The biggest driver of change in DC

Had it not been for auto-enrolment, the charge cap and pension freedoms, schemes would be much smaller, more expensive and with the majority still targeting annuities. Instead of entering a period of relative stability, however, new requirements will provoke even more upheaval.

Most schemes undergo a regular periodic review and then decide whether to make any alterations. Over the past 10 years, more than 50 per cent of schemes have made changes at least twice; this will often entail altering the default investment strategy or switching provider.

Overwhelmingly, the main reason for making a change has been to comply with new regulation or legislation. The aggregate effects of these changes are striking: by the end of 2018 active membership of DC schemes had increased to 18m, average annual member charges had fallen to just 40 basis points, and the number of default glidepaths targeting drawdown had exceeded the number targeting annuities.

Ongoing regulatory and legislative developments will again result in the future DC landscape looking significantly different

Ongoing regulatory and legislative developments will again result in the future DC landscape looking significantly different. Three important elements relate to consolidation, investments and at-retirement guidance.

Promoting consolidation

A key challenge for the Pensions Regulator is that it is responsible for overseeing the governance of tens of thousands of trust-based DC schemes.

One solution is to encourage schemes to consolidate into master trusts. The Master Trust Assurance Framework was introduced to promote high standards of governance among master trusts, which should help existing scheme fiduciaries feel confident that after transferring members over to a master trust, they will be well looked after.

The government is also playing a role here. Legislation has been proposed that will require small schemes to regularly assess and justify why members are not better off being transferred.

Moving into the illiquid space

A by-product of consolidation will be a shift in investment behaviour: larger schemes tend to adopt more sophisticated investment strategies and have a greater capacity to invest in illiquid assets, such as private equity, private credit and infrastructure.

The existing lack of exposure to illiquid investments has attracted the attention of policymakers. The government has suggested that large schemes should report on illiquid investment policies, while the Financial Conduct Authority looks set to update the permitted links rules to allow for greater use of illiquid assets in the unit-linked funds commonly used by schemes.

New rules around environmental, social and governance integration are also effecting changes in investment behaviour. Trust-based schemes must now state within their statement of investment principles how ESG factors are taken into consideration in the investment process, and by October must publish implementation reports setting out how these policies have been enacted.

Regulator focuses on ESG and retirement

The FCA, meanwhile, is pushing ESG higher up the agenda within the contract-based market. The responsibilities of independent governance committee boards have expanded to include an assessment of how their providers are taking ESG into account.

Another area of focus for the FCA has been retirement, where a key objective is to improve outcomes for non-advised customers. By August, providers will need to offer ‘pathways’ designed to guide member decision making at retirement. Oversight of these pathways will also be part of the expanded remit of the IGCs.

Regulatory and legislative change has meant that DC is larger, cheaper and offers freedom for members in retirement. New rules will make it even more consolidated, greener, and more focused on guiding members through retirement.

Jonathan Libre is principal in the Emea Insights team at Broadridge