In detail

The recent DC developments have all been announced as part of the consultation, 'Facilitating investment in illiquid assets by defined contribution pension schemes'. The drive to encourage DC schemes to invest in illiquid assets fits into the Government's "productive finance" agenda. This has become a growing focus for Government and which, in broad terms, sees alignment between the interest of DC pension savers (in the form of potentially higher returns through investment in longer term, less liquid assets) and economic goals (in the form of investment in so called "productive finance" assets such as research and development, technology, and infrastructure, which are seen as key to support economic recovery, financial stability and the transition to net zero).

Although billed as a consultation, 'Facilitating investment in illiquid assets by defined contribution pension schemes' encompasses responses to previous consultations and calls for evidence as well as consultations on new proposals.  In relation to the productive finance agenda, it comprises the following:

• a consultation on new "disclose and explain" proposals on illiquid investments
• a consultation on new draft regulations on employer related investments (relevant to Master Trusts)
• a response to the 2021 consultation ‘Enabling Investment in Productive Finance’ (charge cap reform).

On the separate policy area of DC consolidation, it also contains a response to the 2021 call for evidence ‘Future of the defined contribution pension market: the case for greater consolidation’.

Government rules out further DC consolidation in 2022

Following the introduction of new legal requirements for schemes with under GBP 100 million in assets to undertake value for member assessments, which is aimed at encouraging trustees of smaller DC schemes to consolidate benefits, the Government issued a call for evidence in June 2021 in order to understand the barriers to further consolidation of the occupational DC market. The call for evidence was aimed at identifying the barriers and opportunities for greater consolidation of schemes with between GBP 100 million and GBP 5 billion of assets under management, with the Government putting down a marker in the consultation forward that "it does not intend to stop at GBP 5 billion."

In the response to the call for evidence, the Government has said that it "remains concerned that members are suffering in poorly performing schemes, unable to access the full range of available investments, subject to higher than necessary charges, and generally poorer governance."  It has, however, decided to put the brakes, at least temporarily, on the drive for consolidation in the wider DC market, confirming that it will not bring in any more regulatory requirements "solely for the purpose of consolidation" in 2022.  The decision appears to be driven largely by the consensus from the consultation responses that the Government should slow down the next phase of its consolidation agenda, with some responses going as far as saying that pushing consolidation to the wider DC market too fast could be counterproductive.

For now, the Government is planning to focus on working with the Regulator and the Financial Conduct Authority on a value for money framework for occupational and workplace pension schemes and said that it will "wait and see" what the impact of the new value for member assessments undertaken by small schemes is, before embarking on new policy ideas that might apply to schemes above GBP 100 million.

This seems sensible as small (less than GBP 100 million) schemes will only be going through the value for member assessments soon, and so it does provide the opportunity for the Government to wait and see how it operates with those schemes - and whether any changes are needed to either the legislation or guidance - before applying it to larger schemes, especially given that it is an additional and potentially costly burden for schemes. The Government has also acknowledged that data (from the Pensions Regulator) points to the fact that that consolidation is already happening at a healthy rate and so a wait and see approach also means the Government's objective for further consolidation may well be met in any event. 

For further detail about the new value for member assessments, see our previous alert here.

Proposal for new "disclose and explain" requirements for trustees on illiquid assets

The Government has launched a consultation on the introduction of two new requirements for trustees. Firstly, a new requirement for trustees of relevant DC occupational schemes to be required to disclose their policy on illiquid investments as part of their statement of investment principles.  Secondly, a proposal for relevant DC schemes with over GBP 100 million in assets to be required to publicly disclose their current asset allocation to members (the latter to be disclosed as part of the annual Chair's statement). 

Based on the wording of the consultation, it appears that the current policy intention is that for schemes with both DB and DC benefits, the new requirements would not apply where the only DC  benefits are AVCs, and where a scheme contains both DB and DC sections, the Government has said that intention is for the requirements to apply to the DC section only.  For schemes, or sections of schemes, which are in scope, the Government has said that its intention is for the requirements to apply only to default funds within those arrangements (they would not apply to self-select funds). 

The new requirements build on previous consultations looking at ways in which the Government can remove the barriers to DC arrangements investing in illiquid assets. The current proposals stop short of mandating schemes to allocate a certain proportion of their assets into illiquid investments (something which the DWP acknowledges in the consultation could cut across trustees' fiduciary duties). The Government is, however, hoping that the new requirements will encourage trustees to consider further diversification and investment in illiquid assets. 

"We want trustees to actively reflect on whether their current investment policies and asset allocations align with these market changes and if their current offerings are still in their members’ best interests. We are not requiring trustees or investment managers to change their asset allocation as a result of these regulations but rather to reflect on the decisions they have already made, and the decisions they will make, as part of their ongoing fiduciary duty to create an investment approach that works optimally for members."

The consultation runs until 11 May.  No draft legislation has been published as part of the consultation, although it does contain some details about how the Government would look to implement the new requirements within the current legal framework.  One of the particular areas where the Government is seeking input is how illiquid assets should be defined. This will be a key area in determining how straightforward (or not) complying with the new disclosure requirements would be for trustees if the Government go ahead with their proposals. 

It will be interesting to see whether, if the legislation is passed, it has any impact on how trustees invest. There clearly needs to be suitable investments for DC trustees to invest in that qualify as illiquid assets, and the trustees would still need to satisfy their fiduciary duties by deciding that the investments were in the best interest of members. The obligation to make disclosures about how illiquid assets have been considered is in one sense relatively "soft" as it does not prescribe certain investments. It is similar to the approach which has been taken in relation to disclosures about ESG factors.

New proposal for easements to the employer related investment requirements for large DC Master Trusts

The Government is consulting on draft regulations amending the current employer related investment ("ERI")  requirements for DC Master Trusts with 500 or more participating employers. Approximately 13 providers are expected to be in scope.

The proposed changes would make it easier for the master trusts in scope to invest in other participating employers in the master trust.   They would, however, continue to be subject to some restrictions. For example, there would continue to be restrictions on the level of investments which could be made 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.

The policy objective is to allow master trusts to access a wider range of investments, including illiquid or private credit markets. It recognizes that the current ERI restrictions were put in place before the development of commercial DC Master Trusts and that the risks which the restrictions were intended to address - schemes making inappropriate loans to or investments in their sponsoring employers - is less of an issue in many of the DC Master Trusts, where the participating employers do not tend to be connected in the same way and where the scheme and employers typically operate entirely at arms' length.

Although the proposals will impact relatively few providers, for those providers it does impact, the proposals could make a real difference in practice by simplifying checks and procedures which are currently in place to ensure that the current ERI rules are not breached and which are a high priority given the criminal penalties for breach. The rationale given for limiting the proposed changes to Master Trusts with 500 or more participating employers is that the data suggests there is a considerable gap between those Master Trusts with 500 or more participating employers and those that fall below that figure "making this a sensible place to set a threshold to avoid schemes falling in and out of the scope of this amendment".

Response to consultation on removing certain performance fees from the charge cap

In November 2021, the Government consulted on a proposal to remove certain performance fees from the charge cap. Broadly, the charge cap operates to restrict the costs and charges which can be levied within the default funds of automatic enrolment arrangements. The Government hoped that removing certain performance fees from the charge cap - referred to in the consultation as "well designed" performance fees - would allow DC schemes that want to explore investing in illiquid assets that come with performance fees the flexibility and freedom to enter into these arrangements if they think this will be in the financial interest of members. The Government also hoped it would incentivize asset managers to design a new fees structure in the future that schemes are more willing to pay.

Following a "mixed reaction" to its consultation, the Government has indicated that it will continue to pursue this proposal but has not, set out any timings for next steps and the language in the response suggests that the Government may proceed somewhat tentatively, confirming that any changes "will be intended to first and foremost ensure members are sufficiently protected".  The Government has indicated that if it goes ahead and excludes performance fees from the cap, it is likely to put in place additional disclosure requirements to ensure that those performance fees which are outside the cap remain visible. It has also indicated that it is likely to continue the policy approach in the consultation of targeting only "well designed" performance fees that are paid when an asset manager exceeds pre-determined performance targets for exclusion from the charge cap, meaning that any other performance fees which didn’t fall within the category of "well designed" would remain subject to the cap. This is intended to strike a balance between protecting members and the aim of removing barriers to investment in illiquid assets. The Government acknowledged in the response that the concept of "well designed" fees is a new one and has said that it intends to consult on "principle-based draft guidance alongside any proposed consultation on draft regulations".  

The full 'Facilitating investment in illiquid assets by defined contribution pension schemes' consultation can be found here.