The Lex Newsletter: using pensions to lift markets has repressive ring

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The RSPB would hardly approve. But sometimes it is possible to kill two birds with one stone, according to New Financial. The capital markets think-tank believes the UK can revive its lagging stock market while tackling a crisis in pension savings.

Good luck with that. To succeed, the plan would have to unpick — or swerve round — an implicit contradiction. The financial interests of savers have traditionally trumped all other considerations. These include well-meaning efforts to boost the UK’s sluggish economy.

Much ink has been spilled over the UK’s stagnating capital markets this year. Companies such as building materials group CRH are delisting from London. The decision of SoftBank to favour New York with the initial public offering of subsidiary Arm, a UK-based chip designer, also hurt local pride.

Politicians have long viewed the UK pensions industry as a potential answer.

The country has the largest funded pensions sector in Europe with about £3tn in assets. Yet UK schemes, many of which are mature final salary arrangements, do not invest as much as their international counterparts in potential high-growth assets such as equities. Since 1997, UK pension funds have slashed their allocation to British equities from 53 per cent to about 6 per cent. At the same time, allocation to bonds almost quadrupled to 56 per cent.

Pension funds have had their “risk appetite kicked out of them”, says New Financial’s managing director William Wright. “Layers of well-intended regulatory reform have created a framework and culture in UK pensions that seems actively designed to eliminate risk and discourage long-term investment,” he wrote in a report published on Tuesday.

UK chancellor Jeremy Hunt is keen to tap pension funds for his own causes. His government has been putting pressure on them to plough more of their money into private equity and early-stage businesses in the UK. So far, he has sought to do this via voluntary agreements.

New Financial, which has been working with fund manager Abrdn and US bank Citigroup, thinks the government and others have been looking at the problem the wrong way. 

The think-tank proposes tackling the pension savings crisis first. Millions of people on defined contribution schemes are heading towards an inadequate retirement income in the coming decades.

This could be addressed, says New Financial, by increasing minimum pension contributions for workers enrolled in defined contribution schemes from 8 per cent of pay to 12 per cent over the next decade. Longer term, it would like to see that rise again to 16 per cent. The current 8 per cent minimum is made up of a 3 per cent contribution from employers and 5 per cent from employees.

This would at least wound two birds with one stone. In a 2017 review of the UK’s auto-enrolment pensions policy, introduced in 2012, the government itself conceded that “contributions of 8 per cent are unlikely to give all individuals the retirement to which they aspire”. The Association of British Insurers has been also calling for higher minimum contributions.

The move would automatically increase the total funds that could be ploughed into assets such as equities. Even if percentage allocations remained at current paltry levels, this would still represent more money flowing to UK companies. Shifting the focus to contributions would also relieve some of the political pressure on the industry.

Direct comparisons with other countries are difficult because of different pension systems. However, minimum contribution levels in the UK are low compared with many countries whose pension systems are viewed as potential models for reform. Australia is moving to a minimum 12 per cent of ordinary earnings, for example. 

A move to 12 per cent in the UK would increase the value of a typical pension pot by £42,000 in today’s money over 30 years, according to New Financial’s analysis. It would also increase total annual pension contributions by about £12bn. 

Other pension reforms would still be required. In his Mansion House speech in July, the chancellor announced a voluntary pledge by nine of the UK’s largest pension providers to commit 5 per cent of their so-called default funds for defined contribution pension savers to unlisted equities by 2030. 

Any switch to compulsory investment in the UK should set klaxons blaring for pensions lawyers and trustees. There is an ugly phrase that applies to governments using legislation to lower the cost of capital for themselves or favoured sectors: “financial repression”.

The more immediate problem would be the unpopularity of higher contributions among employees and employers. A private members’ bill, backed by the government, is already set to introduce higher costs for businesses. Reforms include lowering the age for pension auto-enrolment from 22 to 18. 

Any rise in minimum contribution levels might have to be delayed until businesses and employees alike feel less squeezed.

The Federation of Small Businesses said New Financial’s proposals “might make sense to a City fund manager” but “they’re too hard on regular employees and business owners”. 

The chancellor would need a lot of gumption to follow the recommendations.

Other things I enjoyed this week

This article by the FT’s Martin Wolf makes a strong argument for why pension reform is needed.

If you’re finding all this talk of inadequate pension savings stressful, the New Scientist investigates the optimum way to relax.

Have a good week,

Nathalie Thomas
Lex writer