How to attract more DC investment in productive finance and the energy transition

Former Chancellor of the Exchequer, Lord Hammond of Runnymede, is recently reported to have warned that stronger measures are needed to address the “quite shocking” lack of investment by UK pension funds in domestic markets and suggested that the Government's Mansion House reforms may not be enough to achieve this due to their “voluntary” nature.

Mansion House reforms

It is often said that necessity is the mother of invention and with a 40% reduction of new companies listing in the UK since 2008, necessity is the point we are now at. To fuel the government’s plan to boost investment in productive finance, the Mansion House reforms announced new investment vehicles, tailored to the needs of pension schemes and allowing investment into the UK’s innovative companies, including £250m committed to the Long-term Investment for Technology and Science (LIFTS) initiative, intended to provide over a billion pounds of investment from pension funds and other sources into UK science and technology companies.

The government has also announced a new Growth Fund within the British Business Bank (BBB) which will draw on the BBB’s strong track record and a permanent capital base of over £7bn to give pension schemes access to opportunities in the UK’s most promising businesses.
Measures also include to further strengthen the UK’s renowned venture capital industry with a new Venture Capital Fellowship scheme, which will support the next generation of world-leading investors in our VC funds and a £20 million commitment to foster more ‘spin-out’ companies, firms created using research done in universities.

Additionally, the government has put aside at least £50m additional funding for the BBB’s successful ‘Future Fund: Breakthrough’ programme – that will provide direct investment to support these innovative companies to scale up.

All of which is intended to generate around £10bn a year for the economy and sounds terribly exciting, with Australian manager IFM being the first notable investor post the Mansion House announcement. It pledged to invest A$10bn to UK illiquid investments.

So at least our Australian friends believe the UK is a good place to invest but what about our own DC investment chain and is the “voluntary” nature comment from Lord Hammond the issue here?

Quite a lot is already in place at the delivery end; the Australians certainly think so. Globally, London is the second most important place to trade in illiquids and productive finance, particularly for new listings, after the US. So, how can UK Pension schemes take advantage of the second most important place to trade in illiquids and productive finance, which is based in London? 

FCA listing regime

The FCA is currently examining priorities for developing the UK listing regime, following changes put forward for consultation in May 2023 and a further consultation on the new regime in advance of the expected publication of its final rules in the spring of 2024, which include:

• Strategies for making the UK’s listing regime more effective, competitive and easier to understand.
• Assessing post-Brexit implications and priorities for tackling the reduction in the number of companies listing in the UK since 2008.
• Maximising UK market competitiveness and increasing the attractiveness of the UK for investors.
• The potential removal of eligibility requirements that deter early-stage companies.
• Assessing the removal of mandatory votes and ensuring shareholder rights remain protected.
  

The final point here is quite important, with voting and shareholder rights, particularly with the journey to a carbon neutral economy.

Do we just invest in illiquid and productive finance or can we take this as an opportunity to development the critical Green Transition to achieve net zero by 2050?

This is an aspect recently raised by the PLSA, which aims to establish what role pension funds can play in supporting growth in the UK economy. The government and regulators have a potentially unique opportunity here to engage with a range of associated topics such as the Taskforce for Nature-related Financial Disclosures (TNFD), the ‘S’ in ESG and the Green Taxonomy initiative.

For DC investors, initial developments to the supply chain to meet and drive the economic demand include revising the Value for Member/Money (VfM) framework the UK government put forward last year to ensure it consists of more than just low charges.

A charge cap of 0.75% p.a. is going to seriously limit investment in illiquids and productive finance and quite simply the focus of the last 23 years, following the introduction of Stakeholder pensions, is now recognised to have been wrong.

In order to have an appropriate allocation to illiquids and productive finance, the current charge cap needs to go and the Chancellor’s Autumn Statement included a commitment to engage with industry on proposals to ensure all aspects of the pensions industry are supporting best outcomes for savers, including how to shift employer incentives away from low fees towards long-term pension investment performance.

However, a 23 year direction of travel will take some time to turn around and the early ideas around the introduction of a charge collar would need to avoid the collar becoming the norm and the content of VfM merely becoming a checklist. Hopefully the stated intent of the DWP, TPR and FCA to develop a “holistic framework” on VfM will be good news here.

DC consolidation and the need for "courageous policy"

A key challenge is that we have a sizable amount of DC assets in contract-based pensions, which do not have the requirement to involve trustees in any decision making. We do still however, have the legacy with-profits issue to resolve, which is a sizable hurdle in consolidation. Although, if we can resolve GMPe [Guaranteed Minimum Pensions Equalisations ed] , I’m sure we can resolve this.

Further developments include the DWP’s review of the master trust authorisation and supervisory regime. A key outcome of which is that TPR is expected to shift its regulatory focus from preventing scheme failure to investment governance and value. TPR has confirmed that it will focus on value received by members and will challenge master trusts on investment decisions. So, the importance therefore is what constitutes VfM, how that definition will change overtime and who decides on the changes. In 2001, charges were the essence of VfM but now charges are less significant.

Importantly there are many parts in the delivery chain, from salary deduction to investment availability and trade completion, with one of those parts being tax relief, which is at least 20% of any DC contribution.

However, some warn that this is a risk the government may not wish to take but, when challenged, most have been unable to clearly articulate what the risk is.

One view is that philosophically the tax relief is not government money, it’s the tax payer’s money. However, so is road tax, which isn’t invested in the road infrastructure and so the government controls the overall tax collected. If the government was to set parameters in which the tax relief could be invested, the pension member still receives the proceeds, Trustee training is not needed (enabling the investment to be available much more quickly) and the asset is invested where the UK economy needs it (which is arguably good use of government money). Lord Hammond may also be a little happier. And don't forget, we are only talking about the 20% tax relief. The other 80% (member and EER contributions) is available to invest as per the current structure.

If mandating is considered a ‘courageous policy’ (I’m a fan of Yes Minister), one alternative way to reduce the risk is to introduce Auto-Investment to sit alongside Auto-Enrolment, where the tax relief is invested within the stated parameters unless members wish to opt-out. Using the tried and tested theory of using inertia in a positive way that made Auto-Enrolment so successful, Auto-Investment could be equally successful without the Government needing to introduce full compulsion.

With the FCA developing the UK listing regime, the Mansion House reforms may then be just enough to address the “quite shocking” lack of investment by UK pension funds in domestic markets.

Paul Tinslay is a professional trustee at Dalriada Trustees. He will be discussing the impact of the Mansion House Reforms at Net Zero Investor's Defined Contribution Forum on 31 January at the London Stock Exchange. To find out more about the event, click here.