Government’s new illiquid rules to apply to all DC schemes

In its response to the consultation on broadening access to illiquids for DC schemes, published on October 6, the DWP also announced the removal of the original £100mn threshold, meaning DC schemes of all sizes will be subject to the new regulations.

The government launched its combined consultation in March looking at ways to boost DC investment in illiquids. It proposed amending regulations to compel schemes with more than £100mn in assets to disclose and explain their illiquids policies in their statement of investment principles.

Earlier proposals, put to consultation in November, that would have seen performance fees excluded from the charges cap, met with a mixed response from the industry, with some saying it would make little difference and others warning it may in fact prove counter-productive. 

As an industry, we need to move emphasis away from governance requirements that don’t add value, to addressing bigger picture issues

Callum Stewart, Hymans Robertson

The government acknowledged the mixed response in its March consultation and said it 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”.

The document also proposed that schemes with more than £100mn in assets should 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.

Additionally, it set out proposals qualifying a number of restrictions on employer-related investments. The DWP said these rules, though appropriate for the type of schemes available at the time, now unduly limit master trusts’ investments in particular.

Proposals progress — with changes

In their foreword to the new consultation response, work and pensions secretary Chloe Smith and parliamentary undersecretary Alex Burghart welcomed the “broad support” to the proposed “disclose and explain” requirements concerning statements of investment principles, and the consultation response itself lays out draft regulations designed to enact them.

The aim is to bring it into legislation by spring 2023. Meanwhile, the draft regulations also enable trustees to exclude performance fees from charge cap calculations “where they feel this in their members’ best interests”.

“While we realise performance fees and their relation to the charge cap is not the sole challenge that DC and [collective money purchase] schemes may face when looking to invest in certain illiquid asset classes, it does remove a potential barrier. Removal has the capability to help facilitate greater levels of investment in private markets, which may not have been previously considered,” the ministers wrote.

They added that they had “listened” to feedback and “refined our policy” in light of it, stressing they wished to ensure “that the regulatory burden is reasonable and proportionate while still retaining the wider benefits that changes in this area could bring”. 

“The proposed measures emphasise the key role that trustees of DC and CMP schemes, and their advisers, have in ensuring that the impact of different investment arrangements on long-term outcomes are appropriately considered. The role that illiquid assets could play in improving pension outcomes for members should not be overlooked,” they said.

The proposed changes to increase the prevalence of DC illiquid investments comes at a difficult time, however, with the government and the Bank of England still dealing with the falloutfrom a liquidity crisis in the defined benefit sector sparked by chancellor Kwasi Kwarteng’s so-called “mini” Budget on September 23.

The consultation stressed that it is “not requiring schemes to change their asset allocation under the proposed regulatory requirements, but rather to encourage them to reflect on the decisions they have already made, and the decisions they will make as part of their ongoing fiduciary duty to create an investment approach that works in the best interests of their members”.

It argued that disclosure of illiquid investments and policies towards these will “improve the availability of investment information to members and employers, and provide them with the certainty that schemes are providing members with the best possible value”, while also ensuring that trustees are giving “proper consideration” to a “wider range of investment opportunities”.

It noted that responses to the consultation expressed support for the proposals, and argued that they would increase transparency and comparability in investment decisions.

Following engagement with the industry, the DWP also decided on a definition of illiquid investments, these being classed as “assets which cannot easily or quickly be sold or exchanged for cash and, where assets are invested in a collective investment scheme, includes any such assets held by the collective investment scheme”.

The aim of the definition is to be broad enough to encompass multiple illiquid asset types while maintaining transparency and allow for innovation. 

Despite pledging not to direct scheme investments, the government did “propose some prescription”, chiefly to ensure consistent disclosures.

“We propose to require trustees to look through multi-asset investments to underlying investments, aligned with [the definition] above, so that all illiquid exposures are clearly covered in disclosures and all schemes calculate their asset allocations at asset level rather than fund level,” the consultation explained.

Certain changes were made to the initial proposals, however, including the removal of the £100mn threshold, meaning schemes of all sizes will now have to comply. The draft guidance includes a recommended approach for asset allocation disclosure, but this will not be a requirement, meaning schemes can decide for themselves how to disclose information to members.

‘Much bolder action’ required

The industry response to the announcement was mixed, but generally concurred that, though a start, much more work is needed in order to achieve a material change.

LCP partner Stephen Budge said: “We welcome the government’s continued commitment to making it easier for DC pension savers to access a wider range of illiquid asset classes to get a better deal for members, given the broader market environment.  

“We’re still a long way from these types of investments being mainstream for DC schemes and their members. The industry now needs to work together to design products that better fit the needs of members and their retirement aims.”

Hymans Robertson’s head of DC investment, Callum Stewart, was more scathing, however. Despite being supportive of the requirement for trustees to create formal policies on illiquid assets, he expressed his disappointment that the government has not moved “the dial away from emphasis on cost and governance-reporting requirements that add little value, to wider value and opportunity”. 

“As an industry, we will fail DC savers if we don’t focus on areas that can really move the dial in terms of members’ retirement outcomes,” he said. 

“Requiring reporting on asset allocation including illiquid assets in the annual chair’s statement will, in our view, add further costs and pressure on trustees, detracting from a focus on bigger picture areas that can really improve these outcomes.”

Stewart argued that the general thrust of the policy would “perpetuate the current overemphasis on minutiae detail versus bigger picture areas”.

He pointed out that Hymans Robertson had “highlighted the overlap in reporting requirements for the implementation statement, which will provide transparency on how policies with regard to illiquid assets are being put into practice” in its response to the initial consultation.  

“It’s disappointing that this has not been addressed in the response, and trustees will have overlapping reporting requirements going forward,” he continued.

“As an industry, we need to move emphasis away from governance requirements that don’t add value, to addressing bigger picture issues. This includes not tinkering around the edges of regulation — we need much bolder action to improve outcomes for DC savers and we will be responding to the latest consultation with this in mind.”