79: Latest DWP consultation package on DC schemes

The Department for Work and Pensions (DWP) published a consultation package, ‘Facilitating investment in illiquid assets by defined contribution pension schemes’, on 30 March 2022. The DWP is seeking feedback on policy proposals and draft regulations in this area.

The consultation package includes the following:

• the government’s response to the ‘enabling investment in productive finance’ (charge cap reform) consultation;
• a policy consultation on ‘disclose and explain’ proposals to stimulate illiquid investments;
• consultation on draft regulations on employer related investments (ERI); and
• the government’s response to a call for evidence ‘future of the defined contribution pension market: the case for greater consolidation’.

Charge cap reform

These proposals relate to removing performance-based fees from the statutory 0.75% cap on charges that apply to default funds of occupational DC schemes used for the purposes of automatic enrolment.

There were mixed responses to the proposals. Respondents in the financial services sector broadly welcomed them, but trustees’ service and legal advisory bodies and some master trusts were unconvinced that the proposed changes were enough to incentivise DC schemes to change their current approach on investing in illiquid assets with performance fees. There was however agreement from all respondents that the DWP must ensure any regulatory changes planned have the appropriate and necessary safeguards in place to ensure effective member protection.

Overall, the DWP acknowledged the proposals were not supported across the pensions sector and other interest groups. The DWP stated it will take the time to fully consider and understand the concerns raised, engage with the pensions industry, and explore how the concerns might be addressed in preparing the performance fees policy. Accordingly, the DWP will consult again on principles-based draft guidance alongside any proposed consultation on draft regulations in due course.

Disclose and explain proposals on illiquid investments

The DWP is proposing to amend the Statement of Investment Principles requirements currently set out under the Occupational Pension Schemes (Investment) Regulations 2005 (SI 2005/3378) (the investment regulations). The aim is to ensure default arrangements of occupational DC schemes ‘disclose and explain’ their policies on illiquid investment.

Trustees of occupational DC schemes with over £100 million in total assets would be required to publicly ‘disclose and explain’ the percentage of assets allocated in the default asset class allocation in their annual Chair’s Statement across the main asset classes of cash, bonds, listed equities, private equity, property, infrastructure and private debt. The DWP aims to issue guidance to cover the way in which it proposes trustees should disclose this information.

In its ‘rationale for intervention’, the DWP states it has seen a significant increase in DC schemes’ appetite for investing in illiquid assets, but recognises more could be done to demonstrate to trustees that illiquid assets are ‘not off the table’ and ‘could provide members with higher net returns’, so are worth investing in. Rather than encourage investment in only one asset class or sector, the DWP wants to encourage further diversification and investment in assets that bring higher returns.

In this regard, the DWP seeks to ‘encourage greater competition and innovation based on overall value for money in the DC market’. If asset allocation information is available to all members, employers and consultants, this allows them to compare schemes alongside other key metrics, including the scheme’s net investment returns, charges and quality of service.

The DWP believes this will complement the work of the Financial Conduct Authority and The Pensions Regulator (TPR) to create ‘a single framework for value for money in DC pensions’.

Consultation on draft ERI regulations

ERI legislation was first introduced in the 1990s to combat and reduce the risk of sponsoring employers misappropriating pension scheme funds through loans and investments from the scheme. The restrictions currently in force in the Investment Regulations include a ban on certain loans of a scheme’s assets to an employer participating in the scheme, a limit on the trustees investing more than 5% of a scheme’s assets in ERI and a limit of 5% per participating employer with a total cap of 20% of total scheme assets for multi-employer schemes.

The government has noted that this original legislation was based on ‘the type of pensions available at the time’, which were mostly single employer, defined benefit occupational pension schemes. As the pensions landscape has changed dramatically since the initial legislation was first enacted, the DWP is now proposing to correct what it sees as the overregulation of DC master trusts under current ERI legislation, which it claims will assist in reducing unnecessary burdens to schemes and remove barriers preventing schemes from investing member funds in a more efficient manner to improve returns.

The DWP is seeking to update existing legislation so that it recognises the different structure of DC master trusts and the ‘distinct relationship between the scheme and multiple participating employers using the scheme to deliver their AE (auto-enrolment) obligations’. For master trusts with 500 or more participating employers, the DWP intends to implement the draft Occupational Pension Schemes (Investment) (Employer-related investments by Master Trusts) (Amendment) Regulations 2022 to amend existing ERI restrictions currently contained in existing regulations (including the Investment Regulations). The new definition of ERI will only apply in relation to investment in the scheme funder (a person who is liable to provide funds to or in respect of the scheme where administration charges are not sufficient to cover the running costs / is entitled to receive scheme profits where charges exceed those costs), the scheme strategist (a person who is responsible for making business decisions relating to the commercial activities of the scheme), or a person connected or associated with them.

Response to call for evidence on greater DC consolidation

In summer 2021, the DWP’s consultation on consolidation put in place proposals for trustees of DC / hybrid schemes of less than £100 million in total assets to undertake an annual value for members assessment to be reported in the annual Chair’s statement and to TPR in the annual scheme return. Last summer also saw a call for evidence, which sought to understand any barriers for further consolidation of the occupational trust based DC market in the UK, and receive views on how to expedite consolidation for schemes under £100 million, whilst looking ahead towards schemes between £100 million and £5 billion in total assets.

The DWP has reported mixed responses from last summer’s call for evidence. It remains concerned that members continue to suffer in poorly performing schemes. Despite this, the DWP is encouraged that ongoing interventions and proactive trustees will ensure members are the primary and only consideration when deciding the fate of a pension scheme. The DWP is also encouraged by data published by TPR, which suggests consolidation is taking place at a healthy pace of year-on-year decline in the number of schemes.

In response to the feedback, the DWP has decided not to introduce any new regulatory requirements with the sole purpose of consolidating the market in 2022. However, the DWP will work closely with TPR to monitor the impact of the value for members’ assessment, which will start to be produced in 2022, with a longer term focus on creating with TPR and the FCA a value for money framework for occupational and workplace pension schemes.

Comment

There is clearly a lot to consider for employers and trustees of occupational DC pension schemes in this package of consultation proposals. It appears to be the government’s intention to use these proposals as a springboard for greater investment diversification and in pursuing a path to opening illiquid asset classes to DC schemes, whilst ensuring the necessary safeguards are in place to protect members’ interests. The ERI proposals will make life easier for master trusts, and employers and trustees of larger DC schemes will welcome the pause on further consolidation legislation.

Trustees and employers of occupational DC schemes will need to consider responding to the consultation and continue to monitor developments.

The consultation remains open for responses until 11 May 2022.