Charge cap proposals criticised as govt launches illiquids consultation

The new consultation, published on March 30, includes amendments to the statement of investment principles that would require DC schemes with more than £100m in assets to disclose and explain their policies on illiquid investments.

It also proposes updating regulations around employer-related investments to enable master trusts to expand their investment strategies to include private debt/credit, while confirming there will be no further regulations this year with the “sole purpose” of encouraging DC consolidation.

In his foreword to the consultation, pensions minister Guy Opperman wrote that 2022 will be a “seminal year” for value for money in DC, with schemes disclosing their investment performance “for the first time” and small schemes subjected to a “rigorous assessment” to determine whether they offer good value for their members.

We have not seen enough evidence to suggest the change would improve outcomes for members. In our view, changes to the cap are also unlikely to fundamentally alter schemes’ ability to invest in illiquid assets or the volume of investments in the round

Joe Dabrowski, PLSA

“Whilst this work continues, I am determined to pursue the path to opening illiquid asset classes to DC schemes. I am firmly of the view that all DC schemes should be considering diversifying their portfolio,” he said. 

“Ensuring the DC market is fit for the future is a key priority. Innovating the DC investment offer, maintaining appropriate protection for automatically enrolled savers and improving the member experience can be achieved simultaneously if we work in a collaborative, open way.”

Charge cap changes rebuffed

Proposals to exclude performance fees from the charge cap were put to consultation in November last year, the rationale being that these fees act as a barrier to greater DC investment in illiquids.

The charge cap is currently set at 0.75 per cent, and performance fees, often applied to private market assets like venture capital, are payable when investment managers generate high returns.

The Department for Work and Pensions said at the time that excluding performance fees “could overcome barriers to long-term investments” and “provide new opportunities to invest in areas such as British businesses and green projects”, something the government has long been keen to champion as part of the post-Covid-19 recovery plans and its “build back better” agenda.

Experts were cool on the proposals, however, and the government’s response to the consultation — also published on March 30 — noted the mixed response.

“Broadly, the responses received from the financial services sector and some master trusts welcomed the proposal. They reported that the charge cap currently limits DC schemes’ ability to invest in illiquid assets that come with performance fees,” the government’s response explained.

However, other master trusts, along with trustees’ services and legal advisory bodies, said the proposed change was unlikely to incentivise DC schemes to change their current approach, while some warned that it might even be counter-productive.

The DWP said it had “taken on board” the “mixed reaction” to the proposals, and would “take time to fully understand all the concerns raised, engage further, and to explore how these concerns might be addressed in the design of the policy as we pursue this further”.

It said it would consult again on “principle-based draft guidance alongside any proposed consultation on draft regulations”.

Joe Dabrowski, deputy director of policy at the Pensions and Lifetime Savings Association, said: “We do not support changing the charge cap to exclude performance fees. The cap provides an important protection for millions of automatic enrolment savers.

“We have not seen enough evidence to suggest the change would improve outcomes for members. In our view, changes to the cap are also unlikely to fundamentally alter schemes’ ability to invest in illiquid assets or the volume of investments in the round.”

New measures for illiquids

The combined response included a new consultation into various changes the DWP hopes will encourage greater access to illiquids. One such is the introduction of “disclose and explain” requirements designed to compel “relevant [DC] schemes” to set out their policies around illiquid investment.

Alongside this are regulations to compel DC schemes with more than £100m in total assets to disclose and explain their default asset class allocation in their annual chair’s statement.

The proposals are designed to “encourage greater competition and innovation based on overall value for money in the DC market”, the DWP said. 

“If all agents have access to asset allocation information, we believe members, employers, consultants will be able to compare schemes alongside other key metrics, including the scheme’s net investment returns, charges and quality of service. 

"In this vein, we believe this will complement the work of the [Financial Conduct Authority] and the Pensions Regulator to create a single framework for value for money in DC pensions.”

The DWP stressed that the proposed regulations would not require trustees to make any changes to their strategies, but rather to encourage them to “reflect on the decisions they have already made”.

The consultation proposes amendments to the statement of investment principles that would see DC schemes explain their policy on illiquids in their triennial SIPs, and for schemes with more than £100m in assets to disclose the percentage of assets in their default fund allocated to seven main asset classes in their annual chair’s statement.

These asset classes are cash, bonds, listed equities, private equity, property, infrastructure and private debt.

It also proposes qualifying a number of restrictions on employer-related investments. The DWP said that these rules, though appropriate for the type of schemes available at the time, now unduly limit master trusts’ investments in particular.

Callum Stewart, head of DC investment at Hymans Robertson, welcomed the overall thrust of the proposals, arguing that investing in illiquids “provides strong opportunities to improve financial outcomes for DC savers as well as have an impact on the world around us".

“It is a golden opportunity to create benefits for DC savers, and engage them more positively in how their pension is invested, while at the same time having an impact on the world around them.”

However, he suggested the government should make more of the “positive real world impacts from illiquid investments” and not focus “too heavily on financial aspects, particularly costs and charges".

“Indeed, this consultation does not make clear reference to the potential to have positive environmental or social impacts from illiquid investments. It’s time to update the way we think about value to ensure that this is compatible with future DC saver and their real world needs.”

The consultation on these new measures closes May 11.

Consolidation is on track

The DWP published a call for evidence in July last year on further ways of encouraging DC consolidation to ensure schemes provide their members good value for money.

The suggestion of additional measures met with a mixed reception, however, with many warning that there were risks involved in pursuing consolidation too quickly.

The government said that, though it remained concerned members are “suffering in poorly performing schemes”, it was confident “ongoing interventions and proactive trustees” will ensure members “are the primary and only consideration when deciding the fate of a pension scheme”.

It also pointed to data from TPR showing a “healthy” year-on-year decline in the number of pension schemes as evidence that consolidation remains on track.

It therefore proposed no new regulations to encourage further consolidation, though it stressed that would work closely with TPR to monitor the impact of the value for members’ assessment, which will start to be produced this year.

“DWP will work with regulators to create a framework that brings about consistent, informative, member-focused value metrics that will enable comparison and encourage competition on overall value. We believe this will improve member outcomes more so than targeted consolidation measures."