Occupational Pension Schemes (Administration, Investment, Charges and Governance) and Pensions Dashboards (Amendment) Regulations 2023

Baroness Sherlock Excerpts

Tuesday 28th March 2023 Grand Committee

[Baroness Drake (Lab)]

My Lords, I hold pension trustee positions, and refer to my interests as set out in the register.

These pension scheme regulations are being introduced for two reasons. First, the Government believe that they will facilitate greater investment by pension schemes into private markets, securing better returns for savers. Secondly, the Government want to increase DC pension fund investments in UK start-ups, infrastructure, green investment and illiquid asset classes in private markets.

Of course, this is to be welcomed if beneficial alignment is achieved between the best interests of the ordinary citizen and their pension pot, and investments that benefit the UK economy to achieve the win-win. However, there are barriers to be addressed in getting there. The problem with these regulations is that the exclusion of performance fees from the DC charge cap will not be the driver of significant changes of investment in illiquid asset classes, but consumer protections will be weakened where money is invested without the security of that cap. The charge cap was introduced to protect millions of people investing through inertia under auto-enrolment. To achieve the diversification of investments which would benefit the UK economy, the complexities of other barriers to investment in private markets need to be addressed. Overreliance on removing consumer protections from pension savers will not do it.

I will reflect on some of those complexities. The pension regulatory environment, which is in perpetual change, is driven by endless policy initiatives without certainty as to the Government’s underpinning strategy. Recent regulation enabled performance fees to be smoothed over a five-year period, but before even testing the efficacy of those changes the Government proposed reversing them in favour of these. Trustees need greater consistency when considering long-term investment decisions—consistency between not only one Government and the next but one Minister and the next. Also, the complexity of regulation means that government contradicts itself. For example, the Government asked the Productive Finance Working Group to make recommendations on increasing private market investments, while TPR was consulting on prohibiting the schemes from holding more than 20% of assets in unregulated investments.

There is also the need to strengthen confidence in government economic policy and governance, a sentiment captured by the noble Baroness, Lady Lane-Fox of Soho, president of the British Chambers of Commerce, in the FT yesterday, where she warned policymakers that

“businesses are holding off making big investment decisions given the UK’s recent political and economic upheaval”

and that,

“People just don’t feel like taking risks”

in the UK.

Inefficiencies from pension freedoms are weakening the long-term private pension system and the approach to illiquid assets. For example, as savers get to 55 or 57, they can take their pots as cash in a series of lump sums and draw down funds in any combination of timing and amount that they choose. Small pots are growing exponentially. People change jobs more frequently. Pension transfers are increasing, including out of workplace schemes. Trustees have to implement these freedoms, which in turn impact on investment decisions.

Higher costs incurred with illiquid assets need to be borne fairly across the members of the scheme, as they would impact members differently. Those close to retirement or who choose to exit the scheme are at greater risk of paying higher fees without the additional returns.

Then we come to the issue of how to ensure value for members and higher returns when performance fees are outside the charge cap and inert citizens directly bear the investment risk. Achieving that higher value will be very challenging, as will measuring it for the Government to see it, as it is with securing standardised disclosure of performance fees. There is a lot of history here about making fees and charges work effectively for ordinary savers.

Ensuring that fees are payable only for realised outperformance is to rest on a tighter definition of performance fees and the discipline of negotiated agreements between trustees and asset managers. Those are the two big levers that are relied on. The Explanatory Memorandum states that excluding pension fees will encourage innovation on fees, but where is the evidence? It is an assertion, and lots of people assert it in their submissions, but it is difficult to find hard evidence. Exclusion of performance fees might set a precedent for removing other charges. Having removed that hard-fought security for consumers, the gate is open. It can disincentivise innovation because the cap has been removed. It can inhibit the evolution of fee structures and private market products that better accommodate DC pensions to the benefit of the UK economy.

Testing the impact of negotiated agreements between trustees and asset managers needs to be assessed much further before weakening the charge cap, given the challenge of achieving member fairness on performance fees. It is an assertion that those negotiated agreements will produce that beneficial result, but that should be really tested before such a critical consumer protection is removed.

The Government have set up a long-term asset fund, the Productive Finance Working Group is considering recommendations and the FCA and TPR have commenced consideration of value for money. This is work in progress, yet the Government push ahead with amending the cap, increasing the risk to the saver.

Investments that help with transition to net zero, environmental protection, housing or infrastructure which support economic growth and savers’ best interest are to be welcomed. Indeed, ESG and TCFD reporting and governance requirements are nudging schemes more and more in that direction. Several pension providers have indicated that they would no longer agree to traditional performance fees but remain committed to investing in private markets. Some large schemes hold illiquid investments within the existing charge cap. Some fund managers are indicating innovating on growth equity funds, and fee and product structures will evolve from the high-growth prospects of the UK automatic enrolment market—agreements achieved through scheme scale, not by weakening consumer protection.

One of the policy options in the impact assessment was government mandating investment in illiquid assets by pension schemes. Although rejected, this is the second hint at mandation after the joint December 2021 letter from the Prime Minister and the Chancellor. These DC savings are citizens’ private assets. Mandation would replace or undermine the fiduciary duty on trustees, require private assets to be harnessed and directed to meet government policy objectives, and probably risk market distortions. It would risk imposing inappropriate risk appetites on savers and increase uncertainty on liability, consumer protection and duty of care. It would certainly weaken employer engagement, and it could seriously risk undermining public confidence in auto-enrolment. Those are big consequences from mandation.

I have four questions to ask the Minister. Can he confirm that the Government have no intention to mandate how pension schemes must invest? How will value for members assessments be altered in light of the new risks arising to pension savers from these regulations? How will the Government ensure that savers close to retirement or who exit a scheme do not pay higher fees without additional returns from illiquid investments? What new measures will be introduced to enhance the availability of charges and cost information on illiquid investments? What new initiatives are the Government expecting the FCA to take to regulate for fairness and consumer duty in all the private markets that these regulations cover? I am sure that the DWP will say that it is not within its remit to know what the FCA is doing, but to make a decision that lifts such a hard-fought-for and fundamental consumer protection on the level of evidence that is before the Government, without knowing, having considered or having discussed with the FCA its approach, is an omission. It would be helpful to leave those questions.

[Baroness Sherlock (Lab)]

My Lords, I thank the Minister for introducing these regulations and those noble Lords who have spoken. As we have heard, these regulations cover two distinct issues—one minor and the other rather less so. I will do the minor one first; it is a change to correct a drafting error in the Pensions Dashboards Regulations 2022, amending the line in Part 1 of Schedule 2 that specifies which master trusts are required to connect to the pension dashboard by 30 September this year. I do not want to kick a project when it is down, but, to me, that is not the most pressing problem attached to the Pensions Dashboards Regulations 2022. In fact, the Minister recently announced that the entire timetable, which is hard-wired into these regulations, is being scrapped, so the regulations will presumably need to be either repealed or amended. Could the Minister tell us whether the intention is to repeal them or if they are simply going to be amended and when we will know more about that?

On the major provisions in the regulations, the objective behind them is clearly to push pension schemes into investing more of their members’ money in illiquid assets. As we have heard, they will use two basic levers to do that. First, they will require all pension schemes with more than 100 members to explain their policy on illiquid assets and to disclose their schemes’ investments in them; and, secondly, they will exclude specified performance-based fees from the list of charges that fall within the 0.75% regulatory charge cap.

Just to be clear, these Benches would like to see greater investment in ways that will help the transition to net zero and in infrastructure projects that support economic growth, but we have heard today some important questions about the detail of these regulations, and I hope the Minister has some answers ready. First, the question of risk was raised. The noble Lord, Lord Sharkey, is right: I could not find a definition of illiquid assets either, but they clearly cover a wide range of investments. They are not just buildings or infrastructure but, as the Secondary Legislation Scrutiny Committee pointed out, could include art or intellectual property. Some illiquids clearly carry significant risk. This legislation also targets venture capital investments, which often have a high failure rate.

The noble Lord, Lord Sharkey, mentioned the 30th report from the Secondary Legislation Scrutiny Committee, which drew these regulations to the special attention of the House. It expressed concern that, without limits on the proportion of illiquid assets in a pension scheme, the scheme may not be able to deliver the returns that members anticipate. It pointed out that many of those members, of course, have been auto-enrolled by their employer and therefore had no involvement in the choice of their pension scheme investments.

As the noble Lord, Lord Sharkey, pointed out, the committee asked two specific questions that it thought Members of the House might like to put to the Minister. One was about how schemes’ exposure to increased risk of lower returns would be monitored, and the other was how trustees would be guided on assessing the risks to the portfolio. I may have missed this in the Minister’s comments—I heard him talk about advice to trustees on charges, but I am not sure that he talked about advice on assessing risks—so it would be helpful if he would address that.

I want now to look briefly at the proposal specifically to exclude certain specified performance-based fees from the list of charges that fall within the regulatory charge cap. As my noble friend Lady Drake has reminded us, the charge cap was introduced to protect the millions of people who are saving and investing through inertia, so surely there must be a compelling case for the Government to do anything that might weaken that. It is worth pausing briefly to remember that, in 2013, DWP research showed the impact of higher fees on pension savings. An individual who saves throughout their working life via a scheme with a 0.5%—50 basis points—annual charge cap on the value of their pot could lose 13% of their savings to charges. Push that to 1% and they could lose almost a quarter; push it to 1.5%, the figure is around a third. These basis points may sound small but their impact on the value of a fund is really quite significant.

--- Later in debate ---

[Baroness Sherlock (Lab)]

I thank the Minister for taking the time to answer those questions. I just want to ask him to explain the definition of an illiquid asset a bit more. He is right to point to Regulation 3(2)(d), which says that they are

“assets of a type which cannot easily or quickly be sold or exchanged for cash”.

I suppose most things can be sold or exchanged for cash reasonably quickly if you do not mind how much you get for them at a fire sale. I have two questions. If that means

“cannot easily or quickly be sold or exchanged for cash”

at a reasonable price, or at least at the price one had paid for them, would that apply to UK gilts last autumn? Secondly, the reason this matters is that there is a lot of money to be made from this definition. Where that is the case, the definition is likely to end up being the subject of some dispute. What is the mechanism to resolve this? Whose decision is it? Does someone just get to do it? Will the regulator push them, or will it end up in court? How will this be litigated?

[Viscount Younger of Leckie (Con)]

I hope I can be of some help. I think I should write a letter on this quite detailed question, as it takes us further from the question originally asked by the noble Lord, Lord Sharkey. Part of the answer could be—I will need to follow up with a letter—that we do not want to prescribe our approach too much. As I mentioned earlier, it will be very much up to the trustees and pension funds to decide for themselves. It might not be right to have too much prescription here, but I will go no further than that. The noble Baroness, Lady Drake, may know more than me, as one can go only so far with a definition. I will write to clarify further what we mean.