Govt to remove performance fees from DC charge cap

Such performance fees, which are only payable to an investment manager if they generate high returns on their investments, are often found in private market assets like venture capital, and are currently included within the DC scheme charge cap.

The charge cap is set at 0.75 per cent on the default arrangement of certain employer pension schemes.

The DWP said if performance fees are excluded from the charge cap, schemes — if they choose to utilise it — “could overcome barriers to long-term investment”, and “provide new opportunities to invest in areas such as British businesses and green projects”.

While finding the right solution is sensible, it is surprising to see that recent proposals to allow for a smoothing of costs over a five-year period may be abandoned before they have had time to take effect

Joe Dabrowski, PLSA

The consultation follows the announcement by chancellor of the exchequer Rishi Sunak in October that the government would consult “within the next month” on further changes to the charge cap, with the goal to encourage more investment in illiquid assets by DC schemes.

As part of the consultation, the government said it also wanted to explore the impact changes to this area could have on member protection and helping to deliver better outcomes for savers, while seeking proposals on policy design so member protections are maintained.

Guy Opperman, minister for pensions and financial inclusion, said: “As automatic enrolment has developed, we have always wanted to ensure the best outcomes for members.

“This consultation will look at ways to enable schemes to take advantage of long-term, illiquid investment opportunities and provide better returns for members.

“Lifting these barriers can also help contribute to the key role finance has in tackling climate change, by mobilising private finance towards clean and resilient growth and addressing market barriers to longer-term investing in green projects.”

‘Charge cap protects consumers’

Joe Dabrowski, deputy director of policy at the Pensions and Lifetime Savings Association, noted that while the industry body welcomes the intent to make it easier for DC schemes to invest in a wider range of assets and illiquid investments, it “has not seen any compelling evidence to suggest that raising the current DC default charge cap of 0.75 per cent will result in any material change in the volume of investment in illiquids”.

He said: “A focus by employers on securing low-cost provision in a competitive market; the prudent person principle, which requires schemes to take careful consideration of risk and reward; and operational barriers, such as the flexibility to move pots when requested and daily dealing, result in only a very low proportion of scheme investment in such assets.

“Recent proposals to allow for a smoothing of costs over a five-year period may alter this in time, but it is too early to tell.”

He added: “Overcoming behavioural barriers will require regulatory consistency, and while finding the right solution is sensible, it is surprising to see that recent proposals to allow for a smoothing of costs over a five-year period may be abandoned before they have had time to take effect.”

Dabrowski said the charge cap was an important consumer protection that helps derive better value for money for pension savers, and that while pension schemes “will always be interested” in investing in assets with a strong likelihood of delivering long-term returns, such assets must be transparent, appropriate for members and provide value for money.

“For the growth in investment in productive finance, it is important that new and innovative products such as the Long-Term Asset Fund come to the market and meet pensions schemes’ needs, rather than simply a reliance on traditional investment vehicles’ fee models,” he added.

A mixed response

Previous attempts to increase DC investment in illiquids have met with a mixed reception from the industry.

The DWP launched a consultation into the charge cap in March following the government’s “plan for growth”, published that same month, and looked specifically at whether the charge cap acts as a barrier to investment in a range of alternative asset classes, including illiquids.

It followed a call in November last year by the governor of the Bank of England, Andrew Bailey, for regulatory changes to tap DC for investment in the post-Covid recovery.

Pensions Expert was informed at the time that defined benefit schemes, which do not suffer many of the hurdles faced by DC schemes, nonetheless lack substantive allocations to illiquids, suggesting that merely making these asset classes more available to DC will not itself spur significantly increased investment in them.

The March consultation also proposed “smoothing” performance fees within the charge cap, but industry players told a meeting of the BoE’s Productive Finance Working Group in July that this would only make a slight difference. 

Opperman suggested in March this year that the charge cap already has room for illiquid investments, telling a PLSA investment conference that the average large DC master trust is charging members 0.4 per cent within a cap of 0.75 per cent, and arguing against removing a cap they use “barely half of”.