Mansion House pensions proposals: "fewer, bigger, better"

 

Three major pensions developments were announced by the Chancellor in her Mansion House speech:

• The publication of an interim report on phase 1 of the Government's pensions review, which focuses on investment.
• A consultation on proposed changes for workplace defined contribution (DC) schemes. The changes involve a "maximum number, minimum size" rule for default funds or arrangements, and a bulk transfer power in relation to contract-based schemes.
• A consultation on proposed changes to the Local Government Pension Scheme (LGPS). The changes are designed to accelerate the pooling of LGPS assets, boost local investment, and improve governance.

The direction of travel is clear. The Government wishes to see "fewer, bigger, better-run schemes", with the scale to invest in a wide range of asset classes. Its aim is two-fold: to deliver better outcomes for members, and to drive UK growth.

The interim report

The interim report outlines the Government's thinking on four "workstreams" considered in phase 1 of the pensions review.

1. Scale and consolidation in the DC workplace market: Many DC schemes are not of sufficient scale, or are not making use of scale, to invest in productive assets and deliver optimal returns.
2. LGPS: The steps so far taken to pool LGPS assets have delivered benefits in the form of scale, diversification and cost savings. However, progress and approaches have been inconsistent across the scheme.
3. Cost versus value in the DC workplace market: An excessive focus on keeping costs down has been counterproductive. Low investment budgets make it harder for schemes to invest in productive asset classes, with adverse implication both for members and for the UK economy. The proposed new value-for-money (VFM) framework is intended to address this. However, there are concerns that the framework may not achieve the culture-shift required.
4. UK investment: By increasing scale and improving governance, the Government can prime schemes for additional investment in productive asset classes. Separate initiatives will help ensure that there is a pipeline of suitable investment opportunities (eg the National Wealth Fund and the British Growth Partnership). Whilst not all new productive investment will be within the UK, data suggests that, where schemes invest in private markets, there tends to be a significant domestic weighting.

The Government proposes to address the concerns as to the DC workplace market and LGPS via the changes described below.

The Government has for the time being decided not to make specific recommendations in relation to UK investment (leaving aside LGPS). However, phase 2 of the pensions review will consider whether "further interventions" may be needed, to ensure that reforms are benefiting UK growth.

The Government will publish a final report on phase 1 in Spring 2025, together with terms of reference for phase 2.

Workplace DC schemes

The Government proposes two changes for multi-employer DC schemes (master trusts and group personal pensions):

1. Maximum number and minimum size requirements for "defaults". The Government's current thinking is as follows:

• Schemes used for auto-enrolment will be required to have no more than a specified number of defaults. The idea is to limit the number of separate defaults which a provider can operate, to reduce fragmentation. The Government does not say what the limit might be.
• Schemes' defaults will be required to be of at least a specified size. The idea is to prescribe a minimum level for assets under management (AUM). The Government does not say what the minimum might be, but cites claims that benefits start to arise at £25-50bn.
• The new rules might apply either at "default arrangement" level, or at "default fund" level; the Government is as yet undecided. The distinction is important. A scheme might have a single default arrangement whereby contributions are invested in several underlying default funds which are also used by other schemes. In such a case, the default funds might be substantial (in terms of AUM) even if the default arrangement is not.
• The new rules would not apply before 2030 at the earliest. In the interim, providers might be required to formulate plans to achieve compliance by the implementation date (eg to "staircase up" relevant AUM). Such plans would be monitored by The Pensions Regulator/the FCA. It is expected that some master trusts and GPPs might be unable to achieve compliance, and so might be forced to consolidate.
• Further thought will have to be given to special cases – eg existing schemes where there may be public interest grounds for exemption; and possible new entrants to the market.
• The Government will consider whether, alongside the new rules, it might be appropriate to prohibit differential pricing in respect of a given pension product.

2. Bulk transfer power in relation to contract-based arrangements:

• The Government will legislate so that members can be transferred from contract-based arrangements without the need for individual consents. In effect, there will be a bulk transfer power which will override members' contractual rights.
• The bulk transfer power could be used where the existing arrangement had received a "red" rating under the proposed new VFM framework. The power could have wider application, including for non-workplace schemes (eg if a provider concluded that a transfer should be made by virtue of its consumer duty under FCA rules).
• The provider would propose the receiving arrangement, which could be either contract-based or trust-based. An independent third-party expert (generally, the provider's independent governance committee) would decide whether the proposal was in the best interests of members, and whether the transfer should proceed.
• The FCA will make rules to provide safeguards and potential recourse for members. The FCA will oversee transfers, and might be given powers to mandate a transfer, including to a different provider or to a "backstop" arrangement such as Nest.
• The Government has not specified the date from which the bulk transfer power will be introduced.

The Government acknowledges that the proposed DC changes are fundamental, and will require primary legislation. It will decide in due course whether to provide for the changes in the forthcoming Pension Schemes Bill, based on the outcome of the consultation.

Separately, the Government is concerned about the processes whereby employers choose workplace pension schemes. Questions include whether processes are suitably rigorous, and whether employers and their advisers attach too much weight to costs. The Government will consider whether changes should be made in this area, for example so that:

• Employers are required to consider value when choosing a pension scheme, or to have a named executive with responsibility for retirement outcomes.
• The provision of advice to employers is regulated by the FCA.

The consultation closes on 16 January 2025.

 

LGPS proposals: background The LGPS is a defined benefit scheme comprising 86 separate funds. Each fund is managed by the relevant local authority – the administering authority (AA). In practice decisions of an AA are normally made by a committee of local councillors (a pension committee). Successive Governments have sought to promote the pooling of LGPS assets, for investment purposes, as between different funds. The 86 AAs have come together in groups of their own choosing so that there are now eight asset pools. Around 45% of LGPS assets are currently within the pools. A further 27% of assets are managed by the pools but do not sit within them.

 

LGPS

The Government proposes to strengthen the management of LGPS assts in three areas.

1. Reforming the asset pools. The Government will mandate minimum standards as follows:

• Pools will have to be investment management companies authorised by the FCA (pool companies), with the expertise and capacity to implement investment strategies. (At present, three of the eight pools operate on a different model.)
• AAs will have to delegate the implementation of investment strategy to the relevant pool, and take their principal advice on investment strategy from the pool. AAs might still choose to decide their strategic asset allocation, but this should be confined to setting target ranges for asset types or classes.
• AAs will have to transfer legacy assets into (or, in the case of illiquid assts, into the management of) the relevant pool.

2. Boosting investment in UK regions. The Government proposes that:

• AAs will have to liaise with local and regional authorities, and take account of local growth plans and priorities.
• AAs will have to set out their approach to local investment in their investment strategy statement, specifying a target allocation, and report on local investment and its impact in their annual reports.
• Pools will have to conduct suitable due diligence on proposed local investments, and will make the final decision on whether to proceed.

3. Strengthening the governance of AAs and pools. The following changes are proposed:

• Pension committee members will have to have appropriate knowledge and skills. Additionally, a requirement might be introduced for committees to include an independent pensions professional.
• AAs will have to publish a governance and training strategy, a conflict of interests policy and an administration strategy; appoint a single named officer with delegated responsibility for the relevant fund; and undertake biennial reviews to determine whether they are equipped to fulfil their responsibilities.
• Pool boards will have to include representatives of relevant AAs and improve transparency.

The Government proposes to legislate for the changes under (1) above in in the Pension Schemes Bill, with a view to the changes taking effect from March 2026.

The changes under (2) and (3) will be introduced via regulations and guidance.

The consultation closes on 16 January 2025.

Comment

The proposed changes for the LGPS build on those announced in last year's Mansion House speech: to accelerate pooling and ratchet up the advantages which it has already delivered. However, the significance of the accompanying governance proposals should not be underestimated. There will be real challenges for AAs and pools in aligning themselves with the new regime, particularly in cases where pools do not currently use the "pool company" model.

For schemes more generally, there will be relief that the Government has not chosen to mandate UK investment or to tinker with trustees' fiduciary duties. However, there is a sting in the tail for master trusts and GPP providers. The proposed new regime for defaults, though five years off, will be a radical departure, and, as the Government acknowledges, could force some smaller players to exit the market.