This blog post is a rare departure for me. I am going to support, in principle at least, a UK Government initiative! Even if it was overhyped and delivered somewhat less than promised. Yes, of course, there is a but.
In his Mansion House speech last month, the Chancellor presented a series of new reforms to the financial services sector. The aim is to unlock capital for industry and increase returns for savers. The idea is to increase funding liquidity for high-growth companies through reforms to the UK’s pension market and strengthening the UK’s position as a stock market listing destination. The government is also reforming and simplifying the financial services rulebook to ensure growth-friendly regulation of any financial services centre without compromising stability. This is part of a broader process known as the Edinburgh Reforms.
A key element of this reform is the consolidation of pension funds to enable them to raise their returns by making more investments considered higher risk – especially in small firms developing new technologies. According to government calculations, this could create an extra £50 billion of investment into innovative firms by 2030, giving a 12% (£1,000 a year) boost to the pension of an 18-year-old who enrols in one today.
The largest pension scheme in the UK is the Local Government Pension Scheme (LGPS). There has already been a pooling of assets, and the latest consultation envisages further consolidation. Notably, this process is being led by the Treasury, which sees this as part of the UK pension investment reform. LGPS consolidation in Scotland is devolved, so outwith Treasury control. Here consolidation is moving more slowly, supported by trade unions but resisted by employers.
UK pension funds have assets of over £2.5 trillion, the largest in Europe and second only to the US worldwide. However, UK funds have cut their allocation to British-based companies, bringing down the valuations of many UK businesses. UK funds have also been slow to invest in infrastructure, unlike many global funds, who even own critical elements of UK infrastructure. As Colin Maclean put it in The Herald recently, “The process certainly accelerated with Brexit and UK political turmoil, but more recently it has seemed to be driven by financial regulation and some debatable guidance on risk and returns from pension fund advisers. Much of the UK problem seems self-inflicted.”
It's not as if UK funds have an excellent record of success. The investment return on the average UK pension fund over the last 10 years has lagged behind Australia, Canada and the Netherlands. This significantly reduces retirement pensions for those in DC schemes and undermines the viability of better DB schemes. The investment industry is always wary of greater regulation, and the lack of transparency means most pension contributors need more understanding of these issues. This limits the voluntary buy-in by pension funds, and the current initiative is tame.
Another reason for investment reform is the need for pension funds to green their investment strategies and portfolio assets to help the world transition to a net-zero economy. Expertise is needed to achieve this;; small funds rarely operate at the necessary scale. A new report from the University of Exeter funded by the Department for Energy Security and Net Zero highlights the role of pension schemes and other asset owners in the net-zero transition. It warned that it was too late to tackle climate change incrementally, and a dramatic acceleration of progress across society and the global economy was now required. However, the current tools available to pension trustees to evaluate their strategies are limited, and they typically delegate their investment decisions to ESG indices. As a pension trustee, I am only too aware of their limitations.
Pension fund consolidation makes a lot of sense, as does investment in a broader range of asset classes. However, support for the financial deregulation that comes with the broader reforms may be dampened by memories of how previous “light touch” regulation led to the crisis conditions in 2008 – and the main cause of poor investment performance ever since. Also, further movement away from the EU's rules, as the Chancellor envisages, would make it harder to secure the prize of an equivalence agreement with the UK and other jurisdictions.