Pensions and Consolidation

December 22, 2022

The Government has announced a sweeping set of financial sector reforms. There were many bold ideas, but we should be particularly heartened that the Government will be taking pensions, and pension investment, seriously.

The UK pension industry is sometimes seen as the financial sector’s most boring member, and so it is not entirely surprising that the Governments pledges in the Edinburgh Reforms were mentioned as an afterthought. This is unfortunate, because UK pension assets are huge, and there is a massive opportunity here to boost returns and contribute to growth. The Government’s commitment to upping the pace of consolidation and proposing new Local Government Pension Scheme (LGPS) asset pooling rules should therefore be getting more airtime.

Despite having the second largest pool of pension assets in the world, the UK has been behind the curve when it comes to actually investing in a diverse range of assets. We saw this to full effect during the leverage liability driven investment (LDI) crisis, when the defined benefit (DB) pension sector (over 70% invested in fixed income) found itself facing a liquidity crisis thanks to a self-generated run on gilts.

While not nearly to the same scale, defined contribution (DC) pension funds suffer from a similar lack of options thanks to a less mature, less consolidated market than its international peers. Market structure matters, this isn’t just cultural: daily pricing is offered by Australian superfunds, like UK DC schemes, and yet Australian superfunds have 8% of their assets invested in infrastructure, far more than UK schemes. This is largely thanks to the huge size of consolidated, mature Australian superfunds, who can now invest more easily in a huge range of assets.

The Australians did not get there overnight. APRA, the Australian regulator has been pushing consolidation hard for decades. Hopefully the Government’s commitment to increasing the pace of consolidation will include a stronger role for regulators. In our report Unleashing Capital, Policy Exchange called for new ‘have regard’ clauses for regulators through the Financial Services and Markets Bill. Government also needs to look at how pension members can bring more pressure to bear too. One of the reasons Australian superannuation is so successful is that the relationship is directly between the employee and the superfund, rather than mediated via the employer. This gives employees a more direct stake in better returns and bigger schemes. In the UK context, this could help alleviate fears that the master trust market is already too consolidated and uncompetitive, and more accountability to employees should be considered as part of pro-consolidation reforms.

The same pro-consolidation approach has hopefully fuelled the proposals to pool LGPS assets. The LGPS has been calling for this consultation for much of the year, and it is sorely needed. Compared to large government schemes of the same size around the world, the LGPS is far more fragmented, less professionalised, and invests significantly less in ‘productive assets’. Canadian public sector schemes invest about two and a half times more on average in infrastructure and nearly five times more in private equity than the LGPS asset pools in England, for example.

Speeding up consolidation is a good thing, and better guidance can help achieve that. For what it’s worth Unleashing Capital argues that over time the LGPS could be improved further by consolidation of the pools themselves, or perhaps moving entirely to a Canadian model of pension governance, with a centralised board of world-class investment professionals and much investment management undertaken in-house. At least the Government is going to have this conversation.

Indeed, after a year dominated by Solvency II, it is encouraging that Government is looking at the insurance and pension industries with an eye for growth and using this next round to go further still. While an overall vision for growth from Government may be lacking, there is at least some bright shimmers here.

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