour under the 1982 Act — about $780m a year at recent generation — faithfully for three decades. The fee went to zero in 2014 after NARUC v. DOE, and the repository was still not built. Funding a duty and discharging it are two different commitments, and only one of them was instrumented. So write a delivery covenant beside the funding covenant: named milestones, named dates, named consequences. A fund with no delivery covenant is a large pot of money and an undischarged obligation, which is worse than either alone because it looks solved.
It also fails when the horizon is set by a licence, a lease or a plan period rather than by the duty. Put the horizon on the front page next to the rate, and let the two be argued about together.
THE FAILURE MODES, NAMED
So you can see them coming
The rate becomes the negotiating table. People notice that arguing the rate down is easier than arguing the benefit up. The defence is the symmetry rule from III.05, written into policy: the same rate applies to liabilities as to benefits, in the same paper, always.
The trust invests to hit the assumed return. A fund that must earn 7.22 percent real will take 7.22 percent real of risk. Set the investment policy against the realised achievable return and top up the difference in cash; never close a funding gap with a mandate change.
The standard is reached for too early. A constraint cannot be traded off, which is its virtue and its expense. Use it where price genuinely stops carrying information, not where the answer is inconvenient.
The disclosure is made once. A one-off is a press release. The covenant and the review date are what make it an instrument.
THE NINETY DAYS ON ONE PAGE
| Day | Action | Artifact |
|---|---|---|
| 1–15 | Build the outliving register: duty, end date, undiscounted total, provision, rate, assets | The register |
| 16–30 | Pull every external floor you are entitled to cite | The regulatory floor memo |
| 31–45 | Invert every funding ratio into an implied required real return | The implied-return page |
| 46–55 | Pull trailing twenty-year realised real returns; compute the restatement gap | The gap, first cut |
| 56–70 | Draft the trust: trustee, permitted use, covenant, top-up trigger | Trust deed, first draft |
| 71–80 | Publish the schedule in calendar form beside the horizon form | Treasury policy amendment |
| 81–90 | Board adopts the covenant, the review date and the delivery milestones | Signed board minute |
BOARD PAPER TEMPLATE
Long-horizon obligation: [name]
The number. Implied required real return X.XX%; trailing twenty-year realised real return Y.YY%; restatement gap Z.ZZ points.
The duty. [One sentence.] Undiscounted total £__ over __ years, ending in [calendar year].
The position. Assets £__ held [where], trustee [name]. At our realised return the required pot is £__. The shortfall is £__.
The ratio you have been shown before. "__% funded", which at 0% is __% and at 3.5% is __%. We are retiring it in favour of the number above.
What we ask. Adopt the covenant, the top-up trigger and the review date. Approve the delivery milestones separately from the funding schedule.
What we are not asking. A change to the hurdle rate.
APPRECIATIVE QUESTIONS FOR YOUR LEADERSHIP TEAM
- Which commitment made by our predecessors is still holding, and what specifically is holding it?
- Where do we already meet a standard rather than a price, and what has that made straightforward?
- If every long-lived duty we carry published the return it assumes, what would become arguable next year that is only assertable now?
- Which of our obligations would we be content for a successor to reprice, and which would we not — and what distinguishes the two lists?
- What is the smallest duty we could put into a properly trusteed vehicle this quarter, and whose signature does that need?
- Which of our funded duties has money but no delivery covenant, and who would notice first if the money were there and the thing never happened?