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Speaker
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Transcript
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Chris Brown, Director, Burges Salmon
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Hi everyone, hi Helen, it's great to be back for episode two of season four of The Burges Salmon Pensions Pod.
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Helen Cracknell, Associate, Burges Salmon
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Hi Chris.
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Chris
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Hi, yes, we have got a really exciting podcast coming up today, really pleased to be joined by Douglas Hogg who is a Client Director at Zedra Governance, hi Douglas.
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Douglas Hogg, Client Director, Zedra Governance
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Hi Chris, hi Helen, thanks very much for inviting me on.
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Chris
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Pleasure, really good to be talking with you and great to be speaking to another Scottish pensions trustee, because you've been seeing a lot of us and our colleagues and different Burges Salmon people for different reasons, because we've got five lawyers now based up in our Edinburgh office and it's a thriving market and been good to be collaborating on different bits and pieces isn't it?
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Douglas
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It is indeed and great to see the team expanding up here.
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Chris
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Yes, absolutely and long may our collaboration and work together continue. So, today's episode, really exciting we're going to be talking about the Mansion House speech from the Chancellor, on 10th of July 2023 and in particular the proposals for using Defined Benefit assets for investing in productive finance, so without further ado, let's start the podcast.
So Douglas, the Chancellor set out a series of measures to boost outcomes for savers and increased funding liquidity for high growth companies through reforms to the UK pensions market, so that's a first question could you just give us a bit of an overview please of the Mansion House proposals, the policy context to them and what's the proposal for using DB pensions assets for productive finance?
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Douglas
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That's great thanks Chris, and I think at the start of this topic it's really important we use the term productive finance and certainly across the industry we're hearing more and more people use this term, so it's probably worth starting off by saying what do we actually mean by that?
Perhaps the best definition, I think the most relevant here, is what the government thinks it means and certainly in the call for evidence that came out immediately following Mansion House, the DWP defines productive finance as investment that provides equity capital and finance for businesses in the UK, including start-ups, infrastructure and private equity, as well as longer term investments, typically in liquid assets.
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Chris
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So things that will be around for a length of time?
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Douglas
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That's right, a combination of things that are seeking to help boost the growth of the UK economy and also things will be around for a long time in terms of those longer-term infrastructure projects. And when we think about that policy context you talked about at the start, it's probably worth reminding ourselves how have pension schemes investment strategies changed over time and how are they actually using these types of assets at the moment, and of course over the last 20 to 30 years we've seen a huge shift in terms of the investment strategy of a typical closed UK DB pension scheme.
So in particular the regular framework really is focused around de-risking, so over that time period we've seen big moves out of equities into bonds and at the same time out of a UK-bias into more diversified global type approach, and then on top of that I guess if we think about the past year, not all, but the majority of pension schemes have seen big improvements in their funding levels and as such more schemes than ever are closer to that potential final end game of an insurance company buyout, that's led to more de-risking and indeed for schemes who've held some of those illiquid assets, those longer term assets you talked about before, often they've had to try and sell down some of those illiquid assets with the view of being more insurance friendly and insurance ready.
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Helen
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Definitely seen a massive burst of schemes looking to buy in and buy out over the past year or so, but we are seeing more innovation in considering the alternatives as well.
So, I know that Burges Salmon have a team that are working with start-ups and scale-ups, particularly in the tech sector, so we’re actually looking to launch a B-Scale platform that supports companies with a range of documents for scaling a business and lots of information and knowledge around that.
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Chris
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It's like seeing the two sides of it I was going to say, so you've got what we're seeing with the with the B-Scale app is ability to help clients scale up if they're a new business that sort of thing and then from the pensions side, as Helen says, complete innovation, we're seeing clients start to yes, prepare for buy in and buy out but see what other options there are for you know running a scheme on which is all of what we'll get on to now as well.
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Douglas
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And I think that context is so important because with all these schemes of getting closer to buy out or the end game, for a long, long time the mindset for trustees and employers has been that we often hear the term a buyer is the gold standard but I think with the innovation you're referring to we're finding more schemes at least pausing and asking the question, it might well be the right answer for our scheme but actually let's think of all the options that are out there and I think that policy context you're talking about in terms of why is the government looking at it now is because these schemes are are better funded that sort of transition into the insurance framework is going to happen very soon, so in anyway if something is going to change it has to happen now and of course for the government with that huge growth agenda, they see the UK DB private sector market, which is you know still over a £trillion in size, as being a potential source of capital and so I guess from their context they're trying to think can they incentivise some of those assets into this productive finance approach.
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Chris
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Yes, absolutely and worth saying as well that that concept could apply equally to all sorts of types of schemes for example DC, but our discussion today is focusing on using DB and generating surplus in those assets and investment from private sector DB schemes into productive finance.
So you mentioned there well what's the incentive for for following the the government's proposal, so how do you incentivise DB investment into productive assets?
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Douglas
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Well, I think again in terms of the key stakeholders let's think about the employer perspective and also the trustees perspective and as a trustee the focus for my scheme is rightly on protecting the accrued members benefits and so for the majority of schemes you've got that insurance as being sort of an option that's a well trodden in path. From the employer perspective the risk's quite asymmetric and again there's no real benefit to the employer in terms of running on this scheme, actually they only focus more and more on on the downside risk, so in my mind the only way you can sort of incentivise more investment in these types of assets is if you should change the rules of the game effectively.
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Chris
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Yes absolutely, so which rules would you change?
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Douglas
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Well I guess starting from the employer because really to get more investment productive finance we probably need these schemes to decide to run on rather than transparent Insurance framework so for the employer well how can we make that risk less asymmetric, and some of the types of ideas that have been considered are do you make it easier for schemes to be able to extract a surplus if one's arisen before the scheme's wound up?
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Helen
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Sorry just jumping on that, recently in The Telegraph they had an article suggesting that the tax on surplus, return of surplus, to employer might be lowered to potentially even 25%, so that definitely would serve as as an incentive.
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Douglas
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I think that's absolutely right so at the moment if you if you could get a surplus out as an employer then you know it's a 35% hit whereas I guess with all sort of tax incentives in this particular way if that was reduced then that would again perhaps encourage some employers to keep on running on this scheme.
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Helen
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Definitely.
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Douglas
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Some of the other things we're sort to see some schemes do is to think well actually if there was a surplus, even if as the employer you can't get it out of the scheme is there a way to effectively recycle some of that surplus to perhaps increase or subsidise the cost of of DC provision.
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Chris
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Which is easier to do if the DC provisions in the same trust at the moment isn't it, but that could be something that would legislative change it could be a condition on a return of surplus from a DB scheme for the employer to use it for particular purposes, one of which could be DC provision under another scheme or another trust, or a contract based arrangement or whatever.
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Douglas
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That's right and as you see at the moment it's almost a bit of a lottery as to do your scheme rules actually have the DC in the same trust or otherwise and so some sort of standardised framework to allow that to be more of an easier route to go down might again incentivise that type of approach.
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Chris
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It's also a lottery around what your rules say about the ability to return surplus anyway, so it's a lottery as to whether your DC is there and what you can use surplus for, it's a lottery as to how you're able to return surplus because you've got a lottery as to who holds a power say to return a surplus on windup, you've got a lottery as to what rules say about returning surplus on an ongoing basis, and of course schemes with that power at a particular time had to do a section 251 resolution in order to be able to retain that power and hopefully all schemes that had that power and wanted to retain it did do that, but that element introduces a bit more you know variation in approaches from different schemes so, as well as the tax change I guess what we're saying is another change could be simplification legislation overriding schemes rules that says surplus can be returned to the employer subject to these conditions.
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Douglas
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That's absolutely right and and we said that the employer was one side of the equation, when we think about from the trustees perspective again, my role as a trustee is looking after the interests of the members of the scheme, is there a way that the members could also benefit if you were to I guess re-risk the investment strategy in this particular way, and again what's been great about the back of Mansion House is we are just seeing more innovation across the industry of ideas and one of the ideas that also is out there is the potential to maybe pay a PPF super levy so that if something did go wrong with these types of assets well your members benefits might be protected and full rather than I guess the reduced rate that'd be covered under under the current proposals.
So going back to your question how do you incentivise? Well, we need to almost change the game both from the trustees perspective and also the employers perspective.
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Chris
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Yes that's really helpful, and these changes they might not necessarily be too hard to do because overriding legislation, alright there's a legislative process you've got to go through, but overriding legislation could be drafted quite simply and a lot of the conditions you could insert a particular funding level, at the moment you can't return a surplus unless you've got a buyout surplus so you know you can retain that and that protects members interests, so that bit should be hopefully you know, subject to the legislative process of of changing the law fairly easy to do, but my understanding is that the ability to change the tax rate could be done by treasury order, so even even easier to change and yes as Helen says we've got these rumours about maybe that is on the cards for the not too distance future.
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Helen
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There must still be a lot of challenges to doing this and obviously it's a slow shift isn't it to these more innovative approaches rather than the approach that people have been looking to do for many years and now they're suddenly able to for example buy in the schemes.
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Douglas
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I think that's absolutely right and when we think of what some of those challenges are there may be things we might not initially think about. If there is a surplus for example, who does that belong to and that can become quite an emotive issue so even if we can change regulations quite quickly, quite easily, to allow this this framework, you could still create situations in the future where the distribution and sharing of that surplus can be a bit contentious, and on top of that you said Helen, you know the mindset for so many people in the industry be that the trustees, the sponsor, the advisers, the mindset that's been drilled into us over the last 20/30 years is buy out is the gold standard, so actually as you said Chris changing the regulations might actually be quite easy, but how do we change that mindset, it's probably about giving the industry that comfort that these long-term changes are not going to be not tinkered with as we move through time.
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Chris
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Yes absolutely.
So, just thinking of mindset, I'm just looking at my notes here and we've talked a bit about restrictions and potential challenges and things like that, perhaps I could just jump to asking you, Douglas, about thinking thinking towards that mindset, where are your clients at with their mindset at the moment about thinking about these sorts of proposals?
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Douglas
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So again it's been great to see the funding level of so many of our schemes improving to the point where they're actually in a real pole position to to make these decisions, I think for a lot of our clients it's still a case of wait and see, as a trustee again we're thinking about what's best for our members, there is a well trodden path for the insurance route, but at the same time people are very open to ways that could deliver better outcomes for members, for sponsoring employers, and for wider society, so we'll certainly wait with baited breath for the the statement.
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Chris
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Coming out on 22nd of November, yes.
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Douglas
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We will see on the 22nd if it's all been held back for then or if it'll be a be a quieter day.
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Helen
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And one of the big proposals from the Mansion House speech was super funds, obviously Douglas you'll know and our listeners will be aware that the first Clara deal has recently been announced, so that's with the trustees Sear's Retail pension scheme and Clara have obviously committed to providing £30 million of new capital to increase the security of members benefits and also The Regulator's given clearance for this transfer.
Can you comment on the proposals on super funds and how you see this moving forward?
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Douglas
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So again as a trustee anything where it creates more viable options for schemes I look after is very, very much welcome, so we're delighted to see the first transaction for Clara getting over the line, I think with any new solution there's always quite a high hurdle for the due diligence to get the first transaction over the line, so hopefully this will be the first of more to come.
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Chris
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Open the doors.
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Douglas
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Exactly and I think what's important to remember at super funds is they're not going to be right for everybody, the specific circumstances around is there a weaker covenant, what's a particular funding level mean that it's not going to be right for everybody, but for a segment of schemes this addition of external capital into the pension system to replace perhaps a weaker covenant could definitely lead to better outcomes for members, so yes very happy to see the first transaction and exciting to see what happens from here.
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Chris
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Yes, and it was really interesting that, as Helen says, there's the £30 million injection and there's been a bit of commentary about because this is the first transaction everybody's talking about it there's been a bit of commentary about the the level of that over a £590 million scheme and whether that fits.
My understanding, I've read, obviously don't know the detail, but I've seen that there might have been two buy ins completed already for that scheme before the transfer to Clara, so it may be that some of those liabilities were were already secured before, so that what Clara is taking on is perhaps not all of the liabilities in the scheme and what I've seen that I haven't seen being announced is what the funding position and what the price was for the deal, I haven't seen that in anything I've read, so really interesting to hear about the new option for schemes and as you say it'll be right for some schemes, some schemes won't be able to consider it but really exciting that there's a new option out there.
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Helen
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Obviously another option is that the PPF itself will be a consolidator. Douglas, could you tell our listeners more about that?
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Douglas
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Yes, it's really interesting to see the proposals been put out by the PPF and I think when we think about the types of new solution being offered and we talked before about super funds, super funds often used in the breath of consolidation but actually for me the big thing about super fund is bringing external capital to replace a weak covenant and while it's great the first transaction being over the line, I don't think we're going to see super funds scooping up lots and lots of very small schemes in terms of consolidation and of course when we think about the the UK DB landscape, there's this huge tale of of very, very small schemes and for everybody who's worked with small schemes, there are a number of tasks that you still need to do even though you're a £5 million scheme, you still need to do your valuation, your trust reporting accounts and so on, so the costs of actually running these small schemes are so big. I think that if there is a public consolidator, it could play a part in terms of helping all of those smaller schemes to access economies of scale, to get better governance standards, and so on and all of that ultimately could lead to better outcomes for members.
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Chris
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And it's large schemes, consolidated schemes, that are, just linking back to the first part of this discussion, it's easier for them to invest long-term and to direct investments into productive finance and then UK productive finance, whereas because of Clara's model being a bridge to buy out, the idea for schemes that transferred to Clara is that within 5/10 years they move to the insurance market anyway so, Clara's business model is not to run schemes on for a long term into the future, their business model is a bridge to to buy out, so it's not entirely consistent with that government aim either.
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Douglas
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That's right and if we think about almost the segmentation of the market, to be able to run on in a meaningfully way and invest in the productive finance approach that the government might want, you need to be over a certain size to be able to to do that an effective way, maybe that's over £4/5 million to be able to do that and then for some of those other schemes I guess that are smaller, insurance is effectively a form of consolidation but I guess you need to reach a certain funding hurdle to get to that point, so maybe what the PPF saying is, look can the insurance market, as we look forward, deal with this huge tale of small schemes, or do we need to create some other form of consolidation vehicle that would be able to capture them.
Now we're in the situation in the UK whereby you know 20% of the schemes have 80% of the assets and so on, so all of these small schemes, the combined asset pool isn't as big as some of these bigger schemes, but at the same time for me there's two things going on, one sure can you get more assets in terms of productive finance of that's government's aim, but two, for all the small schemes can you actually create a better governance model to deliver better outcomes for the members.
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Chris
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Yes absolutely, and I'm sure the PPF would be a tried and tested practice of taking on schemes and a successful investment strategy, but there would need to be significant change and likely I think they were saying a new vehicle in order to provide for that, so lots to see and lots to hear about.
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Douglas
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That's right and when you think about the PPF's existing model of course is a simplified benefit structure and often the challenge for this consolidation is actually can you, if it was the PPF, can you deal with all of these different types of benefit structures in an efficient way.
Now where I think things get really interesting is if we almost try and pull all of these ideas together, so if you're the government and you're wanting investment productive finance, and that's UK productive finance, even if schemes can run on as a trustee I need to invest for the best interest of my members, not the best interest of the country, so when I look at my investment strategy if I run on and I've got an allocation to productive finance well that's an allocation of my assets, and when we think about how many of those would be actually UK specific, well it's an even smaller slice. Now there's an argument that a slice of the pie is better than than no pie, but in my mind if the government really wants to incentivise more investment in UK assets, it needs to compensate schemes for the diversification benefits they've given up by not going global.
So I'd be really excited if there was some sort of form of public option with perhaps a crown guarantee, that could allow trustees to get comfortable in terms of security members benefits, but at the same time facilitate a way to actually have more of these assets to help boost the UK growth.
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Chris
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That would be really interesting and a point for discussion would be what thresholds or conditions are there in order to be able to transfer to an entity that has the crown guaranteeing liabilities behind it.
Sorry go on, go on.
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Douglas
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Yes exactly, you work out actually what's the right funding level to get in this point so that the risk of the guarantee biting is fairly small, but actually at the same time there's upside and there are examples out there of crown guarantees on particular schemes, if you look to something like the Mine Workers pension scheme, back at privatisation they had a crown guarantee, because the trustees have that, they can follow a different type of investment approach and I think over the 30 years since privatisation, we've seen members benefits in that scheme being increased by about 30% and several billion pounds going back to the government in terms of a refund of surplus, so there is potentially a a blueprint out there. I guess the difference would be that, you know for your suggestion Chris, it' be a high funding hurdle to get into this scheme whereas when the Mine Workers was, it was a lower starting point.
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Helen
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Yes, so Douglas, what do you think happens, what do you think of the time scales, do you think this is going to be a long and slow process to get to the change, or are there some immediate steps that are happening?
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Douglas
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I think the first step is, as Chris sort of alluded to, the Autumn statement coming up shortly, it will just be interesting given The King's Speech was very silent on this matter, what will be said in the statement, but equally on the flip side I guess we did see Rachel Reeves in the papers this week again explaining that she would expect big pension reforms if there was a change of government, so I think step one, we receive what said on Thursday and then whatever would follow after that, I think for me I hope it's not a long, drawn out process because the rate of movement of assets from the pensions framework the insurance framework is rapid, and so if there is a real desire to make a change we need clear guidance and we need it quickly.
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Chris
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Yes absolutely. Well, Douglas, that's been a fascinating discussion and I feel as if we could have done the whole series on these proposals for investing in the UK and the future of DB pensions, and we can only really scratch the surface in this podcast episode, but hopefully that's been, I'm sure it would have been really interesting for our listeners and it's been really good talking with you.
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Douglas
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Chris, Helen, lovely talking to with you as well, thank you very much for inviting me on.
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Helen
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Thank you.
Thank you for listening to the Burges Salmon Pensions Pod. If you want to listen to any of our previous episodes, take a look on Apple, Spotify or wherever you listen to your podcasts. Thanks for listening
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