The UK’s so-called Mansion House Reforms are under way. This cluster of policies takes its name from the residence of the Lord Mayor of the City of London, which is the venue for a regular set-piece policy speech by British chancellors of the exchequer, the latest of whom is Jeremy Hunt.

Liam Kennedy - “The government should not be deterred from applying reforming zeal to the many small DB schemes – an overlooked pocket of institutional capital”

In July, Hunt set out a clear and reasonably coherent set of policies aimed at boosting long-term investment in the British economy by reforming pensions, listings and regulation in areas like equity research, currently under EU-derived MiFID II rules.

Following the speech, the government launched five separate consultations in key areas in the pensions sector: defined benefit (DB) reforms; trustee skills; pension savers; the proliferation of sub-scale and micro defined contribution (DC) accounts (so-called small pots); and the Local Government Pension Scheme (LGPS) in England and Wales. 

The proposed policies range from further pooling in the LGPS to measures to make it easier to aggregate DC small pots, and are aimed at boosting investment in unlisted investments, particularly high-growth venture capital investments. 

Underpinning the government’s thinking is that big is better. Bigger pension funds will have bigger budgets to hire brighter people, make bolder investment decisions and achieve better long-term returns. It will also, so the thinking goes, boost the flagging domestic economy. Lessons have been learned from pension funds in Canada, Australia, the Netherlands and Sweden.

The CEOs of five UK DC pension providers have signed up to a ‘Mansion House Compact’, committing their firms to invest 5% of default fund capital to unlisted equities by 2030. This is significant because the five firms between them manage two-thirds of DC pension assets, and almost all pension savers stick to the default fund. 

This is not the first time a UK government has tried to corral pension funds into investing more into unlisted markets. Over 20 years ago, the then Labour government commissioned the late Paul Myners to report on the pension fund market with a view to challenging perceived risk aversion. 

This government seems determined not to simply leave it up to the industry to change its ways. 

Most DB schemes are now better funded than at any time in recent years but are closed to future accrual and are heavily weighted to bonds and credit with little appetite for equity risk, let alone unlisted exposure. 

Many are on a path to transfer risk to insurers and must be mindful of the need to be ‘buyout-ready’. The insurance market is a natural long-term consolidator of DB pensions, even though it would take many years for it to absorb every last pound of pension liability.

The government would do well to reduce inefficiencies, whereby DB trustees may sell long-term assets like infrastructure equity holdings, only for them to be snapped up by the very insurers vying to take on the same trustees’ pension liabilities. 

Also, as Accounting for Sustainability has recognised, what happens to pension schemes’ net-zero commitments when risk is transferred to insurers?

There is also a strong case to transfer DB regulation from The Pension Regulator (TPR) to the Prudential Regulatory Authority (PRA), which already oversees the UK’s insurers, in order to have  the two under a single oversight body.

The PRA is understood to have privately questioned the TPA’s handling of the LDI crisis of 2022 and the lack of granularity of its insight into the build-up of risks through pooled LDI funds in particular.

Where does this leave the long tail of smaller DB schemes? Attempts to bring these schemes together have not worked, despite the attempts by two consolidation vehicles.

The consultancy LCP calculates that the smallest 2,000 schemes have less than £20bn in assets between them; the largest 20 DB schemes have more than £20bn apiece.

LCP and others reckon bringing 2,000 together would hardly be worth the candle if the aim is to boost investment in unlisted UK markets. Instead, the PPF could shelter smaller, weaker DB schemes willing to pay an enhanced levy. 

Of course, many consultants, lawyers and others earn healthy fee revenue from the smaller end of the DB market and have a vested interest in maintaining it. Many schemes could still be around for years to come. 

But there also many reasons to bring them together and other issues should not be overlooked, including the lack of talented trustees and  investment inefficiencies. The government should not be deterred from applying reforming zeal to this overlooked pocket of institutional capital.

Liam Kennedy, Editor