DWP consultation ramps up pressure on small schemes to consolidate

In aconsultation published on Wednesday the DWP made three proposals to facilitate investment by defined contribution pension schemes in less liquid assets such as smaller and medium sized unlisted firms, housing, green energy projects and other infrastructure.

It would require larger DC pension schemes to document and publish their policy in relation to investment in illiquid assets, and report annually on their approximate percentage allocation to this kind of investment. It would also require some or all smaller DC pension schemes to conduct a triennial assessment of whether their members’ may receive better value if the scheme consolidated into a larger scheme with more scale, and was wound up.

A boatload of smaller schemes should probably be considering consolidating right now, so this extra nudge is no bad thing

Nathan Long, Hargreaves Lansdown

It also proposes an additional method of assessment for compliance with the charge cap, which applies in default funds of schemes used for auto- enrolment.

Part of the rationale for the proposals comes from the fact that more than 95 per cent of members of DC occupational schemes are invested in the default arrangement and are likely to remain invested there for many years. This offers compelling opportunities to invest in long-term, illiquid assets.

Practical difficulties

Consultants welcomed the consultation but point to practical difficulties of implementation. Brian Henderson, director of consulting at Mercer, warned: “Trustees will have to rethink the governance put in play to run the scheme.”

Chris Smith, director in Willis Towers Watson’s investment business, said: “There is a significant governance burden to overcome these challenges, creating a cost which needs to be taken into account.”

“Given the timeframe of DC members, more illiquid assets are a logical fit. The challenge is not the investment case but dealing with some of the operational difficulties,” added George Fowler, partner at KPMG.

Mr Henderson cautioned: “A lot of these asset classes are quite expensive – that is the nature of the beast. Aligned with that, how do you charge? With private equity performance you are looking at performance-based fees, investment minimums so that implies scale.”

Mr Smith welcomed the greater flexibility in the charge cap but criticised the ongoing uncertainty about the future charge cap levels, due to be reviewed again in 2020.

“This makes it extremely difficult to make long-term investment decisions in an expensive illiquid asset. A two to three-year time horizon on charge cap policy is a real barrier to this sort of investment,” he said.

What about the members?

“I don’t see much mention of the members in the consultation,” said Mr Henderson. The members have to understand in what they are invested.”

He concluded: “It is quite a big governance commitment if you want to invest in this space. If you talk to trustees through this, quite a few at the smaller end may want to throw in the towel.”

Nathan Long, senior analyst, Hargreaves Lansdown, said: “A boatload of smaller schemes should probably be considering consolidating right now, so this extra nudge is no bad thing. There remains a question mark on how effective it will prove. It is also important that the returns of the member are prioritised over getting capital deployed into areas where it’s needed for society.”

Richard Butcher, managing director at professional trustee company PTL, agreed: “The potential advantages of scale and consolidation have been well established as long as at the centre of it is the value for members.”

Is consolidation the only answer?

Small fund consolidation to invest in long term assets may not be necessary. Mark Futcher, head of DC at Barnett Waddingham said: “More sophisticated investment strategies, which deliver real longer term benefits to DC savers can be achieved in smaller DC Schemes by engaging the investment managers who can create more sophisticated investment defaults for bundled offerings – these funds could easily achieve the economies of scale needed.” 

He added: “We also need to see more sophisticated administration systems that can cater for more esoteric investments and a relaxation of all funds’ requirement to be daily priced. If we wish to reduce costs in DC, then let us also remove some of the needless, and value detracting, aspects.”

Consolidation is overdue

In conclusion, Bob Scott, partner, LCP, said a nudge towards “consolidation of smaller DC schemes is overdue”. He cited the requirement for DC chairs’ statements as a policy where more pressure could have been applied.

“Ultimately, the government may need to be more blunt – for example to require consolidation unless the trustees can demonstrate it wouldn’t be in members’ interests.  Consolidation has been achieved successfully in other countries – for example in Australia – and the UK could learn lessons from that experience.”

The consultation closes on 1 April 2019.