Rewriting UK pension rules could unlock green growth, directing much-needed investment into sustainable infrastructure
Chancellor Jeremy Hunt has pledged to reform the UK’s pension industry, warning that it may be hindering growth. Whilst on the surface this is positive news, I believe an even more radical approach – and rethink of the system – is required.
If the UK government truly wants to stimulate growth and address the urgent need for greater private capital investment in infrastructure that can tackle societal challenges, as well as the climate and biodiversity emergencies we face, they need to rewrite pension rules.
At present, the infrastructure assets we need to develop do not typically sit easily within liquid structures. This is because they take a number of years to build and reach positive accounting profits.
As a result, in the early years of infrastructure assets it is rarely possible to create liquidity or to list them. Having an artificial requirement for liquidity, as the UK’s pension rules do, is therefore not financially or operationally viable.
Hunt has pointed to my native Australia as a blueprint for reform. Yet the pension system there could also serve as an illustration of the achievements that more fundamental changes can bring and how corporate UK could implement them.
The success of the Australian pension system lies in the fact that they do not require their underlying funds to create liquidity from the assets they invest in, nor from the underlying investment fund itself.
Instead, liquidity is managed at the pension fund level, which I believe is the best place for it, given they (should) know their own liquidity requirements better than anyone. This crucial difference has empowered fund managers to determine deal structures based solely on strategy.
The freedom that comes with this has helped to channel hundreds of billions of dollars into lucrative infrastructure assets, as they provide the key characteristics that fund members seek. Namely, predictable sources of income, ideally linked to inflation; tangible asset backing; the provision of an essential product or service; capital growth potential; and positive environmental and social impact.
Since the Australian government made this change, pension funds there have gone on to allocate over 30% of their capital to this sector. In the UK, this figure stands at less than 3%.
This can be attributed to pension rules here still forcing UK schemes to push their liquidity requirements onto the funds and assets they invest in, effectively restricting investment to listed and/or liquid assets. This setup makes it very difficult to back innovative new products and services, such as vertical farming and waste-based biofuel solutions.
These areas of sustainable infrastructure are poised to play a key role in addressing environmental and social challenges, and the need for investment has never been more apparent. We cannot expect to fix our biggest challenges, including the way we feed ourselves, how we work, how we travel – the list goes on – by continuing to invest in the same things. We need new solutions, and we essentially need to rethink our approach to even our most fundamental tasks.
The current market dynamic in the UK turns off would-be investors, hindering green growth and placing the UK at a structural disadvantage in comparison with countries that permit their pension industries to invest in them.
Another way of achieving a similar benefit to this, could be through the chancellor driving implementation of the much talked about reforms to the Solvency II regime, significantly reducing the risk margin that insurance companies must hold against their private market exposure.
The vast majority of UK defined benefit corporate pension funds either have already or are moving to buyout, shifting their assets to the insurers, meaning they would become custodians of tens of billions of capital which could be – and needs to be – directed for good.
By rewriting pension and solvency rules with these considerations in mind, the UK has the potential to unlock vital sustainable investment, actively supporting technological innovations that can make a meaningful contribution to the global journey towards achieving net zero, and catalysing thousands of much needed new green careers.
Peter Bachmann is the managing director of sustainable infrastructure at Gresham House