Pensions Investment Review: Call for Evidence

Background

On 4 September 2024, the Government published a call for evidence as part the first phase of its pensions investment review. This first phase aims to boost investment, increase pension pots and tackle waste in the pensions system.

In this response

• General comments
• Responses to specific call for evidence questions

General comments

The pace and breadth of pensions reform is a constant challenge for schemes, and, among other matters, they are currently managing the introduction of pensions dashboards and the removal of the lifetime allowance. In addition, absent regulations to validate retrospectively scheme amendments (subject to appropriate safeguards), a huge amount of industry resource will be focused on dealing with the fallout from the Virgin Media decision. We would encourage the DWP to consider schemes’ capacity to deal with further changes when formulating their proposals.

Responses to specific call for evidence questions

Scale and consolidation

1. What are the potential advantages, and any risks, for UK pension savers and UK economic growth from a more consolidated future DC market consisting of a higher concentration of savers and assets in schemes or providers with scale?

We note that the Government anticipates consolidation of the DC pensions market to support greater productive investment and better retirement outcomes.[1] The Pensions Regulator (“TPR”) has been clear that it supports consolidation in the pensions market where it offers value and security to members.[2]

We appreciate the arguments for scale and would support the generally held view that there would be advantages to consolidating very small and/or poorly resourced schemes into larger, well-resourced alternatives. However, we would note that, in our experience, there are also a significant number of well-run and supported single employer trust-based schemes (see our response to question 2 below).

We would also observe that moving savers and pension assets into a small number of large schemes will inevitably concentrate risk and create the potential for more significant adverse consequences for the pensions system should a provider fail. As we mentioned in our response to the DWP’s June 2021 consultation Future of the DC pension market: the case for greater consolidation, larger schemes are not immune to problems or mistakes which, due to their size and scale, could have more wide-reaching impact compared to smaller and medium-sized schemes and potentially be more difficult to resolve.

This risk might be mitigated through authorisation and supervision requirements, such as in the existing master trust regime. Exit strategies and contingency planning would need particularly careful management in a more consolidated environment, to ensure that there would be a suitable alternative provider with capacity to accept transfers of members and assets on a large provider failure, and to ensure that members are appropriately compensated for any losses. That is because, in our view, the risks of a disorderly market exit could not be removed entirely.

A more concentrated market may also result in waning competition which, in turn, could lead to less innovation and less choice for employers over pension provision. We are also concerned that, were the market to contract too quickly, this could have a significant negative impact on other developments such as pensions dashboards and solutions for small, deferred pots. Transfers between schemes can affect administration and member records/data, which are central to the success of those projects.

2. What should the role of Single Employer Trusts be in a more consolidated future DC market?

In our experience, single employer trusts play an important role for those employers who consider it appropriate for their employees. They enable employers to create bespoke pension offerings which can be tailored to the particular needs of their workforce and their wider pension provision. This includes providing unusual benefits, such as DC benefits with guarantees or underpins, and greater financial support such as employer-financed running costs or using DB surplus to fund DC pension provision. These schemes can be, and often are, particularly at the larger end of the market, well-resourced and well-run, and perform an important function. We support proposals to ensure that all DC schemes provide good value and retirement outcomes, and we consider that single employer trusts would continue to play an important role in that landscape.

3. What should the relative role of master trusts and GPPs be in the future pensions landscape? How do the roles and responsibilities of trustees and IGCs compare?

We strongly support the focus in recent years from the Government, the FCA and TPR on more co-ordinated regulation of trust-based and contract-based pension schemes such as the work towards a new market-wide value for money framework. We believe this is the direction of travel for workplace pension provision and provides a more holistic and rounded view of the marketplace. Most employers and individual pension savers do not understand the finer distinctions which separate the different form of pension “wrappers”. With the arrival of pensions dashboards, which will show all pension arrangements “at a glance” on a mobile phone screen, we believe these distinctions are likely to be valued even less in the future, especially from an end user point of view.

However, trustees and IGCs have different roles from a legal perspective, for example trustees are the legal owners of pension scheme assets and have trust law duties to look after those assets, but IGCs are not asset owners and do not have such duties. In practice their roles are not dissimilar though, and whether you are taking part in an IGC meeting or a trustee board meeting, the discussions around value for money and ESG matters tend to cover similar ground. We just need to remember that the method by which a trustee and IGC can achieve any DC policy objectives may need to differ, because of the legal structure that underpins their roles.

Which players in a market with more scale are more likely to adopt new investment strategies that include exposure to UK productive assets? Are master trusts (with a fiduciary duty to their members) or GPPs more likely to pursue diversified portfolios and deliver both higher investment in UK productive finance assets and better saver outcomes?

In our view, there are no inherent differences in the ways in which master trusts and GPPs are likely to approach new investment strategies. While there are differences in the legal and regulatory regime that applies to master trusts and GPPs and how they are structured, investment decision making follows similar patterns. Relevant considerations across the market will include charge caps for default arrangements, market competition, and how appropriate investments are for each cohort of members. Our understanding is that will continue to be the case whether those considerations relate to the fiduciary duties of master trust trustees (ie the need to invest in the best financial interests of members), or consumer duty principles in the case of providers of GPPs.

While default funds may be desirable targets for investment in illiquid assets due to their scale, changes to existing law would most likely be necessary if default funds are required to be invested at a certain level in UK productive finance, especially given the constraints imposed by the charge cap.

In our view, while larger-scale pension schemes may have greater scope to invest in illiquid assets, it does not necessarily follow that larger pension schemes are more likely to invest in UK-based assets as opposed to assets in other locations. Investment decisions are based on relevant factors such as risk level, investment return, costs and charges, diversification, etc, which in turn will be influenced by the geographical location of the underlying investment.

4. What are the barriers to commercial or regulation-driven consolidation in the DC market, including competitive and legal factors?

There is an extensive variety of size and type of pension scheme in the UK (including trust-based schemes, contract-based schemes, occupational pension schemes and personal pension schemes).

Schemes are subject to different sets of legislation, regulation, and scheme-specific rules. Barriers to consolidation vary depending on the type of schemes involved. Particular hurdles apply to contract-based arrangements where bulk transfers without member consent are not possible under current legislation. In trust-based arrangements, the decision to carry out a bulk transfer will require trustees to assess whether there is power to do so under the scheme’s trust deed and rules (taking into account tax legislation) and whether the transfer is in members’ best interests.

Other key barriers, which we raised with the DWP in a paper on barriers to DC consolidation prepared by the DC Governance Group in 2021, include:

• most commercial providers will not currently accept transfers from DC schemes where DC benefits have DB underpins or other guarantees. The transfer of such benefits is typically very difficult to achieve and has been deemed too difficult in many cases. It may also involve a direct cost to the sponsoring company in relation to buying out the value of the underpin, going through a benefit conversion exercise before transfer, or excluding such members from the transfer
• where administration costs are currently paid by the company in a single trust scheme and members pay relatively lower fees, commercial providers may find it challenging to provide equivalent member-borne charges. Members may also bear the cost of consolidation (in the form of transition costs in moving assets between schemes)
• transfers can result in the loss of certain tax protections, eg protected tax-free cash or protected minimum pension ages – this could be an increasingly acute problem as we approach 6 April 2028 when the statutory minimum pension age is due to change from 55 to 57
• discretionary or enhanced benefits potentially available to members under single employer trusts may be lost on a transfer
• smaller schemes may be unattractive to commercial providers and may be unable to consolidate or unable to negotiate suitable terms
• commercial providers may not be able to replicate bespoke investment strategies that are offered in single employer trusts, leading to lower projected outcomes for members
• it may not be possible to transfer members invested in closed or “gated” funds. This was a problem in 2020 when the industry saw the gating of many property funds
• consolidation of DC sections of hybrid schemes could prevent members funding their pension commencement lump sum from their DC pot when their DB scheme pension comes into payment. This can be a significant disadvantage for affected members by removing flexibility over their retirement choices and adversely impacting their retirement plans.

Compulsory winding up and consolidation which overrides any existing legal hurdles may be the only viable option for schemes which are prevented from consolidating for the reasons above. However, any such requirement would need to be carefully considered to ensure members are not disadvantaged by such consolidation.

Costs vs Value

2. Is there a case for Government interventions, aimed at employers or other participants in the market, designed to encourage pension schemes to increase their investment budgets in order to seek higher investment returns from a wider range of asset classes?

We note that there are existing interventions, in particular the exemption of certain performance-based fees from the charges cap, and changes to FCA rules to allow LTAFs as a permitted link under DC platforms, which may become more relevant and widely used if investment in illiquid assets increases.

Our concern is that interventions which aim to increase schemes’ investment budgets could have unintentional negative impacts on other aspects of pension saving. For example, by increasing investment budgets, schemes may need to make an equivalent reduction in other costs, such as administration fees, to remain competitive and, where applicable, within the charge cap. Administration services are vitally important for the successful operation of pension schemes and a focus on investment at the expense of the quality of administration could be counterproductive.

In terms of new interventions:

• a tax incentive for pension schemes to invest in certain classes of assets may be helpful
• some schemes may find it useful to have guidance on factors they should consider when deciding how to split budgets within the default arrangement charge cap (eg between investment, administration and other service providers).

It should also be noted that in the current market there are wider issues at play that could influence schemes’ ability to consolidate and/or invest in a wider range of asset classes. For example, many DB schemes may be redirecting resources at this time in order to address potential historic documentation issues highlighted by the recent Virgin Media decision by the Court of Appeal.

Investing in the UK

1. What is the potential for a more consolidated LGPS and workplace DC market, combined with an increased focus on net investment returns (rather than costs), to increase net investment in UK asset classes such as unlisted and listed equity and infrastructure, and the potential impacts of such an increase on UK growth?

Please see our answer to question 3 in the Scale and Consolidation section above. While greater consolidation may mean that larger schemes are better able to invest in illiquid assets, it does not necessarily follow that such investments will be in UK assets.

3. Is there a case for establishing additional incentives or requirements aimed at raising the portfolio allocations of DC and LGPS funds to UK assets or particular UK asset classes, taking into account the priorities of the review to improve saver outcomes and boost UK growth?

Please see our answer to question 2 in the Cost vs Value section above. Our concern is that mandating certain investments would contradict existing legal and regulatory investment duties. For example, trustees are currently subject to various investment duties (including their fiduciary duty) as a matter of trust law and the existing pensions law requirements under sections 33 to 36 of the Pensions Act 1995, and FCA-regulated providers are subject to consumer duty principles.

Mandating investments could have other unintended consequences such as investment “herding” and unintended impacts on the market. Incentives may help increase investment in UK assets or particular UK asset classes but would not necessarily determine investment decisions which are based on consideration of all the relevant factors.

[1] Press release: Chancellor vows “big bang on growth” to boost investment and savings (20 July 2024)

[2] TPR’s Corporate Plan 2024 to 2027 (3 May 2024)