Hammond’s Budget looks to unlock DC savings for patient capital

Leading occupational DC providers including Nest, The People’s Pension and the Tesco Pension Fund have also agreed to explore the possibility of creating a joint investment vehicle offering pooled access to illiquid assets.

The main thing is that we must not forget that pensions are there to provide an income in retirement for members, not to create a floor of investments to finance part of the economy

Steven Cameron, Aegon

Increasing investment in startups and other long-term investments has been on the government’s agenda since last year’s Budget. However, the new publication on financing growth in innovative firms is the first to aim squarely at the £1tn DC pension market and its regulation.

“The taskforce found that the current methods of calculating compliance with the cap do not easily accommodate performance fees – a fee structure often used to access venture capital, infrastructure and other patient assets," the Budget document read.

“The government will therefore consult in the new year on regulatory changes to ensure that investment strategies are not unduly inhibited by restrictions on fee structures, whilst robustly defending existing member protections.”

The Pensions Regulator has also recently published guidance clarifying how trustees could include and assess investments in patient capital, as part of the government’s plan.

However, Monday's consultation announcement does not appear to address problems surrounding the daily pricing and dealing of illiquid assets.

The consultation was welcomed by Mark Jaffray, head of DC consulting at Hymans Robertson.

“We’ve long been frustrated with how difficult it is to get illiquid assets and long-term investment into DC, as most DC members have a long timeline,” he said.

Some asset managers have attempted to address the clash between performance fees and the charge cap, currently set at 0.75 per cent, by simply capping their own fees. Jaffray said no clear solution to the problem was evident, but suggested the government could consider allowing a portion of the charge cap to be linked to performance.

Schemes more cautious on patient capital

The Treasury’s use of ‘patient capital’ mentions investments like venture capital and start-ups in the same breath as other illiquids such as infrastructure, but schemes will likely be more selective and cautious about increasing the risk in their portfolios.

“About 80 per cent of new startups fail, so that needs to be managed quite carefully,” said Jaffray. In a pooled vehicle such as that being considered by large providers, he expected that high-risk VC would have to play a smaller part than more reliable income streams.

Steven Cameron, pensions director at Aegon, said any consideration of patient capital would have to be taken within the context of fiduciary duty.

“The main thing is that we must not forget that pensions are there to provide an income in retirement for members, not to create a floor of investments to finance part of the economy,” he said.

Darren Philp, head of policy at Smart Pension, expressed a similarly cautios attitude: “Making this happen would be revolutionary for the business world, but while DC pension funds do need to diversify away from the traditional asset classes and incorporate alternatives into their portfolios, they are expensive and not necessarily conducive with the fee pressure in the DC world. "He said the potential returns of a patient capital investment but be considered within the contect of their cost, the efficiency of the vehicle, due diligence, and cash flow management.“We saw with previous Treasury attempts to open up infrastructure to pension funds that funds should only invest where it is in their interests to do so," he added. "While opening up alternative asset classes is welcome, Trustees and schemes need to ensure they are doing what’s right for scheme members and not simply bow to the latest political pressure to invest in a certain way."

Gregg McClymont, director of policy at The People’s Pensions, said large master trusts may not be the primary beneficiaries of any resulting reforms, but that their investigation will help the wider industry.

“We think we will have the scale very quickly to do the things we want to do in that space,” he said, but added: “It’s incumbent on us to be involved in something which might help funds invest in patient capital.”

DC savers cushioned from contribution blow

The Budget also promised £5m in investment in pensions dashboards, with the pledge that state pension data will be included in the service.

Documents also included a response to consultation on the cold-calling ban, which is due to be laid this year. The government will consider banning firms regulated by the Financial Conduct Authority from buying leads from cold-callers.

The relief expressed by some in the pensions industry at seeing the pensions tax regime unchanged in the Budget was compounded by the benefit to auto-enrolment savers of raising the income tax personal allowance to £12,500 a year in 2019-20, earlier than planned.

Industry experts said this would help offset the near doubling of employee contributions under AE in April next year. Employees currently have to pay at least 3 per cent of pensionable salary, but the rise to 5 per cent will bring combined contributions up from 5 per cent to 8 per cent.

“From an auto-enrolment perspective the increase in the personal allowance is probably a good thing because that cushions the impact of the increased contributions,” said McClymont.

Net pay anomaly remains unsolved

However, the increase in the tax allowance will also mean more people are affected by what is known as the net-pay anomaly. More than a million earners miss out on their right to a tax relief top-up because they earn less than the income tax threshold, and their scheme operates a net pay arrangement.

McClymont said it was a “missed opportunity” for government, but remained hopeful of change in the future.

“We need to make auto-enrolment work for the long term and there has been a good start to that, but inevitably there are a few things that need to be ironed out… I think this is one of them,” the former shadow pensions minister said.

Ros Altmann, the former pensions minister and Conservative peer, said the balance of these effects would be positive for DC savers

“It makes the net pay problem worse, but for the vast majority of people in the workplace... the impact on take-home pay of the doubling of contributions next year will be offset by the rise in the tax allowance,” she said.

DB schemes bumped down creditor queue

The Budget held less positive news for defined benefit schemes, which will see HM Revenue & Customs leapfrog them as a creditor in certain circumstances relating to a sponsor’s insolvency.

From April 2020 the taxman will become a preferred creditor in respect of taxes collected and held by businesses on behalf of other taxpayers, such as VAT, income tax, employee national insurance contributions and construction industry scheme deductions. Others such as corporation tax and employer NICs will be unaffected.

With DB schemes treated as unsecured creditors of their sponsor, they may find themselves with a weaker claim on sponsor’s assets.

“You’re further back in the queue,” said David Robbins, senior consultant at Willis Towers Watson, although he added that a lack of disaggregated costings in the Budget made it difficult to quantify whether the impact will be significant.

“If the pension scheme’s going to go into the Pension Protection Fund anyway then that won’t affect members.. It will of course be a slightly bigger strain on the PPF,” he continued. “If the scheme is funded above PPF levels then that means that the amount of benefits that members receive might be slightly lower than it would have been.”

With taxes paid on an ongoing basis by most companies, schemes with some confidence in the strength of their employer are unlikely to be particularly concerned by the change, said Aon partner Lynda Whitney.

However, for weaker sponsors and schemes, unpaid taxes could now have an impact on covenant assessments.

“Where you’re looking at a situation where a scheme’s seriously concerned about the position of its employer, then they’d have to look at asking more questions, and it’s just another question about, ‘Who’s ahead of me?’” she said.