Budget 2021: Sunak announces further changes to DC charge cap

The consultation is intended to establish whether costs within the charge cap — currently 0.75 per cent on the default arrangement of certain employer pension schemes — affect schemes’ ability to invest in a broader range of assets, and to ensure they “are not discouraged from such investments and are able to offer the highest possible returns for savers”, the budget stated. 

“The Department for Work and Pensions will also come forward with draft regulations to make it easier for schemes to take up such opportunities within the charge cap by smoothing certain performance fees over a multi-year period.”

The Autumn Budget and Spending Review explained that the move will “consider options to amend the scope so that the cap can better accommodate well-designed performance fees to ensure savers can benefit from higher-return investments, while unlocking institutional investment to support some of the UK’s most innovative businesses”. 

While the impulse comes from the right place, a plan to scrap the charge cap misses the point. There are a whole host of other concerns leading to industry reticence to invest in these assets, not least around issues regarding fairness for members and the opaque nature of illiquid assets

Laura Myers, LCP

“The government will continue wider policy work to understand and remove various barriers to illiquid investment,” it 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 told 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. 

Pensions minister Guy Opperman suggested, in March this year, that the charge cap already has room for illiquid investments, telling a Pensions and Lifetime Savings Association 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”.

The Pensions Regulator recently had to scrap a proposed rule change that would have imposed a cap on the amount schemes can invest in illiquids, which industry commentators said would have unnecessarily restricted schemes’ investment in infrastructure and private equity, as well as start-up businesses. 

‘Missing the point’

Industry reaction to the chancellor’s announcement was similarly lukewarm, with LCP in particular arguing that another consultation into the charge cap was “missing the point”.

The consultancy argued, as many have before, that there are many considerations more important than the charge cap when it comes to boosting DC illiquid investments, and that these would have to be addressed before schemes consider increasing their allocation to the asset class.

In particular, it cited lingering issues around daily dealing, as well as a lack of transparency around fees and the need for more guidance from regulators around “complex structures and assets”.

Laura Myers, head of DC at LCP, said: “While the impulse comes from the right place, a plan to scrap the charge cap misses the point. There are a whole host of other concerns leading to industry reticence to invest in these assets, not least around issues regarding fairness for members and the opaque nature of illiquid assets.

“There is also the reality that many DC schemes invest via insurers who don’t accept many illiquid assets so this won’t be changed by the magic bullet of charge cap changes. It’s a missed opportunity to address perceived barriers and some industry nervousness.”

The BoE’s Productive Finance Working Group recently said, in a report, that a review of how illiquids interact with the typical “daily dealing” requirements of DC schemes was necessary, but stopped short of calling for a complete overhaul.

“On the surface, the daily dealing nature of the current DC system seems ill-suited to less liquid assets that are not tradable in that timeframe. However, our engagement with a range of industry stakeholders indicates that moving away from a daily dealing format within DC schemes is neither feasible nor necessary in order to accommodate less liquid exposures,” the report stated.

Steven Cameron, pensions director at Aegon, welcomed the government’s keenness to “break down barriers stopping workplace pensions investing more of their billions of funds in illiquid investments, including infrastructure and productive finance”, adding that it is “great that pensions are now recognised across government as an investment ‘super power’ which can support economic recovery”. 

“Illiquid investments can have higher charges, and some are subject to performance fees which can’t be known in advance and could lead to investment charges exceeding the maximum charge for workplace pension default funds of 0.75 per cent,” he explained. 

However, he seconded LCP in pointing out that “this is not the only barrier discouraging pension schemes to invest in illiquids”. 

“With many having charges well below the 0.75 per cent cap, this could be a red herring. An important challenge when implementing these changes will be to avoid raising concerns among workplace pension members that they may be subject to higher charges. Raising such concerns to allow different investment strategies would be the tail wagging the dog,” Cameron added.

Sonia Kataora, head of DC investment at Barnett Waddingham, similarly argued that workplace pension scheme charges “are generally well under the existing cap, and although adjusting the cap (not just in terms of the level but the way charges are assessed) may assist with some investments, this doesn’t tend to be the deciding factor for trustees when deciding whether a strategy creates good value for members”.

“What’s more, the savers who will likely be able to invest in infrastructure assets are younger members (given their long investment horizons) — those closer to retirement will need greater liquidity,” she continued. 

“We need to ensure this doesn’t lead to an unfair charge hike for all members, or an intergenerational divide when it comes to fees and charges. Neither of these are a palatable solution, especially with the DWP pushing hard for best value and fair charging to solve the UK’s pensions crisis.”