The Mansion House reforms: win-win?

On 10 July, Chancellor Jeremy Hunt delivered his much-anticipated Mansion House speech and launched a package of proposals and consultations for reform of pensions and investments. To be known as the “Mansion House Reforms”, the proposals have the following key aims:

• to boost returns and improve outcomes for pension fund holders whilst increasing funding liquidity for high-growth companies;
• to incentivise companies to start and grow in the UK by strengthening the UK’s position as a listings destination; and
• to reform and simplify our financial services rulebook to ensure we have the most growth-friendly regulation possible without compromising our commitment to stability

As the politicians prepare to head off on their holidays, the Government’s summer gift to the pension industry is a package of more than eight separate papers to review and digest – and the financial services sector has been equally “blessed” with a raft of proposals aimed at strengthening the UK’s competitive position as a leading financial centre.

Pensions measures: focus on consolidation and investment opportunities

So what are the proposals for UK pensions? Well, many of the measures will be familiar. Building on previous consultations and calls for evidence, the Government has sought to weave together a coherent strategy aiming to “boost returns and improve outcomes for pension fund holders whilst increasing funding liquidity for high-growth companies”.

Key elements of the Mansion House reforms include:

• implementation of the Value for Money framework;
• a solution for deferred small pots;
• establishment of a regulatory regime for consolidators of DB schemes (so called DB “superfunds”);
• extension of Collective DC schemes;
• provision of more structure and support for members during the decumulation phase.

There is also a new consultation in relation to accelerated and expanded pooling of funds and investment changes in the Local Government Pension Scheme (“LGPS”), and a call for evidence in relation to “Trustee skills, capability and culture” which aims to explore barriers to trustees doing their job effectively and getting the best outcomes for savers.

Changes to DC

Looking in a little more detail at the proposals for DC pensions, the package includes responses to the raft of measures consulted on earlier this year centring on the theme of value for money in DC schemes (read more about the consultation in our earlier update).

Value for Money

As highlighted by Mr Hunt in his speech, in the response to the joint consultation on Value for Money by the DWP, the Pensions Regulator and the FCA, there is a clear message that investment decisions should be based on returns over time not just short term cost alone – the response talks about shifting the focus “from costs to value” in order to help protect savers. The Value for Money proposals are therefore largely to be implemented as proposed, and a consultation on draft regulations (and FCA rules), with proposed phased implementation dates for schemes will follow. 

The new framework will, over time, replace the current Value for Members assessment, required of trust based DC schemes with under £100m in assets under management. Furthermore, as the VFM framework is implemented, the Government will consider how the requirements of the Chair’s Statement could be managed down, and ultimately phased out as the new framework is phased in.

Small pots

In response to the call for evidence Laura Trott has confirmed that the DWP proposes to adopt the “multiple default consolidator” model to deal with the challenge of deferred small pots. The Government has gone on to launch a further consultation which closes on 5 September 2023, the main proposals under which are:

• a central clearing house will be created to act as a central point informing schemes where to transfer a member’s eligible deferred pot. Views are sought as to the design of the central clearing house;
• default consolidators would need to apply for authorisation although there is no detail as to who will grant authorisation and the conditions that would need to be met. However, with all authorised DC master trusts being compelled to apply for authorisation, it would seem likely that TPR will manage authorisation for occupational DC schemes and the Government has confirmed that it will work with the FCA to align the regime with any consolidator for contract-based providers;
• pots will become eligible for automatic consolidation 12 months after the last contribution was made;
• there will be no minimum pot size for automatic consolidation but the maximum will initially be set at £1,000, with the Secretary of State being under a statutory obligation to review this at regular intervals.

Primary legislation to implement a new statutory framework will follow “as parliamentary time allows”, with details to follow in secondary legislation. It is also noted that “in order to stop the creation of new deferred small pots, a more fundamental change to the auto-enrolment framework may be needed”.

DC decumulation

The DWP has also responded to last summer’s call for evidence on how it can help savers, improve member communications, guidance and decumulation products in pension schemes. It recognises that the introduction of pension freedoms has placed greater responsibility on individuals to make decisions in relation to their retirement at the point of accessing their savings, and that they need assistance to make informed choices.

In its newly launched consultation, which runs until 5 September, the DWP recognises that there are a number of ways that schemes currently support their members to make the most of their pension pots including directly offering a suite of products and services, partnering with other organisations to offer a similar range of products and services, organising advice sessions and signposting to appropriate guidance services. However, the Government recognises that this support is not universal and wants to go further and place a duty on trustees to offer decumulation services.

Trustees will have to establish a service offering that which is suitable for their members and consistent with pension freedoms. At decumulation members will have the option to either choose the default service offered by the trustees or access the products and services available under the pension freedoms. As part of their duty, trustees would either need to offer these services in-house, or partner with another supplier who could provide these services. The DWP is also looking to collective defined contribution schemes (“CDC”s) to provide a market for decumulation solutions (on which see further below) and want trustees to consider how CDCs could feature in their offer to members.

Extending CDC

The Government intends to press forward with its proposals to extend collective DC savings to allow unconnected employers to pool assets in new whole-life, multi-employer CDC schemes. Currently CDCs are only available to single employer scheme or two or more connected employers. It is also committed to moving forward with creating provision for CDC decumulation only products, and informed by the new consultation on DC decumulation and continued industry engagement, it will explore how these products could operate in the best interests of members.

The DWP will consult on draft regulations to extend CDC provision to whole-life multi-employer schemes, including Master Trusts, in the Autumn. The draft regulations will also include some changes to existing single or connected employer schemes, being to:

• change the existing valuation and adjustment process to clarify the Government’s policy intention where a multi-annual reduction (where the impact of the benefit reduction is smoothed over three years) is initiated following poor investment performance and there is a subsequent positive bounce back in investment; and
• clarify that, during the wind-up of a CDC scheme, the accrued rights of the dependants and survivors of members or survivors of dependents can be transferred to a flexi-access drawdown arrangement.

Investing DC assets in unlisted equities

Perhaps the measure that has attracted most column inches in the mainstream media is the Mansion House Compact. A group of representatives of some of the UK’s largest DC pension schemes – including Aviva, Scottish Widows, L&G and Aegon – are signatories to the Compact, which commits them to the objective of allocating at least 5% of their default funds to unlisted equities by 2030. The signatory funds together represent around two thirds of the UK’s DC workplace pensions markets. Currently DC schemes in the UK invest less than 1% of assets in unlisted equities. The Chancellor highlighted that if the rest of the UK DC market were to make the same minimum 5% investment in unlisted equities by 2030, this could mean £50 billion of additional investment in high growth companies.

Changes to DB

DB consolidation

Following a not-so-subtle nudge from the Work and Pensions Committee in last month’s report on LDI for pension schemes, as part of the package the DWP has also published the long-awaited response to its 2018 consultation on consolidation for defined benefit schemes. Though the pensions landscape has changed significantly in the last 5 years, not least in terms of significant improvements in funding levels for DB schemes, Pensions Minister Laura Trott is clear that the need for DB superfunds still exists and that “superfunds provide a real opportunity to take significant risk to members out of the system and increase their likelihood of receiving their full benefits”. Additionally, she says that superfunds are likely to invest in a more productive way than many closed DB schemes. 

On this basis, the response promises that the Government will set out its plans on introducing a new permanent superfund regulatory regime, “to provide sponsoring employers and trustees with a new scaled-up way of managing DB liabilities”. The DWP envisages that the “superfund” option will be of most interest to schemes that are 70% to 90% funded on a buyout basis, being those that are unlikely to be fully funded on a buyout basis in the foreseeable future and could, therefore, benefit from removing the risk of employer insolvency but are more likely to be able to afford the price of entry.

The DWP intends to work with industry to develop an expanded, detailed definition of a superfund but currently considers that such a vehicle will be authorised and supervised by TPR and will be:

• an occupational pension scheme set up for the purposes of effecting consolidation of DB pension schemes’ liabilities;
• one where the link to a ceding employer is severed or substantially altered following the transfer to, or by the involvement of, the superfund;
• one where the employer covenant is replaced by a capital buffer provided through external investment that sits within the superfund structure; and
• where there will be a mechanism to enable returns to be payable to persons other than members or service providers.

In an attempt not to restrict innovation in product design, the DWP has decided not to mandate that a superfund be either sectionalised (with multiple standalone sections, with ringfenced capital requirements) or co-mingled (meaning that all incoming schemes will be pooled together). Instead, trustees of a ceding scheme will be required to consider the structure as part of their risk-benefit assessment in deciding whether to transfer to a superfund.

Furthermore, new DB superfunds will not be required to target buy out. The Government says that it would not be appropriate for legislation to mandate that superfunds should be required to target buyout with an insurer as this would “threaten the viability of the superfund market by preventing innovation and variety amongst the prospective market offerings”. However, superfunds will be required to make their long-term objective clear so that potential transferring trustees can consider whether the transfer meets their fiduciary duties.

The introduction of superfunds will require primary legislation and the Government will bring forward legislation as soon as parliamentary time allows.

New options for DB schemes

Following on from last year’s Departmental review of the PPF, it was widely reported before his Mansion House speech that the Chancellor was interested in proposals to increase the role DB schemes play in productive UK investment and, specifically, whether, given its investment success, to extend the PPF’s role to include acting as a public consolidator for DB schemes. With over £1.7 trillion of assets held by occupational DB schemes, the DWP has now launched a call for evidence to explore whether there is scope to enable greater flexibility in how those assets are invested, including whether the PPF has a role to be play as a consolidator vehicle for some schemes.

Responses are requested by 5 September to help the DWP better understand:

• DB asset allocation and incentives around investment strategies;
• current rules and barriers around building and using surplus; and
• exploring the potential for consolidation options.

LGPS consolidation

The focus on consolidation remains a constant for both public and private sector schemes. For the LGPS, there is a consultation on investments which includes a proposal to accelerate and expand the pooling of LGPS funds, suggesting setting a deadline for all LGPS funds to transfer their listed assets (as a minimum) into local government pension pools of March 2025. The LGPS consultation also includes:

• a proposal to amend regulations to require LGPS funds to have a plan to invest up to 5% of assets to support levelling up in the UK, and a further proposal to require them to consider investments in private equity to meet the Government’s “ambition” of 10% investment allocation to private equity in the LGPS, which could unlock a further £25 billion by 2030; and
• potential changes to the LGPS regulations to implement requirements on pension funds that use investment consultants and to make a technical change to the definition of “investment”.

This consultation closes on 2 October 2023 and we will consider these proposals in more depth in future articles.

Pension Trustees

Of key interest to trustees and their advisers will be the call for evidence in relation to Pension trustee skills, capability and culture. The Government recognises that the lynchpin for the effective delivery of its policies to deliver better outcomes for pension savers will be to have “properly equipped and supported trustees”. Mention is made of the fact that some trustees, especially at the smaller end of the market, appear to be unaware of many of their duties and legal obligations. Nevertheless, a key driver of the call for evidence is to understand why trustees are not investing in a full range of assets, including unlisted equities, to the same extent as their international counterparts, which the Government believes will help ensure pension savers are getting the retirement income they expect whilst also supporting the growth of the UK economy.

The jointly led call for evidence by the DWP and the Treasury seeks evidence in relation to the following areas:

• Trustee skills and capability: whether trustees understand their current knowledge and understanding requirements, and the extent to which these are met. Specific evidence is sought in relation to the extent to which trustees understand the full breadth of investment opportunities and the options for consolidating schemes to inform potential policy options around trustee registration, accreditation requirements, and professionalism. The Government has fallen short of mandating that all trustee boards should have a professional trustee (largely due to inadequate market supply) but its long-term vision is to have a smaller number of schemes, each with a professional trustee;
• The role of advice: the Government is keen to understand how trustees use advisors to identify and calculate risk when their investment strategies are formulated and enacted, with a particular focus on understanding how the advice and support provided impacts on a decision whether to invest in unlisted equities. As well as looking at the role of investment consultants, the Government is keen to understand how legal advice has translated into decisions on investment and whether there is a culture of “risk aversion”; and
• Barriers to trustee effectiveness, including fiduciary duties: finally, the Government is seeking evidence on whether the current framework and guidance on fiduciary duties is sufficient to help trustees make decisions in the best long-term interest of savers. Views are sought as to whether more direction from regulators when assessing investment decision-making, including training and guidance, would help. Finally, it seeks view as to whether lay trustees have sufficient time, support and legal protections to fulfil their duties, an issue we highlighted in our blog last year.

It’s interesting that the Government has chosen to focus so heavily on trustee skills, training and advice in its call for evidence. No evidence has been sought as to whether historically, unlisted equities and venture capital have outperformed listed markets and whether there is sufficient capacity in the market to support the volume of investment the Government is hoping for. Furthermore, whilst much is made of the fact that existing case-law regarding trustees’ fiduciary duties may act as an impediment to investing in unlisted equities, no mention is made of whether existing legislation and regulation may also act as a barrier. In particular, we are thinking of the Occupational Pension Schemes (Investment) Regulations 2005 which require trustees, amongst other things, to:

• exercise their powers of investment in a manner calculated to ensure the security, quality, liquidity and profitability of the portfolio as a whole;
• invest assets held to cover a scheme’s technical provisions in a manner appropriate to the nature and duration of the expected future retirement benefits payable under the scheme;
• invest predominantly in investments admitted to trading on regulated markets. Investment in assets which are not admitted to trading on such markets must in any event be kept to a prudent level;
• properly diversify the assets of the scheme in such a way as to avoid excessive reliance on any particular asset, issuer or group of undertakings and so as to avoid accumulations of risk in the portfolio as a whole.

It is unclear at present whether the Government will legislate to repeal existing legislation and/or case law, including the founding principles of trustee investment duties established in the 1886 case of Re Whiteley where the Court of Appeal held that in making investments, pension trustees must take such care as an ordinary prudent person would take if he invested “for the benefit of other people for whom he felt morally bound to provide“. Furthermore, in the 1887 appeal of the case, the House of Lords distinguished between investments made by a business person, which might be speculative in nature, and those made by trustees which must be restricted to those permitted by the trust, and must avoid “all investments attended with hazard“. We await further developments with interest.

Takeaways for trustees

Badged as evolutionary rather than revolutionary, the Mansion House reforms are nevertheless significant, affecting both DB and DC schemes and the public and private sector, and come with an ambitious timescale to boot. The LGPS investments consultation closes on 2 October 2023 and all other calls for evidence / consultations close on 5 September 2023. With draft legislation for deferred small pots, CDC and the value for money regime due in the Autumn and a promise from the Chancellor that decisions will be made before the Autumn statement, it looks set to be a busy end to 2023 in the pensions world.

For now:

• DC trustees should consider whether to respond to the consultation on consolidating small pots and DC decumulation;
• LGPS funds should consider responding to the consultation on investments;
• DB trustees should consider whether to respond to the call for evidence on options for DB schemes;
• All trustees should consider whether to respond to the call for evidence on pension trustees skills, capability and culture;
• Keep an eye out for the draft regulations on extending CDC in the autumn along with further developments in relation to value for money, small pots and DB superfunds in due course.

As always, if you have any questions please do get in touch with your usual contact in the Pensions Team.