On 15th October, we held a seminar as a follow-up to the capital flows panel from the AREF conference in June
Speakers included:
- Moderator: John Forbes, John Forbes Consulting
- Mhairi Jackson, Asset Management Policy Manager, Financial Conduct Authority;
- Shalin Bhagwan, Chief Actuary and Interim CFO, Pension Protection Fund
At the Conference in June, two of the star panellists, Mhairi Jackson and Shalin Bhagwan, had to withdraw from the panel late in the day due a change in the interpretation of the pre-election purdah rules. Since then, we have had a change in government, but momentum has been maintained for the pension and investment reform agenda. Mhairi and Shalin picked up where we left off in June on how regulatory changes are impacting capital flows, with a particular focus on the transition from Defined Benefit (DB) to Defined Contribution (DC) pension plans.
The opening remarks for the seminar noted that in the time between the change of government and the seminar, there had already been three important consultations to which AREF have responded:
- On 4th September, the government published a Pensions Investment Review: Call for Evidence. This had a very short deadline for responses, and closed on 25th September.
- On 8th August, the Financial Conduct Authority (FCA) published Consultation Paper CP24/16 on The Value for Money Framework. This closed on 17th October
- As part of its quarterly consultation in September, the FCA asked for views on a technical point on Long-Term Asset Funds (LTAFs) in the Non-UCITS Retail Schemes (NURS) second scheme rules. This closed on 11th October
These were all discussed in the seminar.
The starting point for the discussions was the accelerated change in DB schemes following the 2022 “Mini-Budget”. As has been widely covered, DB schemes have been de-risking and transferring their pension liabilities to life insurers. There are questions over the capacity of insurers to take all the liabilities that DB schemes want to transfer. In order for the regulatory capital requirements for the insurers to stack up, the liabilities transferred need to be offset by assets that fall within the Matching Adjustment (MA) rules. Shortly after the LDI crisis in 2022, it was announced that the rules would change such that assets that can be included in the MA are those with returns that are “highly predictable” rather than “fixed”. This came into effect on 30th June this year. This theoretically significant change in the MA rules is undermined by a large number of restrictions added by the regulator and we are therefore sceptical that this will make much of a difference in practice. It was also suggested in the seminar that insurers might be circumventing the requirements by reinsuring with counter-parties in offshore jurisdictions with laxer requirements.
There was also a discussion about those DB schemes that are not transferring their pension liabilities to life insurers. A key factor here is what happens to current surpluses in DB schemes that may continue? This topic was covered in a Department of Work and Pensions (DWP) consultation that closed in April. AREF, in its response, that suggested an approach that would enable sponsors ultimately to benefit from surpluses whilst also encouraging investment in the real economy and providing scheme members with a greater buffer against market volatility would be to allow partial withdrawal of surpluses on an ongoing basis spread over time funded by investing current surpluses in higher returning illiquid assets, including real estate.
A very positive aspect of this is the way in which different arms of government are working together. This has not always happened in the past. It is also an important feature of the progress on DC reform, for which the FCA and The Pensions Regulator (TPR) are working hand-in-hand to ensure the same outcomes for contract-based and trust-based DC schemes.
A key element of DC reform will be ensuring more consolidation. There is a recognition that there are many sub-scale and inefficient to run DC schemes. The previous government clearly saw the route to achieving this as being through Master Trusts. This has also been a feature in the thinking of the new government and the view in the seminar was that there would be further pressure on DC schemes invest through Master Trusts and for there to be consolidation amongst the Master Trusts themselves, with a prediction of 6 to 10 surviving.
An alternative route to consolidation is emerging through the development of Collective DC (CDC). The first CDC scheme, for The Royal Mail, launched the week before the seminar, after which the Department of Work and Pensions (DWP) published its detailed consultation on the introduction of multi-employer schemes. CDC can give better retirement outcomes but comes with risk. The FCA is evaluating what those risks are.
In terms of the mechanism for DC schemes to invest in illiquid assets, considerable effort has gone into the development of the LTAF. More work is needed for real traction, for which the investment industry, the regulators and the DC schemes need to work together. A point raised from the audience is the challenge of the investment platforms through which DC schemes invest not being able to accommodate illiquid assets. This is also an issue for funds for retail investors. Although there was general agreement that solving the platform issue is a priority, it was less clear how this might be achieved.
There are more LTAFs in the pipeline, so we can expect more developments in the coming months.
There will be a further seminar specifically on the LTAF to be held jointly with the Investment Property Forum (IPF) on 11th February. Mhairi Jackson will also speak at this.
Many thanks to Osborne Clarke for hosting the seminar at their office.
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