TPR/DWP

“Profit extraction?” what kind of language is that?

This was my immediate reaction after reading yesterday’s “detailed” guidance for DB Superfunds published by the Pensions Regulator

What has followed on social media is a predictable onslaught against private equity, who are seen (rightly) to be providing the capital for pension superfunds to apply for approval and get clearance for deals. To date they have made no profit on capital deployed, and – as this blog will make clear – they have no certainty they ever will.

What is wrong with making a profit?

I do not see insurers, who make considerable profits from buying out pension scheme liabilities, being accused of actually making a profit, nor do I see those making the accusations being accused of drawing salaries or partnership earnings against the profits of their organisations. Everyone who works , has a right to make a living out of their work.

“Monetising” is a dirty word to those who do not have to invest their own capital in projects. But people invest their capital to get a return on it. It is right, in complex markets where the public interest is for transparency, that the way that money is returned to those who have invested (money and time) is clear. That’s why we have accounts. There is also a role for regulators to ensure that this transparency is in place and on rare occasions, such as systemic market failure, there is a case for statutory price controls.

TPR’s perceived problem is that they have no market

Part of the job of Government regulators is to ensure that markets are competitive. Normally, where there is competition, markets form around this, we see this is many competitive areas of pensions – SIPPs, workplace pensions, DB consultancy, fiduciary management and fund platforms are a few examples.

But sometimes, where the opportunity is less obvious , markets are slow to form. The DB superfund market is a case in point. The Pensions Regulator talks about a variety of business models emerging over time, well we’ve had five years and only two models have appeared -Pension Superfund and Clara. This is not market failure – other markets have formed in that time, it is down to regulatory failure.

Who would want to commit capital to an enterprise where the rules about entry and about ongoing “profit extraction” are yet to be established? Indeed, who would want to be regulated by an entity whose attitude towards potential market participants is characterised by distrust?

Yet , that is what DB superfunds are being asked to do by the Pensions Regulator. There is nothing wrong in requiring superfunds to charge market rates for services offered to trustees.

Until a specific mechanism is set out to extract profits, as above, superfunds may need to levy fees and charges on the pension scheme and/or capital buffer in exchange for the provision of services. It is critical that these fees and charges are appropriate, transparent and fair. They should not disrupt the principles underpinning our capital requirements or funding triggers. They should also be consistent with those capitalised in the pension scheme’s TPs.

But superfunds are being asked to provide more than these services, they are being asked to provide a capital buffer – a contingent asset – so that should their pension scheme management fail, the PPF is protected.  This capital comes at a cost, as does the cost of capital deployed over the five years since pension superfunds were announced by Government as desirable to the market. That initial  capital has been considerable and it has been spent at the behest of the legislator (DWP) and regulator (TPR) so that there is a market today.

They should be grateful to have any interest in superfunds at all!

The Pensions Regulator should be recognising the patience and deep pockets of Clara and Pension Superfund’s investors for hanging in there. Actually only Clara has made it to the starting line while the other is considering its options as to whether it wants to resubmit an application. Since the one at the starting line (Clara) is only intending to be a bridge to insurance buy-out , it is correct to say that the Pensions Regulator has no true superfund, no organisation committed to running off liabilities over time without recourse to insurance.

That means it has no organisation that can properly commit to the principles behind the Mansion House reforms. So far, in terms of competition in markets, the Pensions Regulator has failed, but it is lucky in having two potential players remaining, players it seems intent on alientating.

Were there 40 odd players, as there were applying for master trust assurance , the following warning might have been acceptable.

Fees and charges levied should be no higher than equivalent ‘market prices’ We expect the fees, costs and charges to be benchmarked in line with market levels for pension schemes of similar scale and complexity to ensure they reflect the service supplied. In setting these, we expect superfunds to adhere to the spirit of our requirement regarding profit extraction. During assessment, and supervision, trustees should demonstrate to us that the aggregate level of fees, costs and charges that will be, or are being, levied on the pension scheme are at least in line with market levels of pension schemes of similar scale . We would also expect trustees to ensure they are getting value for the services they commission.

But playing hard-ball at this stage does not make you a tough regulator, it shows you do not understand the fundamental dynamics of the market.

There is – within this paragraph , a warning to the superfund and to the trustees of the ceding scheme that profit cannot be extracted from the arrangement by way of higher fees. This of course assumes that superfunds operate at the same level of (in) efficiency as the ceding scheme, TPR might go further and prescribe that superfunds pass on any marginal profits arising from their doing things better – why not – TPR’s principle is clear, no operational profit extraction, and so – no motivation to create operational efficiency.

The reason this price warning is in place is because there is no competition, the reason there is not competition is because Government has so far made it almost impossible for DB superfunds to enter the market and transact. Price control in this instance – results from a failure in regulation and not the markets.

Instead of entering into a constructive dialogue with the market, the Pensions Regulator issues a warning against profiteering which is insulting. No trustee will enter into a contractual arrangement to the detriment of its members, trustees have a choice whether to use a superfund or another consolidator such as the PPF, they have the choice to soldier on.

No other avenue has price controls on it, the latent distrust of the backers of pension superfunds and the implied stupidity or deliberate collusion of trustees is a slur on both parties.

And having closed off one source of revenue creation, TPR might have been expected to clarify the revenue opportunity elsewhere. This is what they are saying

7.3.4 Value extraction

We plan to develop a specific mechanism based on a profit trigger, and will carry out further analysis in order to do this. We plan to engage with stakeholders on the appropriate mechanism and will update this guidance accordingly.

The Pensions Regulator has had five years to work out how DB superfunds can make a profit from their initial investment and from the capital they deploy to keep their members safe.

What is left of a competitive market is now being publicly insulted and expected to persevere in its endeavours with its potential profits being determined by TPR and other stakeholders. Those stakeholders will almost certainly include parties who would rather not see the emergence of superfunds.

Laura Trott, Mel Stride and those at the Treasury who intend the Mansion House reforms to be  a success need to intervene now and make it clear to TPR that they must be clear on how profits can be extracted by superfunds to meet their shareholder’s reasonable expectations.