The latest of the Society of Pension Professionals’ regular columns looks at the debates raised by the government's recently closed consultation on the future of DC.
The government's recently closed consultation on the future of defined contribution (DC) proposes very significant changes to the pensions market in order to encourage scale, which it hopes will drive greater investment in UK productive finance.
Perhaps the most eye-catching proposal is that multi-employer DC schemes used for auto-enrolment, such as master trusts and group personal pension arrangements should operate at a minimum size, perhaps £25bn-£50bn. It is proposed that such a requirement would not apply before 2030, at the earliest.
There is some debate about whether such a minimum size would lead to better member outcomes. The government envisages 'fewer, bigger, better run schemes' and is partly inspired by the Canadian and Australian giant pension arrangements.
There is also some debate about whether mandating larger DC pension plans would achieve the government's policy objective to encourage significantly more investment of UK DC pension assets in UK productive finance. Larger DC plans have the potential to be able build bigger more sophisticated in-house investment teams with greater resources to consider and negotiate more complex private equity, venture capital and infrastructure investments. Bigger pools of capital may also create greater negotiating power because of the larger sums they have to deploy. However, whether an investment is made in UK productive finance (in the absence of further legislative intervention) will continue to be governed by the assessment of the interests of the pension arrangement members.
The level of disruption to the DC market which introducing such a minimum size requirement would create should not be under-estimated. Many providers will not be able to meet the minimum size requirement within the designated timeframe. Current business plans will not have been created with this target in mind. The terms for mergers may be difficult for the smaller party to robustly negotiate. Contrary to the government's objective, there may be a reluctance for smaller arrangements to invest in illiquids in case a receiving arrangement on a future merger does not wish to take an in-specie transfer of those particular illiquid investments.
The consultation asked whether any exemptions may be required to the size requirement. Exemptions would be likely to be needed for arrangements which cater for members with particular beliefs, for example Sharia compliant arrangements. It is also important that these proposals do not stifle the innovation which new entrants could bring to the market (for example CDC) and that the DC market remains a competitive market on an ongoing basis.
If the government proceeds with a minimum size requirement, further consideration may need to be given to where that level should be set. It could be argued that many of the economies of scale could be achieved at a much lower level, for example £5 billion of assets under management.
Consideration would also need to be given to how consolidation to achieve the required size would interact with some of the other initiatives in train, for example, value for money assessments and small pot consolidation.
In order to assist with the consolidation agenda, the consultation also included a proposal to allow transfers to be made without member consent from group personal pension arrangements. It is suggested that independent governance committees could carry out a similar decision-making role to trustees in the occupational pension scheme world. This could facilitate the transfer of the policies held by often disengaged members away from an underperforming group personal pension arrangement.
The government has an understandable policy objective to increase UK DC pension plan investment in UK productive finance. The business of pension arrangements is to provide good member outcomes. No doubt, all key stakeholders would agree that any potential divergence between these two important objectives should be given very careful consideration.
David James is a member Society of Pension Professionals' DC committee and a partner at Travers Smith
