The government has published two consultations on its plans to create defined contribution (DC) and Local Government Pension Schemes (LGPS) pension 'megafunds', alongside the Pensions Investment Review interim report.

The report, which outlined the interim findings from phase one of the review, put forward proposals to legislate for a minimum size and maximum number of DC pension scheme default funds, and to legislate to require for the 86 LGPS administering authorities (AA) to consolidate their assets into fewer, larger pools of capital.

Announced as part of the Chancellor's Mansion House Speech, the reforms are intended to set the DC workplace market and LGPS on a path of fewer, larger funds, which are better positioned to invest in productive assets, more able to deliver greater returns for members of DC schemes, and give greater value for local taxpayers.

This comes after government analysis revealed that the amount of workplace DC assets invested in the UK has fallen "substantially" over the last 10 years, from around 50 per cent to 20 per cent, driven primarily by a movement away from UK listed equities

In the report, the government said it is "concerned" by the evidence that UK pension funds are investing significantly less in the domestic economy than overseas counterparts, with DWP analysis also revealing a 30 percentage point gap in the amount of home investment across asset classes in UK DC funds compared to Australia.

Given this, HM Treasury and the Department for Work and Pensions shared the reform proposals as part of an "interlocking package" of measures that aim to boost investment, increase saver returns and drive a greater focus on value over cost in the pensions system.

A push for scale in the DC market

In particular, the government said that it was "clear" that the future of the workplace DC market lies in fewer, bigger, better run schemes, with the scale and capability to invest in a wide range of asset classes that can deliver better returns for savers long term and invest in the UK.

In line with this, the government's consultation, Unlocking the UK pensions market for growth, is looking at proposals to legislate for a minimum size and maximum number of DC pension scheme default funds.

Whilst the government acknowledged that the the DC workplace market is already consolidating, it said that the reduction in the number of schemes has been most prominent for very small schemes, with growing evidence suggesting that a greater number of benefits can arise at £25bn-£50bn (or greater) of assets under management.

"At the large end of the market, there is variation in size across both master trusts and group personal pensions (GPPs), and there can be fragmentation with GPPs often having many default arrangements and default funds, meaning the average assets per default can be lower," it explained.

"Scale and consolidation among the larger schemes can therefore drive additional benefits."

However, the government acknowledged that there is no consensus on the optimal size of a DC pension fund, confirming that the minimum size and maximum default numbers will be set following consultation, "at a level at which these efficiencies, economies, and investment benefits are realised and that addresses the current fragmentation within the pensions system".

Early timing guidelines have already been provided though, as the government consultation acknowledged that these are "significant market changes and will not be achievable without a sufficient lead-in time", confirming that such a requirement would not apply before 2030 "at the earliest".

"Careful consideration is required of the approach to implementation, for example, to ensure innovation is maintained in occupational pensions and that pension products meet the needs of all employers and employees," it stated.

To support these measures, the government also outlined proposals to enable contractual overrides for contract-based pension arrangements, after industry feedback suggested that the requirement to obtain individual consent from savers to override individual contracts is a real barrier that currently restricts consolidation and the transfer of savers into arrangements that have the potential to deliver better outcomes.

According to the consultation, this override, which would be subject to appropriate member protections, would enable transfers without consent into either a trust-based or contract-based arrangement and would aid the shift to fewer, larger schemes.

The consultation is also looking to explore the role of differential pricing in a consolidated market and the roles of employers and their advisers and seeks views on the merits of proposals to encourage them to focus on value from their workplace pensions.

LGPS pooling plans

Alongside the DC market proposals, the government launched a consultation seeking views on its plans to strengthen the management of LGPS investments.

In particular, the government is seeking views on plans to reform LGPS asset pools by mandating certain minimum standards deemed necessary for an optimal and consistent model in line with international best practice.

The minimum standards proposed would require AAs to fully delegate the implementation of investment strategy to the pool, and to take their principal advice on their investment strategy from the pool.

AAs would also be required to transfer legacy assets to the management of the pool.

In addition to this, pools would be required to be investment management companies authorised and regulated by the Financial Conduct Authority (FCA), with the expertise and capacity to implement investment strategies.

The consultation is also seeking views on plans to boost LGPS investment in their localities and regions in the UK, by requiring AAs to set out their approach to local investment in their investment strategy including a target range for the allocation and having regard to local growth plans and priorities.

It is also looking at plans to strengthen the governance of both LGPS AAs and LGPS pools, by building on the recommendations of the Scheme Advisory Board (SAB) in their 2021 Good Governance Review.

Under the proposals, committee members would be required to have the appropriate knowledge and skills, while AAs would be required to publish a governance and training strategy and an administration strategy, to appoint a senior LGPS officer, and to undertake independent biennial reviews to consider whether AAs are fully equipped.

The government consultation acknowledged that LGPS fund mergers can incur significant costs and risk, although it noted that a number of LGPS funds have successfully merged on a voluntary basis.

Given this, the government encouraged administering authorities to consider whether there would be benefit in merging with another fund, taking into account final decisions on the reforms proposed in this consultation.

Further changes yet to come?

Whilst the government confirmed that, at this stage, it has decided not to make specific
recommendations in relation to UK investment, beyond those outlined in relation to the LGPS, there could be further changes in future.

Indeed, the interim report confirmed that the next stage of the review will look to consider whether further interventions may be needed by the government to ensure that these reforms, and the "significant" predicted growth in DC and LGPS fund assets over the coming years, are benefiting UK growth.

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