For savers, it has the potential to generate higher investment returns over the longer-term; vital for members of Defined Contribution (DC) schemes, particularly those further from retirement looking for a sustained period of growth for their pension pots.
For the UK economy it unlocks significant pools of capital which can be used to provide investment in infrastructure projects and financial support to high-growth companies.
In November 2016, the Government announced that HM Treasury would lead a ‘Patient Capital Review’, to consider all aspects of the financial system affecting the provision of long-term finance. A Pensions Investment Taskforce was set up – made up of institutional investors, asset managers and regulators – to look at how to tackle existing barriers to DC investment in illiquid asset classes.
So, almost four years on, where are we now? And will the increasing focus on ‘responsible’ investment be a driving force for further change in this area?
What progress has been made since 2016?
Since the Government’s announcement in 2016, there have been several developments to encourage investment in illiquid assets, and remove the existing obstacles.
In February 2019, the Department for Work and Pensions published a consultation on DC investment innovation and consolidation which focused, in part, on ways to facilitate the patient capital agenda. It proposed that trustees of DC schemes above a certain size should have to include a statement in their Statement of Investment Principles, setting out the extent to which they had considered illiquid investments in the scheme’s investment strategy.
In mid-2019, the Investment Association announced initial details of a ‘Long-Term Asset Fund’, which would help to widen access to illiquid assets. This new fund would be specifically structured to facilitate long-term investment and its target market would be DC pension schemes, professional investors and private wealth/discretionary portfolio managers.
And in February this year, the Financial Conduct Authority (FCA) published a feedback statement summarising the responses received to its 2018 Discussion Paper on Patient Capital and Authorised Funds, and setting out further detail about the Long-Term Asset Fund.
But there’s still more to be done. Whilst there has clearly been progress in this area in recent times, several existing obstacles to DC investment in illiquid assets still need to be addressed.
What barriers remain?
One of the trickier issues that is yet to be sufficiently dealt with relates to the DC charges cap.
The existence of the charges cap means that DC trustees can be wary of the higher fees that are typically charged, when investing in longterm assets. And it doesn’t help that funds offering access to certain types of illiquid investment – such as venture capital and infrastructure – usually levy a performance-related fee, which is paid on top of the ordinary management fee.
There has been some speculation that the legislation in this area may change to mitigate this. However, in September last year the DWP told the Financial Times that it had no compelling evidence that any additional changes to the charges cap were needed to allow investment in venture capital or growth equity.
Another difficult area for contract-based DC schemes relates to the FCA’s ‘Permitted Links’ regime, which has been viewed by some as another barrier to investment in illiquid assets.
The FCA’s rules are designed to ensure that investments underlying unit-linked life policies are suitable for retail investors, by specifying the types of investment that they are permitted to invest in. Crucially, they imposed a limit of 20% on the proportion of a unit-linked fund which could be invested in a Qualified Investor Scheme (QIS); a type of authorised investment fund that is often used to access illiquid assets. As DC schemes typically invest in financial markets via unit-linked funds, this clearly presented a barrier to investment in illiquid.
There have, though, been some positive developments in this area recently. In December 2018, the FCA consulted on amendments to the permitted links rules, and one of its proposals was to remove the 20% limit on holding assets through a QIS. The finalised rules were published in March this year, although whether these will generate real change in this area remains to be seen.
Is there an appetite for change?
As noted above, at the end of last year, the DWP rejected calls to reform the DC charges cap to facilitate investment in infrastructure.
However, over the last couple of months, the tide seems to have turned.
In a speech at the Pensions & Lifetime Savings Association investment conference earlier this year, Guy Opperman emphasised that the industry should “not be under any illusion that investment in infrastructure and illiquid is something the government is passionate about”.
Is this a response to the impact of the Covid-19 pandemic on the UK economy? There appears to be a growing sense amongst policymakers that the relationship between the government and institutional investors must become stronger, to allow those investors to support the UK’s post-Covid-19 recovery.
So, watch this space…
This article was featured in Pensions Aspects magazine September edition.
Last update: 19 January 2021