Consolidation of pension schemes has many advantages, including for regulators, but it also brings some challenges – such as understanding the concentration of risk, something the Pensions Regulator is currently looking at as it considers whether to take a more supervisory approach. 

 

Consolidation is being driven by government – in the defined contribution space – and by sponsoring employers in the defined benefit space. The potential benefits of having fewer and larger funds look after more members range from better governance to lower investment and administration fees. The regulator might also have an interest in overseeing fewer funds that they can build strong relationships with.  

 

 

However, the regulatory approach may need to change from the current risk-based one if the market is transforming to consist of fewer but larger entities. 

 

“As you move to almost too big to fail financial institutions, what does that mean for us as a regulator? We need to almost change as a regulator and perhaps be a bit more like the [Prudential Regulatory Authority],” with detailed controls and supervision, said TPR’s executive director of policy, analysis and advice, David Fairs, speaking at a webinar organised by consultancy XPS on Monday, revealing that this would be a theme for TPR’s board away day this week. 

 

Fairs highlighted that DB schemes do not currently have what he called “a safe destination” for consolidation, meaning an authorised vehicle such as DC master trusts or collective DC schemes, and that there are still about 5,500 DB schemes, 80% of which have fewer than 1,000 members. 

 

“For superfunds we don’t have a regime, we have an interim assessment, but we’re still waiting for a response from the DWP,” he said, noting however that the interim regime mirrors many of the requirements for DC master trusts, such as fit and proper assessments and financial sustainability. 

 

Given this, he said the only vehicles that were not currently subject to authorisation or an interim regime were DB master trusts. “When you look at that landscape [we have] an authorisation regime for DC master trusts, CDC, potentially for superfunds. DB master trusts look a bit out of kilter with that,” said Fairs. Amid the benefits of consolidation, “the challenge is we don’t have a safe destination” for DB schemes, he said, adding: “It will be interesting to see if the market does develop in that way.” 

 

 

Consolidation also brings other regulatory challenges. Fairs pointed to the concentration of professional trustee firms, where “a relatively small number of them now have control over significant assets”. Similarly, just 14 administrators look after 74% of memberships, and there is only small number of software providers.  

 

Developments with investment platforms and new approaches such as capital-backed journey plans are also keeping TPR on its toes. The fact that DB is not a growth market makes it more at risk of conflicts. 

 

“As you get these activities and it’s a declining market, the challenge for us is that professional advice is not getting compromised by commercial interest and you get a fight over a reducing number of schemes,” he observed. 

 

 

Australia has already been through the kind of consolidation the UK market is entering, and as such the UK regulator is in exchange with its Australian counterpart.  

 

Australia’s private sector DB closed to members in the 1980s; public sector DB followed in the 1990s, with the pensions market being 86-87% DC now. Only a fraction of several thousand private sector DB funds are left. Most were moved to the retail life sector and bank-owned funds, but more recently the industry multi-employer funds have been pitching for the business, said Nick Sherry, a non-executive director at various pension organisations and former superannuation minister in the Australian government. 

 

Sherry argued that consolidation leads to greater professionalism, more focus on fiduciary duty and greater investment sophistication and pointed to evidence that scale gives higher long-term returns: “It’s not a perfect correlation but a strong correlation.” 

 

There is currently a debate in Australia about just how big a fund needs to be in order to achieve the benefits of scale, he said. Sherry was recently made chair of a fund with assets worth AUS$6.9bn, but what might be considered large in the UK is not seen as such elsewhere. “We are under significant pressure to merge,” he said. 

 

While Sherry advocated the benefits of scale, he said there are some dangers and concerns chiefly around complexity, while responsibilities can become blurred. Where funds become very large, they can become “complex, bureaucratic, and have executive domination. With some of the larger funds I’d seriously question whether the trustees are setting the strategy or business plan,” he said. 

 

Sherry also wondered if all of the UK’s thousands of trustees understood their fiduciary duty or had the skills to “get down into the nitty-gritty" of investments, administration or cyber security. The Australian regulator rigorously enforces rules and creates transparency, he said, through public benchmarking, shutting funds down for poor performance, as well as operating a licencing system for trustees. Trustees are also legally liable as individuals, he said: “You can lose everything if you don’t observe your fiduciary duty.” 

 

How will pensions regulation need to change as schemes consolidate?

David Fairs

Danny Vassiliades