The UK Chancellor of the Exchequer Rachel Reeves has pledged to turn the nation’s pension providers into Australian- and Canadian-style “mega-funds”, by supercharging consolidation with measures such as imposing minimum size requirements on defined contribution (DC) funds.
Delivering her first Mansion House speech on Thursday, Reeves said Australian super funds invest three times more in infrastructure compared to UK DC funds and 10 times more in private equity, which she attributed as a benefit of super funds’ massive sizes.
“More often than not, it is Canadian teachers and Australian professors reaping the rewards of investing in British productive assets through their pensions schemes rather than British savers,” she said.
“That’s not good enough, and we need to change that.”
The UK Labour government will introduce a Pension Scheme Bill in 2025. Apart from DC consolidation, the bill will also gather the £500 billion ($981 billion) Local Government Pension Schemes – a defined benefit scheme currently administered by 86 local pension funds – into eight pools. Reeves said the bill is expected to unlock £80 billion for investment in private assets.
“We will take a more proactive approach to working with investors to ensure that capital is directed to the UK’s biggest growth opportunities,” she said.
The rising DC powerhouse
Since the introduction of auto-enrolment (AE), which requires UK employers to set up and contribute to a pension account for employees upon their joining, DC funds’ assets under management (AUM) have ballooned. They are expected to reach £800 billion by the end of the decade – a honey pot for a government desperately looking to rejuvenate investments into the domestic economy.
Reeves unveiled the interim report of the Pension Investment Review during her speech and a public consultation on the appropriate approach to drive scale in UK DC funds. The proposal is broadly two-fold.
Firstly, the government is proposing to set a maximum number of default funds in the AE market. Under the current setting, unless employees make an active choice about where their money is invested, employers would place their pension into a default fund.
However, the consultation said the size of the default funds varies significantly between pension providers, a single provider may also offer multiple default funds.
“This fragmentation means too many providers – particularly amongst those that serve the contract-based market – may not have the flexibility or requisite scale to invest in productive finance assets,” the consultation said.
“Respondents to the Call for Evidence highlighted how the Australian system effectively requires schemes to offer a single default fund.”
Secondly, the consultation proposed to have a minimum AUM size on a default fund level. While a specific threshold is being canvassed, it quoted industry analysis which said £25 billion to £50 billion is where “in-house investments, access to wider asset classes, and other scale benefits” start to come through.
The Australian prudential regulator APRA also similarly said super funds with more than $50 billion in AUM can more easily spread their costs, whereas funds with less assets than that are more likely to run into sustainability issue.
If the size requirement is to be introduced, the consultation said the timing will be no earlier than 2030.
Cautionary tale
The Conexus Institute* executive director David Bell said while industry analysis on Australian funds suggests there is a positive relationship between scale and realised investment performance, the link is “relatively modest and very noisy”.
“This is consistent with research undertaken by Geoff Warren and Scott Lawrence that the most important issue is how funds adapt their operating models and build capabilities to maximise the advantages and mitigate the disadvantages of their scale,” he told Investment Magazine.
“Of course, scale creates a range of additional issues beyond investment performance, relating to areas such as member services. There have been examples this year that some large funds have struggled to provide quality member services.”
The latest AFCA data suggests mega funds received the most complaints in the 2024 financial year – AustralianSuper led the pack with 1550 complaints received in the period, followed by Australian Retirement Trust with 568, and United Super (trustee of Cbus) with 493.
However, the consolidation is likely to be beneficial for UK regulators to maintain oversight on the pension sector, Bell said.
“Regulatory requirements and regulatory complexity are almost certain to increase. This may squeeze out small funds, thereby allowing regulators the ability to focus their attention on larger funds which have the most members,” he said.
“The proposals in the UK will likely provide a more productive environment for their domestic regulators.”
*The Conexus Institute is a not-for-profit think tank philanthropically funded by Conexus Financial, the publisher of Investment Magazine.
