Policymakers ‘want productive finance to work’ for UK pension schemes

The cap, first introduced in April 2015, limits all administration and investment charges for ‘default arrangements’ to 0.75% of the total funds under management, but excludes transaction costs.

‘Default arrangements’ are investment funds chosen on behalf of pension scheme members who have not selected a specific fund to invest with.

The latest UK Department for Work and Pensions (DWP) proposals would allow trustees of qualifying schemes to engage in ‘productive finance’ – long-term investment areas like technology and venture capital - where investment managers typically demand a performance-based fee if they generate high returns.

The DWP said the change would make it easier for schemes to invest in new British start-ups and the infrastructure needed for the transition to net zero.

Tom Barton, pensions expert at Pinsent Masons, said: “The charge cap is a core part of the package introduced to provide value for, largely, the auto-enrolment population who save by compulsion rather than choice.”

“Until recently, the only talk has ever been of the cap coming down – although market forces seem to have largely done the trick in that respect.”

“The fact that we’re now talking about an exclusion from the cap shows just how much the policymakers want productive finance to work,” Barton added.

Performance fees often combine a fixed annual management charge and a performance-based fee paid on investment returns above a so-called “hurdle rate” – though only the second element would be removed from the charge cap.

The DWP is considering whether to impose a pre-set “hurdle rate” to prevent unfair practices as well as whether to specify which asset classes would apply to the performance fee exemption.

Under the proposals, performance fees would also need to be disclosed to pension fund members in the chair’s statement, though many large master trust providers have already made clear that they will not pay performance fees of any kind.

“There are certainly mixed feelings about performance fees. Some consider them a barrier to productive finance investment; some consider they should be done away with altogether in favour of alternative charging structures,” Barton said.

“The consultation rightly asks how we identify genuine performance fees, though this may be easier said than done.”

“Concepts like look-through at different levels of the investment supply chain are still not well understood,” he added.

“Whatever the case, schemes with the requisite scale will feel under some pressure to explore productive finance.”

“They will need all the usual investment advice, but should still also think about value, even if the cap is to be disapplied,” he said.

In the consultation, the DWP also proposed the removal of a ‘smoothing mechanism’ for the charge cap calculation that was first introduced in October 2021.

Barton said: “Clearly the freshly introduced smoothing mechanism has not delivered on the policy intent, although it is still very early days.”

Any change to regulations would come into force in October 2022.