Chancellor’s Mansion House speech: the consolidation game for DC pension funds

The new Government’s central mission is to achieve the fastest sustained level of GDP growth in the G7 group of developed countries.  And after a first Budget that lacked much ‘growth’ content, Chancellor Rachel Reeves’ first Mansion House speech was chock full of new announcements that she hopes will help boost growth in the coming years. 

It was Reeves’ announcements on pensions – and, in particular, her plans to create DC ‘mega’ funds – that grabbed many of the headlines.  The Chancellor hopes that larger DC default funds will be able to realise greater economies of scale and invest across a more diversified range of assets, including private market assets such as infrastructure and private equity.  But what is she proposing, and by when?

Consolidate me (from 2030)

The centre-piece of Reeves’ proposals is a plan to drive DC fund consolidation further and faster than the last government had planned. The Chancellor acknowledged that consolidation is already happening, particularly at the lower end of the market; and that the new value-for-money framework being developed by the FCA would also have an impact.  But in her view, “the pace is too slow”.

To speed up the process, the Government is consulting on two key proposals:

• First, to limit the number of auto-enrolment (AE) default arrangements or funds a provider can offer.  The consultation seeks views on what the maximum number of funds should be, but the government clearly has a low figure in mind, citing the example of the Australian system under which many schemes offer a single default fund;
• Second, to set a minimum size (AUM) threshold for default funds.  The consultation highlights evidence suggesting that significant economies of scale and asset diversification benefits can start to be realised in funds of between £25bn and £50bn.  It therefore seeks views on what the minimum size of an AE default fund should be to maximise investment in productive assets.

Despite the Government's urgency to implement these changes, the consultation indicates that neither of the proposed requirements will take effect before 2030. This delay is intended to give schemes and funds sufficient time to scale up and meet the necessary thresholds.

Mind the contract

Despite the greater scale of some Group Personal Pension (GPP) default funds (relative to master trusts), the Government has identified challenges with gaining the necessary consents from scheme members for bulk transfers or mergers to enable consolidation. 

The challenge is particularly highlighted in relation to the incoming FCA value-for-money (vfm) framework.  Under the current arrangements, a scheme identified as not providing value for money would require member consent to transfer members to a different scheme which is judged to provide vfm. 

As such, the government proposes to enable contractual overrides for contract-based pension arrangements, subject to what it terms “appropriate protections”.  The aim of the change is to establish equivalence with the trust-based DC market, so that GPP scheme members can be transferred to “better performing arrangements”.

Shifting from cost to member value

Member value is also the focus of a third group of proposals.  In recent years, successive governments have identified a narrow industry focus on ‘lowest cost’ rather than ‘member outcomes’ as a barrier to achieving wider investment diversification and the generation of higher long-term member returns.  Through the joint industry-government Productive Finance Working Group, industry culture was identified as a particular challenge.

While the Value-for-Money framework is designed to help shift this cultural focus, the government is also keen to hear views on the role of employers and pension consultants.  In particular, the consultation seeks views on two questions:

• whether a duty should be placed on employers to consider the overall value of their auto enrolment pension arrangements – or whether a named executive should be given responsibility; and
• whether regulating the advice that employers receive on pension selection would deliver better member outcomes.

Allocation freedom! (for now)

In the run-up to Mansion House, some had speculated that the Chancellor would mandate DC default funds to invest a proportion of their AUM in specific UK asset classes.  However, the Interim Report of Phase One of the Pensions Review, published alongside the Mansion House speech, notes that “at this stage, the Review has decided not to make specific recommendations in relation to UK assets.” 

The Review cites evidence that where pension schemes manage private market portfolios, they tend to operate a significantly higher domestic weighting than in more liquid asset classes – which suggests that with greater scale and more diversified investments, DC default funds may allocate proportionally more to the UK.  Nonetheless, the Review identifies a “sustained pattern” of withdrawal by DC pension schemes from UK listed assets.  Consequently, the next stage of the Review will continue to consider whether further government interventions should be made.

What’s next?

Most immediately, the DC consultation is open until 16 January 2025.  We expect consultation responses to inform the final report of Phase One of the Pensions Review and the drafting of sections of the Pension Schemes Bill, both of which should be published in the Spring.