Chancellor Jeremy Hunt delivered a highly-anticipated speech in London’s Square Mile on Monday, outlining plans for longer-term reforms to enhance the competitiveness of the UK economy.
Dubbed the “Mansion House reforms,” Hunt intends to bolster the UK economy by directing pension savings towards illiquid assets with potential for higher growth. Additionally, he plans to encourage consolidation among smaller funds, aiming to enhance their efficiency.
Directing pensions towards private companies
Recognising the substantial size of the UK’s pension market, Hunt highlighted the potential impact of directing defined contribution pension funds toward private companies. By allocating a portion of default funds to unlisted equities, he said the government aims to unlock significant investment opportunities for high-growth businesses.
“Channeling defined contribution pensions into private companies holds immense potential for driving growth and investment. It presents a unique opportunity to direct pension funds toward high-potential businesses, fueling economic prosperity and creating long-term value,” said Hunt.
At the core of Hunt’s initiative is a significant component known as the “compact.” This agreement, signed by nine major pension providers in the UK, pledges to allocate 5% of their default funds for defined contribution pension savers towards unlisted equities by 2030.
This commitment has the potential to unlock billions of pounds in investment capital, enabling high-growth companies to thrive and contribute to economic expansion, said Hunt.
The Chancellor explained that by connecting pension funds with private companies, the initiative establishes a mutually beneficial relationship. Pension fund holders benefit from potentially higher returns on their investments, while private companies gain access to essential capital to support their growth and expansion.
Brian Slattery, senior vice president and head of Northern Europe, Clearwater Analytics, said that investing in riskier private markets resembles a “considerable shift” in strategy for many pension funds.
“Most pension fund investment portfolios are made up of straightforward and relatively low-risk assets like long-dated government bonds and high-grade corporate bonds”, he explained.
“They must ensure they have the necessary capabilities in place to execute this shift smoothly. Failing to do so will put pension funds at risk of missing out on the immense returns available in Britain’s private sector,” he warned.
Investing in alternative assets – such as private equity – will allow these schemes to access a wider variety of companies, explained Lee Hollingworth, head of UK Retirement at Franklin Templeton, particularly as the number of listed companies declines. “Many firms are choosing to float much later or are often acquired before that point,” he says.
However, Hollingworth warned that private assets, such as private equity, are not a “magic bullet”. He said, “Asset owners and managers still need to ensure any asset they allocate to provides the right risk-return profile for this investment goal and ensures the best outcomes for its members.”
While the compact does not mandate where pension funds invest, some stakeholders have warned that channelling investments towards UK illiquid assets could fuel a bubble in prices in the sector. Others have cautioned that the compact potentially interferes with pension scheme trustees’ fiduciary duty to maximise returns.
Chris Smith, investment manager UK equities at Jupiter Asset Management, said: “It is crucial that the pension compact remains voluntary both in letter and in spirit. Fundamentally, pension fund trustees have a fiduciary duty to carefully and thoughtfully maximise the risk-adjusted returns for their members, and trustees should be making these important investment decisions independently without interference from politics.”
Turning back on EU MiFID II rules
Hunt acknowledged the ongoing debate surrounding the unbundling of research costs, which involves separating the cost of investment research from the overall asset management fee. The Chancellor expressed the need for closer examination of this practice to ensure individuals receive the best value for their investments.
“We are committed to enhancing transparency in pension investments. The unbundling of research costs is a crucial step towards achieving fair and transparent practices within the asset management industry,” the Chancellor said.
Hunt explained that he aimed to repeal “unnecessary EU laws” with the aim of streamlining regulations and fostering a more competitive financial sector. Hunt said he welcomed City lawyer Rachel Kent’s ‘Investment Research Review’ and accepts its recommendations. This includes rolling back the EU’s MiFID II rules, which prevented stockbrokers from providing research for free by “bundling” it with share trading services clients pay a commission for.
Hunt also welcomed the FCA’s commitment to start immediate engagement with the market to inform any rule changes on removing the requirement to unbundle research costs by the first half of next year.
Julia Ashworth, co-chair of Euro IRP, said giving the buy-side the optionality to pay for external research services in a bundled fashion offers the opportunity for asset managers to compete more effectively internationally, “and with greater research access to deliver optimum performance for ultimate investors”.
“As the FCA moves to implement this, transparency and accountability will be vital to ensure end investors and the wider market can clearly understand asset managers’ use of independent, unconflicted research to ensure integrity in the investment decision process,” she continued.
Likewise, Mike Carrodus, CEO of substantive research, said that MiFID II’s Research Payment Account (RPA) structure, which was mandatory if asset managers wanted to continue to pass on research costs to clients in Europe, was “too onerous” from the perspective of all the largest buy-side firms and many of the smaller ones.
“These latest recommendations seek to keep the transparency ethos from that RPA structure alive while jettisoning anything that would make asset managers see rebundling as not operationally workable,” he said.
Adam Forsyth, head of research at Longspur Capital, warned that there is a high chance fund managers will use this as an “excuse” to stop paying for research, putting pressure on brokers to target research on companies where trading commissions are highest or where they think they can win corporate business. “That means small and mid-cap companies are unlikely to see more research,” he said.
“While existing coverage by brokers will now be able to go to any investor, that does not mean it will to the right investors, especially in specialist areas,” warned Forsyth.
Collaboration “key” for a secure financial future
Concluding his speech, the Chancellor stressed the importance of stakeholder collaboration to ensure a secure and prosperous financial future. The successful implementation of the proposed reforms relies on the collective efforts of the government, regulators and businesses, he added.
Hunt stated, “Collaboration is key to achieving our goals. By working together, we can create a secure financial future for all and drive economic growth.”
He claimed that the collaboration involves open communication, sharing best practices and addressing challenges collectively. The aim is to create an inclusive and responsive system that caters to the diverse needs of pension fund holders.
Hunt also said that collaboration extends beyond domestic boundaries to international partnerships, recognising the global nature of the financial industry. Engaging with international counterparts and learning from their experiences can help shape policies, foster harmonisation and enhance the UK’s position as a global financial hub.
He concluded that the government’s commitment to engaging with trade associations, industry experts and regulatory bodies demonstrates a dedication to fostering an environment that promotes cooperation, innovation and long-term stability.
(Image by Chris McAndrew. Licensed under CC BY 3.0 Unported)
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