On Tuesday 30th November 2021, Rishi Sunak, the Chancellor of the Exchequer, proposed a loosening of the current 0.75% fee cap on Defined Contribution pensions. He is proposing this to direct some of the capital within UK pension funds into growth areas such as venture capital & private equity (VC & PE), whose fees have historically prevented such funds from investing. Consultation on the matter will continue until 18th January 2022.
A Defined Contribution (DC) pension is a fund that, upon retirement, will regularly pay out an amount of money (an annuity) that is dependent upon the amount invested, and the growth of those investments over time. It is distinct from a Defined Benefit pension as the annuity is dependent on returns from investments, not an amount decided in advance. DC pensions are the most common type of plan for private-sector employees in the UK, with 22.4 million people enrolled as of 2019. The gross assets, excluding derivatives, held within DC schemes reached £146 billion in 2019, according to the ONS.
The 0.75% cap on fees for DC pensions has existed since April 2015, when it was introduced by Conservative Chancellor George Osbourne, in an attempt to prevent the “erosion” of pensions. Most pension funds charge fees well under the threshold, with the average charge in 2020 being 0.48%. Earlier this year, however, a joint working group of The Bank of England, Treasury Office and Financial Conduct Authority all endorsed the removal of the cap, as they claim it will encourage much-needed investment in illiquid assets.
Sunak’s primary motivation for excluding what he deems “well designed” performance fees from the cap is to allow investment by pension schemes in areas that may contribute to his government’s ‘levelling up’ agenda. These areas, such as VC & PE, typically command prohibitively higher fees. Almost 70% of money held by UK DC pension funds right now is tied up in government gilts, and most of the rest is invested in the ordinary stock of non-UK based large companies. This is the case because pension funds seek stable growth and low risk, whereas VC & PE tend to offer higher risk and less predictable (albeit potentially far greater) returns.
There are likely to be wide-ranging consequences stemming from loosening the fee cap. Whilst the PE & VC industries have lobbied for the changes for years, not all parties are as enthusiastic. For the 22.4 million holders of DC pensions, even a small increase in fees threatens to compound throughout their contribution period and significantly eat into their annuity. Mick McAteer, a former FCA board member who now directs the Financial Inclusion Centre, has argued that the proposed changes will “undermine the value of pensions savings” and do more harm than good by incentivising inefficiency in investment.
The chancellor has, however, proposed several possible upsides for DC pension holders. He argues that by cutting restrictions on fees and therefore on investments, pensioners will see the upside when they start drawing annuity. They are well-positioned to gain from the higher gross returns that fewer investments can offer, as their time frame for returns is typically long term, as contributions last their entire career – typically at least 30 years. Therefore, they can afford to be tied up in infrastructure, VC & PE, which can be illiquid.
Sunak also views the loosening as benefitting Britain’s entrepreneurial spirit’. If he can incentivise pension funds to give capital to VC & PE firms, their money can then be ploughed into green energy and infrastructure projects, as well as British businesses. From the government’s perspective, this would theoretically mean delivering growth to the private sector and pensioners without increasing taxes. Both Canada and Australia have seen benefits from similar reforms, where both pension funds and infrastructure projects have grown. Much of the development is likely to be focused in the North of England, where Johnson has made a series of pledges to ‘level up’ the regional economies.
The proposed loosening of pension fee caps will likely have wide-ranging consequences. Whilst sentiment from savers is generally negative, there has been industry-wide support due to a range of potential upsides to business. Only time will tell if the changes lead to reasonable growth within areas of PE & VC in the UK, or simply subject DC pension plan holders to increased costs for little to no benefit.
By Otto Rutter
Sector Head: Edward Raftery