Consultation outcome

Chapter 4: Using transparency as a prompt

Updated 21 June 2021

This was published under the 2019 to 2022 Johnson Conservative government

Background

1. We proposed^{[footnote 36]} that ‘Relevant schemes’ (broadly, schemes offering money purchase benefits other than from Additional Voluntary Contributions (AVCs) alone) with 5,000 or 20,000 or more members, or alternatively £250 million or £1 billion assets to provide for money purchase benefits, be required to report their policy in relation to illiquid investments, in their Statement of Investment Principles (SIP)^{[footnote 37]} and potentially their default SIP^{[footnote 38]}.

2. Schemes in scope would also be required to report annually, via the implementation statement, on their main default arrangements’ approximate percentage holdings in illiquid assets, accompanied by a breakdown in holdings.

3. Our intention was to prompt larger schemes to consider the diversification benefits of illiquid investments.

Stakeholder responses

Summary

4. Stakeholder responses on the topic were split. A majority of respondents favoured some sort of transparency measure to prompt consideration of illiquid assets but this feedback was concentrated in a large number of responses by asset management firms specialising in illiquid assets.

5. Other respondents were opposed to the measure. A range of concerns were expressed around practicalities of the measure, whether the measure was needed to drive real change and whether implementing it would have undesirable or unintended consequences.

Practical issues

6. Stakeholders identified a number of practical issues, most prominent being the definition of illiquidity. Particular assets which are typically liquid may become illiquid at times of market stress, meaning that assets will move in or out of the definition, without any asset allocation decision on the part of the trustees^{[footnote 39]}.

Several respondents also emphasised this would lead to difficulty in accurately reporting holdings via the implementation statement.

7. It was suggested that a feasible definition would need to rely on an assessment of whether the assets were traded on public or private markets. But this would come with additional complexity and perverse consequences, which we cover in the Government response below.

8. Many respondents highlighted the long time horizon of defined contribution (DC) savers, suggesting that the benefits of a longer-term tie in to illiquid assets should follow. However, others also highlighted that members will wish to transfer and decumulate, and the timing of such flows cannot be exactly predicted.

This is likely to require some form of unitisation of the assets to ensure that both savers who depart and those who remain invested get ‘their’ assets.

9. One respondent to the consultation also highlighted the impact of “gating” open-ended funds on member transfers (blocking member withdrawals, whilst some of the assets are sold), which became a wider concern later in 2019, and again in 2020 in response to COVID-19. This risks being problematic in a default arrangement where the member has made no choice of fund.

10. Respondents pointed to other liquidity challenges. Smaller schemes which had invested in illiquid assets would find it more difficult to consolidate or wind-up into master trusts. Master trusts with large participating employers would also be vulnerable to a liquidity crunch if those employers sought to switch.

These are real considerations as we are keen to increase the pace of consolidation further. There has been a 12% fall in scheme numbers^{[footnote 40]} in the past year and employer switching is expected to continue at a rate of between 5% and 10% each year.^{[footnote 41]}

11. In relation to reporting holdings, a range of practical impediments were raised, including the need to avoid conflict with investor confidentiality clauses, and the need for “look through” of assets, potentially over multiple layers.

Whether further measures are necessary

12. Stakeholders raised a number of concerns about the necessity of additional reporting.

13. Several highlighted that comparable SIP requirements already exist, meaning that a more granular disclosure in relation to one asset class may not add particular value.

Existing requirements include the trustees’ policies in relation to the kinds of investments to be held, the balance between different kinds of investments and the expected return on investments.

The annual implementation statement, by which schemes will report their implementation of their SIP policies, is intended to cover all aspects of the SIP, meaning that disclosures of actual practice in relation to these policies will also be made public.

14. Other respondents suggested that some form of ‘nudge’ via transparency was unlikely to drive change. Trustees were well aware of the existence and potential of alternative assets and where they had not invested, there were good commercial or fiduciary reasons for their decision.

These included concerns about the cost, value, risk or return of available products; the lack of functionality on the part of many investment platforms to host assets which are traded less frequently than daily, and, for smaller schemes, an awareness that they lacked the scale or governance capability to access or evaluate such assets. We have set out our proposals on ways to drive consolidation in Chapter 2.

Undesirable consequences

15. Stakeholders identified several undesirable or perverse consequences from the proposal. These covered the impact of a reporting threshold, the focus on one asset class above others, and the perceived conflation of public policy and fiduciary goals.

16. We suggested that schemes with 5,000 or 20,000 or more members, (or alternatively £250 million or £1 billion assets) should be required to state their policy. Whilst an asset based threshold of perhaps £250 million was most widely favoured, a small number of respondents queried the use of such a threshold.

They suggested it might well stifle or stymie innovation amongst smaller schemes who would perceive a message from government that they were not able to invest in a broader range of assets.

17. Clearly, this is not the case – with sufficiently low administration costs, such schemes can invest in Real Estate Investment Trusts (REITs), other closed-ended investment companies specialising in real assets or venture capital and in open-ended funds such as those invested in property.

18. Many stakeholders queried the focus on one asset class above others. Some respondents argued that there is no more an automatic premium in less liquid assets than in any other type of asset.

Any illiquidity premium can be diminished and ultimately eliminated by an excess flow of funds seeking to gain advantage from it and a few stakeholders suggested that this was already happening in illiquid assets.

19. Some highlighted that schemes should be free to invest in members’ interests rather than in accordance with government steer, and asked why government was not also mandating schemes to state their policies on emerging market debt, smaller companies, or other asset classes which appeared to offer attractive returns.

20. More broadly, there were concerns that investment in any assets should remain a fiduciary decision, not one which is perceived to be driven by public policy. The proportion of illiquid assets in a portfolio was said to be no more a measure of social goods than the volume of liquid assets.

Government response

Background

21. We thank stakeholders for their constructive challenge on this proposal. Whilst many respondents – not solely confined to firms with a commercial offering in this space – favoured the proposals and thought that they may help to offer a “nudge”, support for the proposals was relatively soft.

22. Stakeholders suggested that it might start a conversation, or prompt trustees to think about such investments. They did not point to other ongoing or complete proposals in the UK or abroad where such interventions had been successful.

23. We agree with the view put forward by some stakeholders that the situation in respect of consideration of Environmental, Social and Governance (ESG) risks and opportunities is different. In that instance, there was clear evidence of conflation of factors which could well be financially material – consideration of which is wholly aligned with trustees’ fiduciary duties – and purely ethical considerations.

There is also is no requirement that trustees report on percentage holdings invested in a ‘green’ or ‘climate-friendly’ way – only that trustees take account of the opportunities and risks these factors present.

24. To date, we have not found any evidence of similar misunderstanding or conflation around illiquid investment opportunities in DC occupational schemes. As schemes grow in size, we are seeing consideration and selection of illiquid and real investments increase, suggesting that the barriers have predominantly stemmed from a lack of scale and a lack of accessible products, both of which repress demand.

We are consulting on actions to address both of these other points in this consultation.

25. Turning to the specific points made in stakeholder responses summarised above, we respond on definitions and reporting, the impact of a threshold, managing scheme liquidity and the liquidity premium.

Definitions and reporting

26. On the definition of illiquid assets, we accept that there are risks in a discussion around illiquid vs liquid assets being boiled down and reduced to a contest between the merits of public and private markets. Successful economies will generally have well-functioning examples of both.

27. The same assets can straddle both public and private markets. Investment Trusts (strictly closed ended investment funds^{[footnote 42]}) are traded on public markets, but contain illiquid assets, such as commercial property.

28. It would appear contrary to classify REITs as illiquid based on the underlying assets, as they can be traded readily through public markets. But to classify them as liquid whilst open-ended property funds are deemed illiquid would also be at odds, if government policy then sought to nudge trustees away from liquid readily-tradeable ways of holding a basket of assets and towards potentially less liquid ways of securitising exactly the same assets.

29. Reporting of asset allocation in default strategies is also already happening, via the reports produced by such firms as Corporate Adviser^{[footnote 43]}. Requiring schemes via legislation to separately publish data which they are already freely giving to data aggregators may not be burdensome, but it might seem unnecessary.

Thresholds

30. Government policy has rarely imposed levels of membership or assets above which new duties apply. However, if we were to follow this logic and apply the duty to all schemes with more than 100 members, in line with some existing requirements which flow from the Institutions for Occupational Retirement Provision (IORP) directives, we would extend the scope of legislation from around 50 schemes to approximately 900.

This would bring in schemes with very limited governance budgets or capability to invest and may begin to constitute an unwarranted burden.

Managing scheme liquidity and the illiquidity premium

31. We fully accept that decisions on liquidity to manage member transfers and switching, and the long term goals of the scheme should rest with trustees. We also acknowledge the risk that mandatory reporting of percentage holdings in illiquid assets, however defined, could become perceived as a race.

32. More broadly, stakeholder views around an illiquidity premium are mixed. Many agree on the presence of an illiquidity premium, while others have argued that much if not all of the premium can in some instances be explained by leverage and company-level risk.

33. There are clearly a range of considerations for trustees before they make a decision to invest. We are encouraged to see that schemes are already moving towards a broader range of assets, including illiquids and real assets, as they develop scale.

This indicates that there is not a lack of understanding of fiduciary duties leading to market failure, or harm to member outcomes.

34. We have listened to the responses from stakeholders and reviewed the wider evidence in favour of this measure. We have concluded that taking forward this particular measure is not appropriate at the current time and we will, therefore, not be legislating for a SIP requirement in relation to illiquid assets.

We will continue to monitor this as the market grows and consolidates and we will review diversification of investment approaches, especially amongst the largest defined contribution pension schemes.

35. We will also continue to explore with stakeholders and across government how we can best enable trustees to invest in a diverse range of assets, including less liquid products, to deliver the best outcomes for their members.

1. Chapter 3, paragraphs 1-19 of Investment Innovation and Future Consolidation: A Consultation on the Consideration of Illiquid Assets and the Development of Scale in Occupational Defined Contribution schemes ↩

2. Required by section 35 of the Pensions Act 1995 ↩

3. Required by Regulation 2A of the Occupational Pension Schemes (Investment) Regulations SI 2005/3378 ↩

4. In any case, respondents highlighted that it is not the illiquidity of the asset per se which automatically adds value – assets do not automatically gain value on becoming illiquid. We cover this point more below. ↩

5. The Pensions Regulator. DC Trust – presentation of scheme return data 2019 to 2020 ↩

6. Corporate Adviser. Workplace Savings Report. November 2019 ↩

7. Definition for closed-ended investment fund ↩

8. See for example Workplace Savings Report (November 2019) and Master trust and GPP defaults report (June 2019) both accessible from https://corporate-adviser.com/research/ ↩