DWP launches further consultation to facilitate investment in illiquid assets

For some time, the Government has been trying to encourage greater investment in illiquid assets (such as infrastructure projects) by defined contribution (DC) pension funds. As part of this, the DWP launched a consultation last November on proposals to exclude well-designed performance fees from the DC charge cap, which applies to default investment funds within auto-enrolment DC schemes.

In a follow-up consultation launched today, 'Facilitating investment in illiquid assets', the DWP has signaled it is putting those plans on hold to give it time to "fully understand all the concerns raised, engage further, and to explore how these concerns might be addressed". However, it has not given up on its ambition to promote greater investment in illiquid assets by DC schemes, and it is now proposing to issue principle-based guidance on performance fees and to require DC schemes to disclose and explain their approach to illiquid investment.

The DWP is also consulting on proposals to relax the restrictions on employer-related investments for larger authorised master trusts.

Performance fees

Having received a mixed reaction to its proposal to exclude performance fees from the DC charge cap, the DWP has today confirmed that it is put those plans on hold. However, that proposal has not been taken completely off the table, with the DWP planning to:

• 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 DWP pursues this further, and
• consult on principle-based draft guidance on performance fees.

Alongside this, the latest consultation also contains new proposals to require:

• DC pension schemes to disclose and explain their policies on illiquid investment in their scheme's Statement of Investment Principles, and
• DC schemes with over £100million of assets to publicly disclose and explain their default asset class allocation and the benefits they feel these assets bring to their scheme and members in their Chair's statement (where the trustees are required to produce one).

The proposals only extend to default arrangements of occupational DC schemes. Defined benefit schemes would not be affected by these proposals nor will self-select funds. For hybrid schemes, the proposed requirements would only apply to the DC section(s) of such a scheme.

The DWP believes that these new disclosure requirements would result in a significant shift in the mindset of pension schemes, their trustees and ensure consistency (with some schemes already voluntarily disclosing this information). By providing this information to members, employers, consultants, trustees and the market at-large, the DWP also hope to continue to encourage competition based on overall value and as holistic a range of data as possible.

The DWP does not want trustees to have to spend significant resources or time forming their ‘house view’ of the issues that keep illiquid asset allocation low within DC schemes. Rather the goal is to enable members to understand why their pension scheme does not simply invest in equities and bonds or, alternatively, why their scheme only invests in equities and bonds. It envisages the average illiquid assets policy statement will only need to be minimum one paragraph, maximum three paragraphs long.

What is an illiquid asset?

The scope of any new disclosure requirements relating to illiquid investments will, to a large extent, be determined by how an "illiquid asset" is defined in the new legislation. The DWP outlines two options:

• Option 1: Illiquid assets could be defined at the fund/vehicle level. Schemes use a range of different vehicles to invest in illiquid assets. Some of these vehicles are in effect liquid i.e. they (or shares in them) can be traded frequently and sold with ease despite investing in illiquid assets. The regulations could specify that, given almost all DC scheme investment is done indirectly, illiquid funds or illiquid vehicles are the more appropriate subsection of investment options to hold a policy on. Funds could be deemed as illiquid once they reach a certain percentage threshold of their allocation being illiquid.
• Option 2: Illiquid assets could be defined at the more granular asset level. If the investment itself is not able to be sold frequently, perhaps daily, this could be counted as an illiquid asset no matter the investment vehicle through which this is disclosed. This could be done by listing asset classes that are considered illiquid. This would require a scheme to ‘look-through’, for example, a multi-asset fund to understand the allocation within a particular fund.

The DWP's aim is to keep the scope of investments that trustees could report on as part of their illiquid assets policy as wide as possible. It also wants to avoid defining illiquid assets according to the vehicle or the characteristics of the vehicle through which they are accessed. Consequently, it is currently in favour of a definition aligned with Option 2. However, it is seeking stakeholders views on this.

Employer-related investment restrictions for DC master trusts

Today's consultation also contains proposals to amend the restrictions on employer-related investments (ERI) for authorised master trusts with 500 or more active employers. This is to address some of the difficulties caused by the ERI legislation for multi-employer master trusts (such as the need to monitor the extent to which the scheme's assets are invested in any employers that participate in the master trust). Consequently, the DWP is proposing to amend the definition of ERI for these schemes so that restrictions on ERI will only apply in relation to investments in the scheme funder, the scheme strategist, or a person who is connected with or an associate of the scheme funder or the scheme strategist.

According to data held by the Pensions Regulator indicates this relaxation will apply to 13 out of the 36 authorised master trusts.

Comment

The fact the DWP has put its plan to exclude some performance fees from the charge cap on holds seems to be a recognition that this is not the silver bullet the Government had hoped it might be. It also reflects the concerns raised in response to the DWP's November consultation.

The Government is clearly still determined to increase investment in illiquid assets by DC schemes. However, it is unlikely that the proposed new disclosure requirements, in themselves, will move the dial. Instead, the Government needs to address the more material barriers to investment in illiquids that DC schemes face (and which are highlighted in today's consultation paper), such as the lack of quality products, appropriate valuation platforms and flexible pricing structures. It also needs to continue its drive to shift the focus in the industry away from low cost and on to good value (and overall net returns) for savers.

If you would like to discuss how these proposals may impact your scheme or organisation please speak to your usual Herbert Smith Freehills’ adviser or contact one of our specialists.

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