Depriving small pension providers of their human right to enjoy their business, interference with fiduciary duty and mandation of investments are all significant interventions for Government to make in the UK economy, not just the pensions sector. So holding these market interventions to the highest scrutiny is of paramount importance.
Through a wide range of committees, each focusing on key subject areas, the Society of Pension Professionals (SPP) engages in a huge level of detail around the many consultations now shaping the UK pensions system. For David James, chair of the DC committee of the SPP, and committee member Harriet Sayer, co-ordinating the expertise of the industry – the body brings together actuaries, lawyers, professional trustees, DC consultants, investment managers, providers, administrators, covenant assessors, and other pension specialists – is key to ensuring new rules and regulations can be as useful as possible.
The day job for James and Sayer is at law firm Travers Smith, with the roles of head of pensions and senior counsel, respectively. So looking through a DC lens, which policy initiatives are set to have the biggest influence on the market, and what unforeseen consequences could emerge?
James points to the work around mega funds as critical. “The amount of change these institutions will experience as they increase their size is going to be massive. How much they do in house and how they evolve their capabilities, how technology is going to change things, use of AI, targeted support and value for money are going to be real game changers. And we’ve got a lot of clients working on how the industry can look after people better in the retirement phase, turning pots into pensions,” he says.
Innovation window
The SPP has made representations to acknowledge while there are benefits from scale, size of scheme is no guarantee of outperformance. And that historically the evidence shows smaller providers performing better. But it accepts the direction of travel on scale requirements is now set.
So does the SPP expect any smaller providers to survive or enter the market by 2030 through the innovation window included within the regulations.
“I think we don’t know is probably the honest answer,” says James. “I don’t think we have enough detail. This is an extraordinary innovation intervention in the market in many respects. There are not many other areas where they’d say you have to be big and create exceptions to it. One of the problems is that you potentially create a closed shop of people who’ve got scale and other people can’t come into the market. There was a point when the scale was more controversial and now the controversy is focused
on mandation.
But what is allowed to squeeze through that innovation window is going to be quite an important question, given without these interventions you wouldn’t need to demonstrate that you’re an innovator to join the market.”
Sayer adds: “The SPP has emphasised the need for scope for innovation and allowing new entrants. And retirement CDCs are a good example of where you’d want to allow schemes to offer
new products even if they weren’t necessarily at scale. And there’s scope for those exceptions built into the Pension Schemes Bill.”
Human rights
So as lawyers, what do James and Sayer think of the legal argument that an owner of a small provider might have that the scale rule clashes with their human right to enjoy the business that makes a profit for them?
James says: “There is a right to property. It’s quite high level but then there’s a public interest test where you can make a decision that actually overall this is objectively justified. The Pension Schemes Bill has a consideration of the Human Rights Act in the back of it. Parliament is sovereign albeit that they need to negotiate through the Human Rights Act.”
Capability boost
While the SPP does have reservations about shutting out smaller players, Sayer is excited by the potential of the scale that is being achieved, and does expect something different in future from an investment perspective.
She says: “We do a lot of horizon scanning, seeing what’s happening in the Canadian and Australian market which is obviously what Rachel Reeves has been doing a lot of. The in-house teams and resources they have and what that does in terms of changing the relationship that they have with external asset managers is genuinely exciting. In terms of the capabilities that they’re going to have, they’re going to completely outmatch anything we’ve seen before.”
Enforcing mandation
While the pensions minister says he does not want to activate the reserve mandation power, most providers have fallen into line with his wishes by signing the Mansion House Accord, and/or its predecessor the Compact. But the Accord is not a binding contract on signatories, and with three big providers not even signing it, there is still wiggle room for those who want to retain freedom to invest where they wish.
So what do James and Sayer think the Government will do if providers drag their heels on meeting their Mansion House Accord targets?
“They have made it fairly clear they don’t intend to use this power. They want it to sit in the background there and let the market do its job,” says James.
“There is a power to do it and Parliament is sovereign, but politically is very interesting when you think of the optics of it. They’re planning on everyone falling into line. But forcing stragglers would have some difficult issues.”
Sayer points out that enforcing the mandation clause causes political risk for whichever minister chose to do so. She said: “If it’s the government exercising that power and the investment doesn’t perform, whose fault is that?”
So do James and Sayer expect everyone to fall into line? “It is too early to say. By 2030 who knows, because by then the whole market will have moved on. We’ll have a series of experiences with private markets and value for money and having to have forward-looking metrics and thinking more deeply about what we’re expecting from investments. But in the short term I think it’s moving in that direction anyway.”
Amber or red
While the latest iteration of the value for money framework softens some of the harder edges around the performance test, James and Sayer think there is a real possibility that an existing provider will get an amber rating for its default, something that could cause huge complications for it.
Sayer says: “You can’t have a regime where it protects some funds from having an amber rating – otherwise [the system] doesn’t work.”
This is where the rules’ flexibility for providers to move members in an amber-rated default to an alternative green-rated one comes into play.
James says: “It gives an outlet there, and maybe that’s right from a policy perspective, where you’ve got one side of your business which is performing adequately and one isn’t.”
Sayer points to flexibility introduced in the latest version of VFM that allows members to stay within amber-related schemes where there are valuable guaranteed annuity rates or complex charge structures.
But will providers worried about having an amber rating then need to have two £25bn default funds (or two £10bn defaults by 2030), to make sure they have a viable back-up?
James says: “That then depends on what counts as a default, under the same common investment strategy. It is still to be worked out what’s going to count and be viewed collectively. Organisations are going to be nervous about this and obviously it’s existential for them. So there’s a lot of effort and thought and time going into staying away from that. There are issues around whether it will cause herding, to try and not take a bit of a risk. Is it more important to stay in the middle of the pack than to take a risk and try and get to the top of it with the risk that it might not come off and you’ll go to the bottom.”
Pension or property
James says the SPP spends a lot of time at present making a concerted effort not to approach pensions in a silo. “One of the great things about the SPP is that it brings together all sorts of different professionals from organisations who do all sorts of different things. The pension is just one part of what people want – they pay rent or they have mortgages and they may need care costs and they may have personal debt and they may have a different career progressions.”
Pensions for the self-employed is a key area of focus for the SPP, as is the issue of whether pensions should be accessed for first home purchase, although there is no fixed house view on this complex question.
Sayer says: “People can see both sides and can flip-flop even within the space of a week.”
Deferred annuities
James and Sayer’s firm, Travers Smith. has been advising on the Nest/Rothesay Life deal that will see the development of an innovative retirement income solution that involves buying slices of income to insure against tail-end longevity risk.
This is just one of several models, including CDC, flex-then-fix, flex-and-fix, that are not only going to potentially revolutionise the way pensions are withdrawn in retirement, but will also influence how schemes manage risk in the run-up to retirement age.
This is one area that Travers Smith has been focusing on with its work on the deferred annuity model. For the Rothesay/Nest model, the impact of the purchase of income on the overall accumulation strategy is limited.
“It’s only a percentage of the pot. You’ve also got your higher growth element, and that changes over the time. There’s a lot under the bonnet there which aims to smooth the income from the members’ perspective. The really innovative bit is trying to solve for that ‘I don’t want to run out no matter how long I live’ piece,” says James.