The new Labour government wasn’t exaggerating when it said it was embarking on the biggest overhaul of the U.K. retirement system in decades.
Last week, Chancellor of the Exchequer Rachel Reeves and the government released details of its plans for U.K. defined benefit and defined contribution plans, covering both the public and private sectors, all with an eye on fueling U.K. growth and domestic investment.
And, of course, improving outcomes for participants.
A series of announcements and publications from the government last week called for overhaul of the DC market and local government pension scheme (LGPS) segment that sources said will have a greater impact on the former than the latter.
In brief, the government wants to consolidate more than 60 multiemployer DC arrangements; push even more consolidation among England and Wales’ 86 LGPS funds, which have been busy combining their about £360 billion in assets across eight pools; and spur greater investment in U.K. productive assets and local communities.
The change is intended model plans in Australia and Canada, where large superannuation funds and the so-called Maple 8 are often held up as shining examples of sophisticated asset owners, with large allocations to private assets.
"Pension funds will always play an important role in the gilt market," Reeves said in her inaugural Mansion House speech on Nov. 14. "But for too long, pensions capital has not been used to support the development of British start-ups, scale-ups or to meet our infrastructure needs.
"I have long been of the view that this hurts our economy because our highest-potential businesses cannot expand and savers are not seeing the returns on their investment which they deserve."
Reeves went on to cite Australian and Canadian plans' size in helping them to invest in productive assets.
"And more often than not, it is Canadian teachers and Australian professors reaping the rewards of investing in British productive assets through their pensions schemes rather than British savers. That’s not good enough and we need to change that," she said.
As such, the government also released its interim review into the U.K. retirement landscape, detailing its thoughts on the need for change and what might be achieved.
A DC focus
“In my opinion, the potentially biggest shift is on this DC (side), rather than LGPS,” said Gregg McClymont, executive director-public affairs Europe at IFM Investors — an infrastructure specialist manager owned by Australian super funds and with A$218.3 billion ($141 billion) in assets under management. “There are lots of moving parts and consultations still to be done, but it looks like government is deadly serious about learning lessons from Australian DC.”
Before his role at IFM, McClymont was director of policy and external affairs at master trust The People's Pension, West Sussex, England.
The U.K. DC market comprises more than 1,000 plans with 12 or more participants.
But for its overhaul, the government is concentrating on the largest plans — about 30 authorized master trusts and and 30 providers of workplace contract-based arrangements.
A contract-based arrangement is between the individual participant and the provider of the retirement plan — usually an insurance company. These plans must comply with Financial Conduct Authority rules, whereas trust-based plans are ruled by the Pensions Regulator.
"Perhaps most significantly, the government wants a single set of reforms which cover both master trusts and contract-based schemes, rather than as separate parts of the market,” McClymont said.
Total DC assets are set to hit about £800 billion by 2030, but the government said there’s a “wide variation in member outcomes and limited diversity in how pension providers can and do invest.”
That's why the government looked at evidence from Australian and Canadian plans, which it said “suggests that scale can give schemes access to a wider set of investment opportunities,” such as infrastructure and private assets.
There’s also a nod to the Dutch retirement system of industrywide arrangements. Both the Dutch pension funds and Australia’s industrywide supers have large allocations to unlisted assets, McClymont said.
“They have the scale and the long-term approach, which encourages major allocations to unlisted assets. That’s where government wants to get to in the U.K.,” he added.
The U.K. government estimates a total of 4% of workplace DC plans is currently invested in private equity (1%) and infrastructure (3%). That compares with Australia's supers having an estimated unlisted domestic infrastructure exposure of 54%, and Canadian plans' 22% allocation to domestic infrastructure, according to a government document.
The Dutch market’s large pension fund providers, like the big Canadian plans, also have large and high-profile infrastructure investments.
APG Asset Management, the €550 billion ($596 billion) manager running the assets of the Netherlands’ largest pension fund, recently teamed up with Japan’s GPIF to jointly make investments focused on infrastructure in overseas developed markets. Alongside the ¥248.2 trillion ($1.6 trillion) Government Pension Investment Fund, Tokyo — the world’s largest pension fund — APG will be investing multibillion-euros into global infrastructure projects.
And Dutch pension provider PGGM, with more than €240 billion in assets, has an infrastructure investment team, PGGM Infrastructure, with a €13.9 billion infrastructure fund with 37 investments as of Dec. 31.
There’s also an underlying focus on value for money — something carried through from the previous Conservative government.
That focus “does look to the Australian system,” McClymont said, where superannuation offerings are subject to an annual performance test. Those funds that record two consecutive fails can no longer accept new participants.
“But a really important (point) that’s oft missed is that it’s only been in operation for two or three years — the long-term success of the Australian system flows from other factors, namely sizable employer contributions and a series of funds with scale which take long-term decisions in the interests of members in line with their fiduciary duties,” McClymont added.
Size is everything
Another key message on the DC side was that the government is looking to set a minimum size of a DC default funds.
“That’s really interesting to me,” McClymont said. “In Australia that wasn’t done per se but… (supers) have consolidated rapidly. How can (the U.K.) achieve that given we don’t start from the same place? A size of scheme test would be a major market intervention if set at £25 billion or above.”
McClymont's reference to £25 billion comes from a point made in the government’s interim review, which stated that evidence from international arrangements show that it’s only when pools of assets reach between £25 billion and £50 billion that they achieve scale and can diversify into productive assets. Part of that is because they’re able to hire skilled staff and perhaps bring investment in-house, and more than £50 billion affords greater direct investment and an increasing ability to negotiate lower investment fees.
One source said it’s “significant market intervention if the government gets to a place … where you can’t be in the DC market unless you’re over £25 billion in assets.” The source cited previous Pensions Minister Guy Opperman, who had pushed in 2022 for consolidation in the DC market. As part of that, Opperman wanted plans with under £100 million in assets to justify their continued existence via a value for participant assessment.
“But £100 million to £25 billion is a big shift,” the source said.
Technology focus needed
The push in DC means “only the best master trusts will survive this wave of consolidation,” said Benoit Hudon, president and CEO for Mercer U.K. “It should be better — raising the bar in terms of quality. We’ll see how it plays out,” he said.
Investment options and having the best technology are what drive better participant outcomes, he said — something that has been realized in Australia, for example.
“So consolidation in the DC space makes absolute sense — that’s the direction Australia went, with about a dozen super trusts. There’s the option for members to go from one to the other,” he said, referencing competition that exists in the Australian market where participants are free to choose their super fund.
Those scaled plans have offices in London, Hong Kong, and other financial hubs, and scale “gives those schemes an opportunity to be direct investors in infrastructure and utilities around the world. They have the possibility to go anywhere and pick what they believe will be the best risk/return in investing,” Hudon said.
These plans also have the opportunity to pay lower fees for those third-party services — although there’s a caveat to lower fees, Hudon said.
“It’s not the lowest fees that will deliver the best proposition. To deliver good (outcomes) you need technology — one of the biggest issues is how complex it is for people to understand how to invest,” he said.
To support those participants and help them to make the best decisions, the right communication tools are needed — and that involves technology, which requires investment, Hudon said.
The average U.K. DC plan fee hovers around 20 basis points, between 18 and 22 basis points, he said.
“In Australia, the average is 75 basis points — four times higher,” Hudon said. “The reason is that the industry has agreed, and even the unions (in Australia) are on side with this, that to deliver good outcomes you need a good platform. This requires technology.”
Look for for part 2 of this analysis next week, focusing on the LGPS reforms and defined benefit.
