Why UK pension funds need urgent reform to benefit all

The term tracks the funding gap that starves British SMEs of the finance they need to grow. Crucially, that gap can widen in times of crisis, such as the economic uncertainty of the last two years brought on by the Covid-19 pandemic.

Currently, it is estimated that there's as much as a £15bn gap per annum in the growth-capital available to companies that are too small to be funded by public markets, but large enough to have outgrown venture capital funding. An overreliance on debt is not a long-term solution.

According to BGF's research, there are around 21,000 of these businesses in the UK that make up the dynamic and fast-growing midsection of our economy.

There is an urgent need - and I believe a compelling opportunity - to identify new pools of capital that will serve these growing firms in need of funding.

Not only could this solution close the gap, it could fuel Britain's growth for years to come - and that's by unlocking the power of our domestic pension funds. It can take Britain from laggard to leader in driving the knowledge-based economy of the future.

By 2025, defined contribution (DC) pension schemes will have become one of Britain's largest reserves - with close to £1trn in capital. The impact this could have if invested into UK enterprise is enormous, while giving savers a stake in Britain's entrepreneurial future and the real economy.

Pension funds have the power to be transformative because they think and plan longer term - unlocking vast pools of institutional capital that would yield results for the invested companies and the pension holder themselves.

In order for this to become a reality, regulatory change is needed to address the existing framework and enable for the pension pots to be used to their full effect.

The government recently closed yet another consultation on pension fund reform, with outcomes set to be revealed imminently.

The key change we need to see is to the charge cap of the DC schemes which has unduly restricted the schemes' ability to invest broadly by focusing instead purely on cost. We need a focused exemption to the current rules that would allow a wider investment mandate. This exemption would enable DC schemes to direct a greater portion (we are proposing up to 5%) of investment to high-potential growth-stage businesses, and in turn deliver higher long-term absolute returns for pension holders.

We would propose for the exemption criteria to include the need for funds to only make minority growth investments, not buyouts, in select SME companies that are based in the UK and with a longer average hold period.

Exempted funds should also have strong ESG principles at their core, should direct the majority of their capital outside London and the south east, and target sectors identified as critically important by the government - such as life sciences, artificial intelligence, and clean energy.

Unlocking the hidden capital of UK pension funds could provide fast-growing UK businesses with the financing they need to grow, employ, and invest. It will power UK GDP and benefit the millions of savers who have auto enrolled in DC pensions. This is a winning combination.

It's time for the government and our financial institutions to be bold and tackle the long-standing growth-capital gap head on.

With the pensions system under review, we have a huge opportunity to address the structural problems that have plagued our financial infrastructure for almost a century.  

By breaking down the stifling barriers that inhibit pension scheme members from gaining exposure to growth-stage businesses, we can redefine the pension system for good and create benefits for us all.

Stephen Welton is founder and executive chair of BGF