Paving the way for significant change: Government confirms plans for scale, consolidation, value and investment in the UK

By way of reminder, the objectives of the Review were to address fragmentation across the workplace pensions system, boost investment, increase returns and address “waste in the pensions system”. The focus of the Review was multi-employer, commercial defined contribution pension schemes and the Local Government Pension Scheme.

The Final Report is clear on the themes of scale and consolidation across the DC pensions market to achieve “bigger, better and less fragmented schemes”, placing a greater focus on value which schemes can deliver and driving investment in productive assets. But what does the Final Report tell us?

1. Headline points

• Commercial DC providers and master trusts must have a “main scale default arrangement” of at least £25 billion by 2030 (ie what is commonly referred to as a default fund or option)
• The scale test will be applied at arrangement level – not across the whole DC scheme/master trust – so a scheme/provider must have at least one “megafund” default arrangement at the centre of its proposition
• For those sub-scale, there will be a transition pathway; schemes will need to apply for entry in 2029, show at least £10 billion AUM by 2030 and provide a credible plan to reach £25 billion in AUM by 2035
• There will be a “new entrant pathway” to enable new market entrants with innovative products to seek regulatory authorisation
• The Pension Schemes Bill will introduce a contractual override regime to facilitate consolidation for contract-based schemes; contractual overrides will only be allowed where it is in the best interests of savers certified by an independent expert
• The Pension Schemes Bill will include a new VFM Framework for the DC pensions market with the first regulatory assessments expected to take place in 2028
• The Pension Schemes Bill will include a “reserve power” enabling the government to set “quantitative baseline targets” for pension schemes to invest in a broader range of private assets, including in the UK 

2. Achieving scale – can we build it?

The Final Report concludes, somewhat unsurprisingly, that with scale comes economies and efficiencies, as well as the opportunity for greater diversification of investments and, specifically, productive asset classes.

Although the consultation proposed that multi-employer DC schemes should be required to have at least £25-£50 billion in assets under management (“AUM”) by 2030, the Final Report acknowledges the time needed to build scale and has settled on the lower end of this range such that providers and master trusts will need to have £25 billion AUM by 2030. This will be applied at “arrangement level”, which means the scheme will need at least one main default arrangement which meets the scale requirement by 2030. The Report confirms that, as expected, the scale requirements will not apply to DC/defined benefit hybrid schemes which are only available to a closed group of employers related through their industry or profession, or to default arrangements that serve protected characteristics, such as religion.

The Final Report confirms that this framework will be set out in the forthcoming Pension Schemes Bill, with further regulations anticipated as a result. A key aspect of this will be what constitutes “arrangement level” for these purposes. The definition of “main scale default arrangement” which will be contained in the Pension Schemes Bill will therefore need close inspection.

Importantly, the Final Report still makes room for smaller schemes with reference to a ‘transition pathway’ which will enable smaller schemes to reach scale – although “smaller” in this context still means the scheme/provider will need at least £10 billion AUM in an arrangement by 2030 and it must provide the relevant regulator (we assume the FCA or TPR, depending on the type of scheme) with a credible plan to have £25 billion in AUM by 2035. There will also be a ‘new entrant pathway’ which will enable new market entrants with innovative products to seek authorisation. This will be key to incentivising further development in the DC market and to avoid concentration risk.

Whilst collective defined contribution (“CDC”) schemes will be out of scope of the reforms for now, this is to be kept under review.

3. Consolidation is the aim of the game

The Final Report reinforces the Government’s policy of reducing the number of default arrangements in the DC marketplace. Consequently, legislation will prevent the creation of new default arrangements – but how the detail of how this will be applied and what this limitation actually means is still to be confirmed. This feels a potentially seismic shift in the dynamics of the DC market by narrowing schemes’ and providers’ ability to offer tailored default arrangements to new clients, but may reduce the issue of “inadvertent defaults” which many providers face.

Of particular note is the confirmation that the Pension Schemes Bill will introduce a contractual override regime to facilitate consolidation for contract-based schemes. This will be an important step to address the issues arising from underperforming legacy arrangements, and so better enable providers to take action to improve member experience and outcomes. The regulatory framework which will apply to the contractual override is to be developed by the FCA and will be subject to consultation in due course, but the Report indicates that the contractual override will only be permitted where it is in savers’ best interests, certified by an independent expert. Where savers are bulk transferred internally, it must be to the arrangement offered by the provider which provides the best value.

These steps, alongside the Value for Money Framework for DC schemes, are intended to drive improvement, or lead to the wind-up and consolidation, of underperforming funds. The Final Report promises a ministerial review of the VFM Framework and contractual override in 2029 to assess the effectiveness of these initiatives.

4. It’s about the value

Whilst DC scheme cost is still a key factor, the Final Report shifts the spotlight to the value of the pension benefit. The VFM Framework legislation under the Pension Schemes Bill will support this by providing a basis on which pensions savers will be able to assess performance of their scheme across a wider set of metrics to help understand the overall value of their pension rather than this being driven only by cost data.

Although the consultation raised the potential of placing a duty on employers to consider value in their pension scheme selection, the Final Report confirms that this will not be take forward through legislation. The issue of market competition and provider selection will still be kept under review with input from the FCA and CMA. 

5. And so to investment…to mandate or not to mandate?

The Final Report envisages that the actions being taken in terms of scale and consolidation will enable DC pension providers to invest in a wider range of asset classes including private markets. Investment in science and tech start-ups, pre-IPO companies and infrastructure projects are cited as examples.

Whilst Government also acknowledge the recent Mansion House Accord (which has seen a 17 of the largest DC pension providers commit to investing 10% of their main default funds in private markets, including 5% in the UK), the possibility of mandating investment in a particular manner has very much been left on the table.

The Pension Schemes Bill will include a “reserve power” which, if deployed, would enable Government to set “quantitative baseline targets” for pension schemes to invest in a broader range of private assets, including in the UK.  The government does not anticipate exercising the power unless it considers that the industry has not delivered the change on its own, following the Mansion House commitments. The Final Report also stresses that there would be safeguards to protect savers’ interests if the power were used, it would only intervene  in this way having made a thorough assessment of the potential impacts of any proposed quantitative targets on savers and economic growth and any requirements under the power would be consistent with the fiduciary duty.  It is not clear whether the intention is this power would only apply to commercial DC schemes or could be used more broadly.

Suffice to say any step towards mandating investment in any way would represent a significant shift in the pensions world, and one which would certainly be subject to great scrutiny. However, at this stage, the reserve power feels like a deterrent and it is reassuring that the government has at least committed to any exercise of its power being consistent with the existing principles of fiduciary duty.

6. Building the supply for the demand

The Final Report recognises the need for a “strong pipeline” of UK investment opportunities if DC schemes are to use their combined asset strength to achieve the objectives which have been set.

A range of initiatives and strategies are referred to in the Final Report which are intended to contribute to the increased volume of “investible projects” for DC pension schemes. Clearly, the development of these and their suitability for pension arrangements in particular will be critical to the implementation of the policy objectives.

All eyes on the Pension Schemes Bill

Now that we have the warm-up act of the Final Report, the focus will be on the impending Pension Schemes Bill which is expected at any moment. This will provide further detail, but not all the answers as we can expect a raft of regulations and further consultations on these significant developments.

The Government has also flagged the next instalment of the Pensions Review, which will focus on retirement adequacy and outcomes. Whilst the timing for that launch is not yet known it will, along with the Pension Schemes Bill, undoubtedly prove to be compulsive reading and set a direction of travel towards 2030 that will change the DC landscape significantly!