What's driving the government's consolidation plans?

‘Scale does matter…we want fewer, bigger, better pension schemes.’ 

These were the words of our new pensions minister at the PLSA conference in Edinburgh last week.

While the word ‘consolidation’ was only used twice in the Minister’s headline address, it was the key theme throughout. 

In this blog I look to unpack some of the nuances associated with the 3 key drivers of pensions consolidation which the Minister set out in his speech - with the 3 bold quotations below direct from the Minister's speech itself.  I add in some of my own thoughts on what the government might be hoping to achieve by such a policy focus.

1. 'Larger schemes are better placed to invest in more productive asset classes.' It’s no secret that behind the government’s drive to consolidation is a view that larger consolidated schemes can increase allocations to UK productive finance, delivering diversification of returns for members and supporting the government’s broader growth objectives.
   
   However, scale alone does not guarantee productive finance investment - and many in the industry consider further financial incentives may be needed to achieve the government’s ambitions in this area. This remains a hot topic of debate across the industry, particularly in the context of the Mansion House compact and government efforts to drive pension investments into productive assets through voluntary commitments of market participants.
   
   In addition, there remains a gap in available investible assets in certain sectors even for schemes achieving the scale to invest in these markets. Indeed, Mr Bell recognised in his speech that investible assets are needed and that government itself has a part to play in unlocking planning reforms and in setting up the British Growth Partnership to provide access to these ‘investible assets’ for pensions funds. 
2. 'Scale also helps reduce costs - and increases bargaining power.' Economies of scale are perhaps the most commonly referenced driver of consolidation for those outside the walls of Whitehall.
   
   Consolidated vehicles (such as DB and DC Master Trusts) are typically able to leverage the enhanced buying power that comes with greater assets under management and the potential to share fixed costs among schemes, employers, and members. For certain schemes this can lead to significant cost savings and improved efficiency compared to the status quo.
   
   However, focusing on cost alone means that the member’s perspective can be ignored. Cost is only one facet of member value and it's essential to consider this holistically. This includes thinking about investment offerings, member online access and service experience, and member choice. In my view. the drive for efficiency should not overshadow the importance of delivering this value to members.
   
   There was some implicit understanding of this point in the Minister’s Edinburgh speech – with a reference made to the need for policy reform to ‘focus more on value, and less narrowly on cost or price.’  
3. 'Only large pension schemes can provide active, engaged ownership… … scale of course is an enabler of change.' While there is some logic behind the Minister’s suggestion that Investment Stewardship is most effectively applied by larger Schemes, this is rarely currently cited as a key driver for consolidation by trustees and sponsors. 
   
   In reality, in my view there is more than one way to drive scale when it comes to active ownership – it doesn’t have to be physical consolidation. Instead, industry forums and collaborative initiatives can provide scale through a different route with specifically directed action – something physical scale alone does not always guarantee.
   
   And clearly, there is also a role for their investment consultants to play, given that the total assets on which they advise often dwarf even the largest schemes.

How can the Minister achieve his objectives? 

It’s clear that the drivers for pensions consolidation are multifaceted and nuanced. On the one hand I have seen consolidation in practice lead to enhanced governance, economies of scale/reduced costs and increased innovation to the benefit of Scheme members.

On the other hand, consolidation also presents challenges including the risk of a focus by all parties on cost over value in assessing the benefits of scale. And that’s not to mention the potential systemic risks of creating consolidation vehicles which are deemed to be ‘too big to fail.’

For the Minister to be effective in delivering the benefits outlined in his speech I think the following 3 things are critical:

• Government should provide clarity on what is considered to be ‘productive finance’ and support schemes of all sizes to invest in the UK energy transition, UK infrastructure and in UK private markets through working with industry in developing the regulatory frameworks for investible assets in these markets.
• There should be the introduction of regulation of investment consultants and IFA serving the corporate market so they are required to recommend to sponsors schemes which offer value for money rather than low cost schemes (the recent government consultation on whether Company Directors should have a new legal duty to assess the ‘value’ of their DC arrangements is I think a step in the right direction)
• The Government needs to recognise that physical scale does not, in isolation, automatically lead to enhanced investment stewardship and that there are other ways to support schemes–including by making explicit what its expectations of asset owners, asset managers and consultants are in respect of active ownership through guidance or regulations and a potential wider review of Trustee fiduciary duty.In short, it’s a question of specifics. 

It's understandable that for scheme trustees and sponsors the pros and cons of consolidation can seem fairly unclear, with mixed messages from differing sources. Individual Scheme circumstances are key – and the ability for trustees and sponsors to weight up the benefits and challenges versus the specifics of the current scheme arrangements and emerging government policy.

If this is an area you are considering do get in touch – we have lots of hands on experience of working with clients to consider which consolidation options might be the right fit for their schemes and circumstances.