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Mansion House Reforms: Is market consolidation the only way?

23 January, 2024

7 MIN READ

When Jeremy Hunt delivered his Mansion House speech in July of last year, it was the UK pension regime that took centre stage. To many industry observers, the Chancellor’s speech signalled the start of something new—a radical overhaul that, for some, is as warranted as it is overdue.

But why the keen interest in pension schemes? In short, the Chancellor is trying to stimulate growth in the UK economy. The extent to which this can be achieved through monetary and fiscal policy is limited, which is why the assets held by UK pension schemes represent something of an untapped resource. As far as domestic growth is concerned, increasing pension scheme investment in ‘productive finance’ has real potential.

Recap: What is productive finance?

According to the Bank of England, “Investment in productive finance refers to investment that expands productive capacity, furthers sustainable growth and… make(s) an important contribution to the real economy”.
Examples include manufacturing plants and equipment (which can help businesses achieve scale), research and development (which improves the knowledge economy), and technologies, infrastructure, and unlisted equities related to these sectors.¹

Where does DB consolidation come into it?

Today, the DB market is—to borrow directly from the Chancellor’s speech—‘fragmented’. The majority of schemes are small, with less than £100 million in assets, meaning they lack the necessary resources to invest in productive finance, as described above. Consolidation would change this: a smaller number of schemes would hold a greater proportion of the UK’s pension assets. As well as driving the Chancellor’s growth agenda, having fewer, bigger schemes creates economies of scale, potentially improving outcomes for members and scheme sponsors alike.

What are the pros and cons?

There’s plenty to be optimistic about here. In essence, the Reforms look to achieve three very worthy objectives (more on this later).

They also pose a healthy challenge. Should an insurance buy-out really be considered the Holy Grail for DB schemes? Is de-risking always the right course of action? Where many in our industry would once have answered ‘yes’ without hesitation, in reality, the situation is much more nuanced.

That said, potential issues arise when considering each of the aforementioned objectives in turn:

Objective 1: The better and more long-term use of UK pension assets

Whilst we agree that UK pension assets could be used more constructively, it’s not just a bit ironic that the supposed solution to a problem driven, at least in part, by regulation is a government entity (i.e. the Pension Protection Fund (PPF)). In other words, if UK pension schemes have not been significantly investing in growth assets to date, then one of the main reasons for this has to do with the guidance—both implicit and explicit—imposed on them by the prevailing regulatory framework.

Certainly, the Mansion House Reforms seem to be encouraging schemes to take on more risk, and consider alternatives to buy out. There’s certainly merit in the latter—the former perhaps needs more thought. For years, private sector pension funds have been encouraged to do the exact opposite: actively de-risk, primarily as the funding regime for DB pensions appeared to make this a requirement, without actually stating as much. With the Mansion House Reforms, the government is changing tact—in tone, at least—but without offering schemes much of an incentive to invest in growth. Above all, surpluses are presently very hard to use, be it to improve member benefits or to return cash to the sponsoring company. Although not earth-shatteringly exciting, changing the trajectory of the Funding Code—for example, to include simplified regulatory requirements around surpluses—could be what’s required if we are to see trustees increase their allocation to return-seeking investments.

Objective 2: The creation of economies of scale to improve member/sponsor outcomes

One of the advantages of consolidation has to be the economies of scale it creates. Thanks to their size, larger investors stand to deliver better net investment returns. And better outcomes should be encouraged, not just for the benefit of smaller schemes, but for the benefit of the UK pension regime, and UK economy, as a whole.

That said, it’s unclear how establishing a public consolidator, by way of the Pension Protection Fund (PPF), would deliver better outcomes than the private sector. As well as representing a huge change in mandate, is a government entity really best placed to manage assets?

Naturally, there are other ways to deliver economies of scale: the services of a master trust, fiduciary manager or professional trustee do just this. The seemingly endless requirements placed on trustees, and how this impacts the life, and economics, of ‘smaller’ schemes, is the elephant in the room here. Part of the reason smaller schemes struggle with efficiency is the regulatory burden imposed on them. A regime that was heavily influenced by the Maxwell scandal of the 1990s²has snowballed to such an extent, that trustees today are in short supply. If funding regulation was made less restrictive—and the requirements for smaller schemes and trustees, in particular, were simplified—then there’s no reason a fiduciary manager couldn’t handle the rest. In other words, and although not as glamorous, the benefits of consolidation can be felt without the use of superfunds or the PPF.

Objective 3: Greater investment in the UK economy to bolster domestic growth

A stronger economy benefits everyone. But to what extent should UK pension assets be used to prop up the economy? Is it a step too far to mandate pension schemes invest a certain percentage of their funds in UK private assets? Would doing so in fact be detrimental to member outcomes?

To illustrate this point differently, take UK government bonds (gilts). Undoubtedly, investing in gilts lowers the government’s borrowing costs, but that doesn’t necessarily make gilts a great investment from an expected returns perspective.³ Top-down allocation requirements neither make sense when you consider the way capital markets operate, nor do they leave trustees with the bandwidth to consider what works best relative to their scheme. Even worse, they may introduce systemic risk, as was exemplified by the 2022 gilts crisis.

Perhaps, instead, we should return to a simpler time. Rather than implicitly—or, worse, explicitly—mandating allocations, the objectives and obligations of schemes and their trustees could revolve around generating long-term investment returns to pay member benefits as they fall due. As well as making life easier for trustees, we believe this focus would go a long way to accomplishing the goals set out in the Reforms.

How are SEI’s client directors helping?

As discussions concerning the Mansion House Reforms gather pace, we continue to reflect on the issues that matter most to DB trustees. As a global company with a significant UK footprint, SEI services defined benefit (DB) clients, defined contribution (DC) clients, and the broader financial advice industry. Our client directors bring this breadth of experience of bear in advising schemes on a wide range of topics, including regulatory reform.

¹‘Her Majesty’s Treasury, Bank of England and Financial Conduct Authority convene working group to facilitate investment in productive finance’, Bank of England, 20 November 2020.

²The Maxwell scandal refers to the theft of c.£500 million of pension fund money from the pension funds of media tycoon, Robert Maxwell’s, companies. The scandal led to the Pensions Act 1995 and other key pension reforms, which were designed to protect pension schemes from the vagaries of the sponsoring employer.

³For example, when one expects a negative return in real terms.

Interested in finding out more?

Contact a member of the team today.

Ian Love, CFA

Head of Asset Management, UK, EMEA, and Asia

Kerstin Hartmann, CFA

Consultant Relations Director

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