These areas are all interlinked, and the legal and practical considerations for pensions practitioners span across all three of them. Whilst more detail is needed, what is clear is that trustees and providers will need to substantially re-think the way they approach investments and how they demonstrate that they are delivering positive outcomes for pension savers.
Productive Finance
Over recent years, successive Chancellors have set out plans to encourage pension schemes to invest in Britain but these have generally been light on detail. This is an initiative that the current Chancellor seems to have fully embraced. In summer 2023, the Chancellor outlined plans to drive consolidation in the DC market and to encourage investment in less liquid assets.
Since summer 2023, we have seen 9 of the UK's biggest DC schemes sign the Mansion House Compact under which they commit to invest 5% of their assets under management in less liquid assets by 2030. We have also seen a "compact" (i.e. a voluntary expression of intent) launched by the British Venture Capital Association, which has seen a significant number of its members stating an intent to supporting pension funds investing in this way.
The key drivers for this policy are: (i) the prospect of attracting significant investment in British infrastructure, technology and business; and (ii) a desire to achieve better outcomes for pension savers. In particular, the loss adjusted investment returns often achieved by Canadian and Australian pension funds who do invest in Britain as part of a balanced portfolio generally far outstrip returns experienced in current, traditional UK DC schemes.
The Autumn statement, delivered on 22 November 2023, saw further helpful changes introduced to support this initiative. However, to date, pension scheme trustees have appeared relatively sceptical. Save for a few outliers, there has been little enthusiasm for this initiative from the pensions industry as a whole.
The Budget appears to be trying to address this inertia by introducing a disclosure obligation. Under the new proposals, by 2027 DC schemes will be required to publicly disclose their levels of investment in British business, their costs and net investment returns.
Local Government Pension Schemes will be required to disclose their level of investment in UK equities from April 2024.
Value for Money (VFM)
Linked to the Productive Finance initiative, over the last year there has been a shift in focus away from annual management fees towards a more holistic assessment of whether pension savers are getting value for money.
Both the Financial Conduct Authority and the Pensions Regulator have been considering VFM for some time. The March Budget announced plans to significantly increase their powers in assessing VFM and protecting pension savers.
Under the reforms, DC schemes will be required to publish a comparison of their performance data against competitor schemes, at least 2 of which must be managing a minimum of £10bn in assets.
Where schemes failure to demonstrate VFM they may be prevented from taking on new customers or even be compelled to wind up.
It is anticipated that these powers will be in force by 2027.
Pensions Lifetime Provider
In the 2023 Autumn statement, the government outlined plans to introduce a pot follows member, life time provider model. Initial consultation with the industry has taken place since this announcement and the government confirmed its commitment to further explore this model.
What practitioners need to consider
Much of the detail around these government policies remains to be settled on.
When considering these changes, trustees are legally bound to abide by their fiduciary duties and act in the best financial interest of members. We have seen significant debate within the industry over what this means in practice, particularly in the context of the "ESG" investment discussion. A perennial question for all trustees moving into this new world will be "What does good look like and how do you demonstrate it?"
The government has made it possible for pension funds to theoretically invest in less liquid assets through Long-term Asset Funds ("LTAF"). There has also been a relaxation on charges caps for automatic enrolment default funds. However, at this point there are still many questions over how LTAFs will be structured and work in practice. The vast majority of the Trustees we speak to are reluctant to engage in this area until market norms begin to emerge and detailed regulatory guidance is issued. Also, although not explicitly stated, the pressure to invest in Britain is at odds with the current legal framework around registered pensions scheme investment which is naturally geared towards securing the best financial outcomes for members. To the extent that productive finance meets this criteria, then fine. However if this is demonstrably not the case, Trustees will be loath to invest in UK centric investments where there are better returns to be had elsewhere. Indeed, under the current legal framework, they would be heavily censured for doing so.
For many trustees, who are grappling with an increasing governance burden, Productive Finance comfortably sits in the "too hard" column.
A key challenge for VFM will be the detail regarding how it is measured. Even the strongest advocates of investing in less liquid assets will tell you it is a long-term play. This is perfect for pension savers. However, such investments are unlikely to produce exceptional returns in the first few years. The industry is still awaiting detail on what VFM will actually look like and how any longer-term investments will be assessed.
Whilst it is not clear exactly what VFM will look like, it is clear that we are moving away from the "race to the bottom" on annual management fees that we have seen since the introduction of automatic enrolment 12 years ago.
Similar concerns are being raised in respect of the proposed lifetime provider model. Many in the industry are concerned that by severing the link with employers, who often have more negotiating power and capability in respect of fees and fund selection, many individuals will actually end up worse off in the long run. Significant consideration is needed regarding how to determine whether the lifetime provider model will be in individual pension savers' interests and how to regulate this.
Whilst we are in no doubt the DC pensions world is in need of reform and that both more diversified investment and a more sophisticated approach to assessing value for money are welcome, we are a long way off from actually seeing what it will look like in practice.
This article first appeared on Law360 here.
