Not such a Quietroom – 20 years and partying strong!

Posted on July 5, 2023 by henry tapper

Mark Scantlebury and Vincent Franklin set up Quietroom in 2003, knowing only enough about pensions to reckon they could make a difference.

20 years on – they have!

They gave a great party last night – befitting an organization that has given much more to pensions than it has taken out.

Here’s Bob Dylan in Subterranean Homesick Blues, reminding us that though we’re all 20 years older , we ain’t 20 years wiser!

20 years of schooling and they put you on the day shift

I’ll take Bob’s  further advice

Look out kid
They keep it all hid
Better jump down a manhole
Light yourself a candle
Don’t wear sandals
Try to avoid the scandals
Don’t want to be a bum
You better chew gum
The pump don’t work
‘Cause the vandals took the handles

Vince and Mark are still watching the parking meters, albeit at a safe distance. It’s time for Simon, Rhys , Joe and the next generation to get that pump working again!

 

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DWP must learn from the abject failure of TPR’s VFM reporting.

Posted on July 5, 2023 by henry tapper

The current VFM measurement system is failing miserably

This is the conclusion of Government research published yesterday (July 4th)

 

The DC schemes survey (PDF, 2,191KB, 47 pages), published today (Tuesday 4 July), showed a lack of awareness from small schemes around new value for members assessments

The old “value for members” system is still failing

The original Value for Members requirements were introduced in July 2016 but are still not being followed.

Problems center around an obscure measure – “the Key Governance Requirement for measuring Value for Money (KGR2)” KGR 2 which requires that Trustee boards must assess the extent to which member-borne charges and transaction costs provide good VFM

For all scheme sizes, the primary reason for not meeting KGR 2 was that they did not research the characteristics, preferences and needs of members and take account of this when assessing VFM.

A third of schemes (33%) met this aspect of the requirement, ranging from 78% of master trusts to 21% of small schemes.

Figures above the bar show changes since the last survey in 2021

 

That two thirds of schemes are not complying with a key regulatory policy shows either a very poor compliance or a policy that is simply not fit for purpose. Trustees are aware of their need to comply with TPR dictats, they are not normally uncompliant, TPR has created unworkable requirements that need to be changed.

The new VFM requirement is failing even more!

Worse than this, it appears that most Trustees aren’t even aware that there is a new VFM requirement upon smaller DC schemes in 2021.

Of the 208 schemes with under £100 million AUM quizzed on their awareness of the assessment requirement, 64% reported they were unaware of it. Smaller schemes were more likely to be unaware of the requirements, with 58% small and 70% of micros schemes unaware compared with 15% of large schemes and 23% of medium schemes.

As was noted in last year’s LDI crisis, the small schemes are the problem. TPR should be aware that a failure among small schemes can create systemic problems. The Government has to be concerned that it cannot measure the VFM of small DC schemes.

Commenting on the numbers, TPR’s Nicola Parish asserted that all this was about to change

“The upcoming joint value for money framework will increase transparency and competition in the market, so now is the appropriate time for trustees to evaluate whether they can compete with the best master trusts in offering value for money.”

This is a bold statement and suggests that the new framework will bring change.

Are things changing?

The short answer is no. The net performance tables which were included in the New Value for Member assessments are what’s causing the trouble and they are simply copied across from TPR’s  current VFM assessment.

They require data that is not generally available and analysis which is beyond the internal competence or advisory budget of most trustees. They also require benchmarking against other schemes, something that is nigh-on impossible for all but the largest schemes.

Even were there the budget, there are not enough advisers competent to do the work.

The result is that these VFM assessments are not getting done

note – only one Maser Trust was surveyed

Predictably, those Trustees who had done some work on VFM, worked in their comfort zone (governance). Net performance and benchmarking were largely ignored. Less than a fifth of schemes had made an attempt to benchmark performance with other schemes.

Is there a problem?

The survey again shows that large schemes (especially master trusts) will throw resources at a problem to be compliant but that the smaller schemes, where problems are most likely to arise, are unaware or under resourced and therefore don’t comply.

Though most members are in large schemes, there are sufficient in small to matter – and matter a lot. The VFM framework must find new measures which are both intuitive and operable, not just for large schemes, but for small schemes and for sections of multi-employer schemes that are unique to one employer.

The DWP, TPR and FCA should not expect that compliance will improve , simply because there is a more comprehensive framework in place.  The issue is now out in the open – because of this research.

But the research shows that VFM is not yet considered an issue for most trustees. It has passed them by.  It will also have passed sponsoring employers by. Employers are interested in assessments that make sense to them, most multi-employer schemes do  not report at an employer level – VFM assessments need to speak to employers as well as trustees.

These issues have gone unnoticed since the 2021 introduction of the VFM regulations, because no-one reads Trustee Value for Member statements – even I suspect TPR. It took an external research unit (OMB) to tell the Regulator the scope of the problem

Despite this, the new Value for Money framework consultation imports the entire TPR apparatus for measuring and benchmarking net performance , recreating the problem on a larger scale.

This will lead to the same two fundamental issues

  1. Unawareness

  2. Non compliance

Is there a solution?

Yes. Other countries, notably Australia have opted for intuitive VFM measures that are operable and get noticed. They may be blunt, but they do the job.

It is time that net performance tables, which are inoperable and indigestible, be thrown out and replaced by data based on member’s actual experience.

The net performance tables are a DB fix to a DC problem and show that DC simply doesn’t fit into the DB box.

A better way is available and we at AgeWage, along with an increasing number of consultants and trustees, argue for it.

For those of us who believe in VFM as a measure, it is impossible to stand by and see the Government continue to hammer square pegs into round holes.

It needs to listen to industry practitioners and data experts who align their interests to the interests of the end users of VFM assessments- trustees, employers and ultimately members.

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Thames Water: Thin Capitalisation and the Credit Risk of Indexed Linked Corporate Debt

Posted on July 5, 2023 by henry tapper
GUEST BLOG FROM WARWICK LIGHTFOOT

Thames Water’s challenges reflect over use of debt and leverage, the retreat from public markets to private equity and the huge credit risk of indexed linked debt in the private sector.

In a paper prepared for the European Tax Policy Forum in April 2008 Multinationals’ capital structures, thin capitalization rules, and corporate tax competition Andreas Haufler and Marco Runkel set out the issues of thin capitalisation neatly. 

The tax bias to debt and against equity 

This is that

‘existing corporate tax systems permit the deduction of interest payments from the corporate tax base, whereas the equity returns to investors are not tax deductible. This asymmetric treatment of alternative means of financing the capital stock offers firms a fundamental incentive to increase the reliance on debt finance. Corporations will thus trade-off the tax advantages of debt against its non-tax costs, where the latter arise primarily from an increased risk of financial distress and the resulting agency costs due to conflicting interests between debt and equity owners.’

Sustained international concern about erosion of the corporate tax base

Most of the official interest in thin capitalisation exhibited by national tax revenue authorities, the IMF and the OECD has focused on the scope that putting debt on a balance sheet may erode the tax base and revenue collection. It is particularly significant in relation to multinational firms and inward investment. Transfer pricing creates opportunities for international firms to load debt on subsidiaries located in high tax jurisdictions and to make interest payments to another subsidiary with a lower corporation tax rate on profits. Most advanced economies since 2000 have brought in thin capitalisation rules to reduce the scope for this.  It is generally considered that such rules put up the after-tax cost of capital and that there is a trade off between revenue collection and attracting inward investment, which is generally sought after because it is associated with technology transfer and a range of beneficial spillovers that increase productivity.

Debt finance and undercapitalised business 

There is however a further dimension to thin capitalisation: it results in corporate balance sheets with higher ratios of debt in relation to equity. This makes their balance sheets more vulnerable in the event of an adverse trading event or wider general economic shock. The increasing use of debt in company balance sheets for purposes of tax planning combined with readily available and cheap debt finance from bond markets has over the last twenty-five years interacted to increase company leverage significantly. It explains the growth in the role of private equity capital and has contributed to the atrophying of public equity markets in advanced economies such as the UK and US that traditionally have had large public equity markets at the centre of their capital markets. The wider aspects are explored in The atrophying of publicly traded equity markets: why stock markets no longer match up with the economy.

Cake shops with balance sheets as fragile as banks

The result has been that company balance sheets are loaded with debt and become vulnerable to adverse events. Firms such as chains of patisserie shops have the kind of leveraged balance sheets that expose them to the sorts of risks more usually exhibited by banks or insurance companies. Banks and insurance companies are subject to rules about capital because of the inherent risks in their businesses and their systemic role in the economy. Yet many ordinary firms appear to exhibit comparable risks without the full systemic implications of a major bank going bust. We saw this during the covid emergency where during the interruption of normal business, because of the debt on their balance sheets, many non-financial firms were desperate and needed the special fiscal measures to help them to keep going. Some help would have been necessary but the scale was amplified by the fragility of many company balance sheets.

Complex public sector infrastructure, rent seeking and the scope to ‘coin it’

Where public infrastructure investment contracts are involved there is huge scope for rent seeking. A consortium of normal infrastructure firms set up a specialist vehicle to carry out a major contract. They finance it with debt. That company then subcontracts with the normal construction and engineering firms who do the work at contracted prices. In practice the special purpose vehicle, loaded with debt, subcontracts with its shareholders. There are few profits in the firm that issues the contracts and a lot of debt. When something goes wrong at the margin the special vehicle set up or used goes bust. Its shareholders have made huge profits through the previous contracts. As one distinguished British transport economist put it in relation to the public-private partnership financing the modernisation of the London tube almost twenty years ago: they were ‘coining it’. The story was later laid out in the reports of the National Audit Office looking into the matter.

Thames Water’s history is an illustration of all the things mentioned so far in this article. An involvement with the public sector. Taking a previously publicly traded company private. Ownership vested in private equity. The aggressive use of debt and a vulnerable and unstable company balance sheet. Along with the use of debt to pay dividends to the private equity owners. The Financial Times Lex column reported on July 1, 2023, that Thames Water has £14 billion of debt, that its Australian owner paid itself £3 billion in dividends during its eleven year period of ownership. The Financial Times leading article on it succinctly summarised the position: ‘Problems at Thames show how sector was reshaped by financial engineering’.

We would all like some private index-linked bonds to invest in, but the credit risk is huge

For bond investors there are three risks. These are: will the money be paid back and interest be paid – credit risk; will interest rates go up reducing the capital value of existing bonds on the secondary markets, market risk; and will inflation erode the real value of the income stream and principal, inflation risk.

The use of debt by the owners of Thames Water also offers an interesting gloss on the properties of indexed linked debt in the private sector. For any long-term investor debt indexed to inflation is a very attractive proposition. In the long-term the biggest threat to the value of a bond holder in the long-term is unexpected inflation. A century ago in 1924, Edgar Smith published a monograph, Common Stocks as Long-Term Investments. Smith in his famous article showed that on the basis of investment returns from 1866 to 1922 that equities in the long-term albeit with variability of return outperformed debt. This is because an equity portfolio offered investors a share in future rising profits whereas debt offered a ‘fixed income’.

When inflation is put into the mix the disadvantage of bonds is amplified hence the cult of equity when inflation took off in 1950s

In the context of debt, the fixed income it provides is eroded in real terms by price inflation. Both the real value of the interest goes down and the real value of the principal that is repaid on redemption is reduced. A long-term debt instrument that protects an investor from inflation is therefore very attractive. This explains the attraction and the expense to the investor of indexed linked government bonds such as UK Gilt Linkers and US Treasury TIPS, and why the market in them is so illiquid. Yet the credit risk to the investor of whether the borrower really is able to pay is huge. Examples of such investors include pension funds, insurance companies and central banks that may choose to secure their indexed linked pension fund liabilities in this manner.

Governments are able to offer indexed bonds which in the event of inflation are expensive to service. However, before an investor accepts a higher rate of interest on a private corporate index linked bond, the credit risk they have to consider is very different. Thames Water has issued index linked debt. In principle, given that the price regulation it operated under is tied to inflation, this should be the sort of private sector index linked debt that a firm could comfortably manage. Yet it appears that the water company has a debt index to the RPI while its regulated income is linked to the CPI.

The challenge of meeting a commitment to service an index linked debt is illustrated by the benefits enjoyed by private retail investors in UK Index Linked National Savings Certificates. These were issued in the 1990s and are tax free. For higher income tax rate investors, on an after-tax basis, they are often the highest yielding part of their portfolio. Even after they matured and if unredeemed no longer paid a rate of interest, they just continued to be indexed for inflation until cashed in.

The heart of the matter

At the heart of this process of financialisation has been a tax system biased to debt and against equity, aggravated by a decade of very low interest rates and the micro-economic mispricing of credit for almost two decades.

Warwick Lightfoot

@WARWICKLIGHTFOOT
Warwick Lightfoot is an economist was Special Adviser to three Chancellors of the Exchequer between 1989 and 1992, he is the author of America’s Exceptional Economic Problem.
This article was first published on Warwick’s blog and is reproduced with his kind permission

 
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Ending workplace pension’s “cost is king” culture. Be careful what you wish for!

Posted on July 4, 2023 by henry tapper

The ABI’s report yesterday started with a call for greater investment in productive UK assets and tailed off into a list of demands for higher auto-enrolment rates and a demand to end “workplace pension’s “cost is king” culture. Pensions Expert reported

The ABI said ending the “cost is king” culture in the defined contribution market, where charges rather than scheme value was a focus could also help shift funds towards more UK centric investment.

To do this The Pensions Regulator (TPR) would need to “review and update its DC investment governance guidance to encourage trustees to focus on overall value” and that “both TPR and DWP’s default fund guidance should incorporate the framework – once finished – to rebalance the focus on costs towards a more value orientated approach”

There’s no doubt right now , that employers looking to buy a new workplace pension on the secondary market are using price as the primary determinant.

To this end, some workplace pension providers are advertising one default to demonstrate their ESG credentials, typically incorporating investments into private market, and using another default for price negotiations. The other default has no “expensive assets” but invests in passive funds.

It’s a legitimate tactic , it wins mandates and the argument is that once you have the money onboard, a provider can then promote a higher priced default at a later stage.

That’s fine so long as there is good reason to do so. But will an employer see the likely outcomes of a workplace pension improve by putting up the price? Will a Pensions Regulator demand a provider and employer agree to put the price up? I think it is possible, just as skiing uphill is possible, but the general direction for skiing is downhill.

Rebalancing the focus

A lot is made of re-educating dumb employers. The OFT noted 10 years ago

Employers make workplace pension decisions and unless we find a way to get dumb employers to engage or understand their pensions, employers will continue to make dumb decisions.

The ABI wants the Regulator to “rebalance the focus”, but how is TPR likely to do this? Can they install a reverse price cap so that no-one is allowed to charge below say 30 bps? Should there be a minimum allocation of the AMC to investments – say 50%? Should the tax reliefs available to employers and savers be limited where there is not an investment strategy in place that demonstrably makes our money matter?

I have written on many occasions that any test of the cost and charges of a scheme should focus on how the AMC is apportioned. If investments are getting a couple of basis points from a 20bps charge, then there’s a 18bps allocation to “other” – typically member support and engagement and a return to the funder of the scheme to meet the overhead and provide capital for the future. But if investments take up 32 bps of a 50 bps AMC, the retained cost from the provider is the same.

Assuming that £ for £, a 32bps investment budget  translates into a 30pbs higher spend than the aforementioned 2bps, we might rely on  Hymans Robertson’s 10-10-10 formula.

So an extra 30bps investment spend,  can support a 30% allocation to diversified illiquid solutions, which can improve retirement outcomes by at least 30%.

Would the ABI be happy to see their member’s cost test be flagged red for “underspend”?

It is one thing for the ABI to suggest TPR gets tough on the “cost is king” culture. But for costs to be properly understood, they need to be transparent. Knowing how much of the AMC is being spent on investments and their management is critical to knowing the likely outcomes of a workplace pension. It is a forward looking measure – certainly if you agree with Hymans that the more you spend – the more you get (and that the equation is exponential).

Many of the workplace pensions do not reveal the amount of an AMC allocated to investment management, so the cost measure isn’t worth much. After all, it is already counted in “net performance”. If net performance is representative of what a member actually pays (rather than an approximation) , knowing the AMC is irrelevant, the employer needs to know what the AMC is buying.

If an AMC is underspending on investment, an apportionment of the AMC between investment and other will show it. You can own a Bentley , but if you put a lawn mower engine in it, it won’t get you anywhere.

The onus is on the ABI members who provide insured workplace pensions , to come clean on investment budgets and the amount of AMC allocated to the management of the default’s investment.

Tests on costs inform on future growth and transparency

I am behind keeping a test on cost in the VFM Framework so long as it splits the use of the AMC as suggested above. If this information is not available then I suggest a cost score is marked as red as a matter of course. Employers need this information.

If the amount allocated to investment falls below a threshold (say 20bps) then I would argue the workplace pension is underspending and should be marked down, minor underspends should get an orange and major underspends a red.

Workplace pensions getting a red score on cost might risk being stopped for competing for new business or even stopped from doing business. This is the way of it in Australia and it is the explicit threat of the VFM consultation.

If the ABI really wants to stop the “cost is king” culture, I suggest they support proper cost disclosure. Doing so , may avert more radical measures from Government.

The ABI need to be careful what they wish for and explicit about ways it can be achieved.

 

 

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Derek Benstead provides a fresh view on collective pensions this morning at 10.30am

Posted on July 4, 2023 by henry tapper

Derek Benstead, DB by name – CDC by nature!

 

Pension PlayPen Coffee Morning 10.30 am Tuesday 4th July

Fresh from his visit to Parliament to explain to the Work and Pensions Committee why open DB schemes have a future (along with CDC) , he’s now joining us for  Pension PlayPen Coffee Morning.

I worked with Derek when we were both at First Actuarial and came to rely on him to explain ideas that I didn’t understand. He taught me in simple language how liabilities are valued , how actuaries assess mortality and what words like “prudence” and “risk” mean.

He explained the concept of the open scheme “sweetspot” to me with this diagram, which I have used hundreds of times on this blog and in presentations to staff

For Derek, it’s open accrual that counts and not the particulars of the guarantees on offer. So he can talk about CDC and DB as interchangeable.

He is a lover of simple pleasures like flying kites and teaching people. He is a benevolent pedagogue and he’s one of the best explainers I’ve ever come across.

But he’s not just an explainer, Derek thinks things through from first principles. Back in 2009, the Government Actuaries delivered a damning verdict on CDC – consigning it to the actuarial dustbin. Derek, then quite young in his career, wrote a riposte that has become legendary and allowed CDC to fight another day. He tells me that he’d actually proposed that Stakeholder Pensions be CDC pensions back in 2001!

And when Royal Mail and the CWU union were in deadlock, it was Derek and his boss Hilary Salt who nudged the conversation towards what was then nothing more than an actuarial concept. Derek could properly be though of as one of the great  advocates of UK collective pensions.

So I’m really pleased that we will be talking with each other for a few minutes after 10.30 am on Tuesday July 4th. Although the session is an hour, I hope that many of our colleagues in the Pension PlayPen will join us- and that if you aren’t in the PlayPen, that you sign up to attend this session.

 

You can register for the session here

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Do we need a secondary market for workplace pensions?

Posted on July 4, 2023 by henry tapper

How TPR explained “employer duties (no mention of pensions!)

The auto-enrolment rules prescribe that if you run a company with workers you normally have to offer them the opportunity to join a workplace pension of your choosing, either on an opt-in but usually on an “opt-out” basis. As the screenshot above shows, the employer duties focussed on AE compliance and not the workplace pension

The choice of workplace pension does not need advice and – provided the choice is to an authorised workplace pension –  the choice puts the employer in a regulatory safe-harbour.

Judging by research done in 2015 by the CIPD, these are the main factors that influence an employers choice of workplace pension. “Good member outcomes” is not on the list.

It follows, that many workers are saving into a workplace pension chosen out of convenience to the employer, not the member outcome.  There is very little in this decision making,  that talks to VFM.

Part of the Government’s concern is that some workplace pensions are still set up to help the employer and disregard members.

There have been no prosecutions as far as I am aware of employers negligently or fraudulently using a workplace pension for gain, prosecutions have focussed on the non-payment of payroll deductions to pension schemes (aka theft).

Workplace pensions can go wrong and often do. To ensure that good money is not invested after bad, the Government has set up a system of governance of workplace pensions designed to spot pensions that have gone bad. Workplace pensions set up as GPPs are looked after by IGCs – those set up as occupational pensions , by trustees. The idea is that failing workplace pensions report themselves to the FCA and TPR respectively as not offering members value for their money. They then have to hand over the keys and walk away, the pensions are administered and invested by another provider.

There may be instances where this has happened but I have not seen one. Virgin’s IGC reported its stakeholder pension as not fit for purpose but the plan still exists under Virgin’s stewardship.  Some of the occupational pensions that have folded into master-trusts may have done so because they didn’t consider they were offering members VFM. But by and large, what consolidation that has happened so far, has occurred for commercial reasons. Employers don’t want to run their own pension schemes, commercial workplace pensions “want out” at an acceptable valuation.

The impact of the DWP’s proposed VFM framework is intended to change things. The Government has it in its head that many schemes are not giving members value for money. Either they are invested poorly, or they charge high  and retain charge as profit or they aren’t delivering a decent quality of service. There will be tests to ensure that schemes don’t rip-off members, invest productively and support members properly.

If they don’t , then the schemes may be required to hand over the keys.

If a multi-employer master trust is forced to cease trading, then the employers will find themselves in a new workplace pension, there will be no need for them to take any action , though they may be required or want to explain what’s going on to staff.

But there is a stage before closure – where workplace pensions are on a written warning to improve, where employers may be made aware that their scheme is in special measures. In such cases there may be an impulsion on employers to review the decision taken to choose that provider. This is where the comparative data that the VFM consultation envisages the Framework providing – becomes useful.

The idea is that employers will be able to compare what they have with what they might have with a view to switching providers. This is how the Government wants to create a secondary market in workplace pensions where the employer is the determinator of the ongoing arrangement and does not passively accept the new provider and the new provider’s terms.

This is what I and others see as the primary outcome of the DWP’s consultation. We think that the consultation response, due out in the next couple of weeks, will put an onus on employers to pay attention to their choice of workplace pension.

This will require a change in employer knowledge and understanding – not much has changed since the OFT wrote this ten years ago.

The VFM Framework is expected to address this issue.

By giving employers simple headline metrics by way of three RAG (red orange green) tests on performance, services and cost, it will excite interest in where the money is going by employers and ultimately savers.

If the Government is right, then this will create a new opportunity for providers with a good (green-green-green) story to tell, to promote themselves to a wider audience. I expect the vast majority of this promotion to be by direct offer, no provider will be involved. This may be the opportunity that banks like Lloyds and NatWest – which own  master trusts, could take to market their plans to bank corporate customers.

It might also be the opportunity for advisers active in advice to the top end of the workplace pension market, to digitalise their service and extend it to a wider group of employers. There is no “De Facto” for workplace pensions and there is certainly no pension aisle in the MoneySupermaket.

It’s been done before in the primary market and it may be time for a workplace pension choice engine for the secondary pension market

Sceptics may say that the disruption caused by switching providers, negates the VFM latent in the ceding provider and that purchasing may be on cost – or just on past performance. These are justifiable concerns that the VFM Framework needs to address.

But it looks likely that many small and medium businesses , who have previously avoided engaging in the workplace pension, will do so, not least for the sake of senior executives who will over time become major stakeholders in those plans (by dint of their pots).

And it seems to me inevitable that those who make decisions on behalf of their staff, are held accountable for those decisions, by their staff, by their representatives and ultimately by the regulators.

We will therefore need a secondary market in workplace pensions, one that caters for more than those employers who can afford to take advice from employee benefit consultants. That will mean a fresh opportunity for progressive advisers – keen to make a mark and help in the quest for better Value for Money.

 

 

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Thames Water and the peril of private markets.

Posted on July 3, 2023 by henry tapper

Not all utilities are in private hands , not all borrow more than they are worth and not all are facing the existential problem of Thames Water.

It’s an uncomfortable reality for Government, in a week when the Chancellor will be announcing his plans to get pension funds to invest more in private markets, that private investment seems to be at the core of Thames Water’s problems.

In an interesting piece of analysis by the FT’s Helen Thomas, the problems that have accrued at Thames Water are compared with the relatively smooth progress made by the three publicly listed utilities, Severn, United and South West Water.

Nearly 90 per cent of the extra investment approved under the 2021 green economic recovery programme for England’s water industry came from the three listed companies. The companies that will bring forward most investment spending, through a separate initiative, to shore up ailing infrastructure are United and South West.

Not only is Thames failing as a private market stock, it is failing as an ESG stock.  This is embarrassing not just to Government but to those who argue that private markets offer better opportunities for growth and to improve the pension scheme’s carbon footprint.

While we should not one bad apple spoil the barrel, it is important that the lessons of the demise of Thames Water are learned before similar stocks are targeted by our pension funds. Nearly a third of Thames Water is owned by two of our large DB pension plans and this should result into a regulatory case study. That study should include TPR, who issue guidelines on pension fund investment and OFWAT, who regulate water companies.

The problems at Thames Water do not mean that pension funds should only invest in listed equities, but they provide us with a timely and salutary reminder that household names do not necessarily behave in a responsible way.

As Helen Thomas concludes, environmental and social factors are a good proxy for governance and good governance a key determinate of which private stocks to pick.

There are no easy answers, given the need to balance attracting huge investment with tougher operational and financial regulation. But considering who shows themselves to be a responsible owner, and the apparent restraining influence of the public equity markets, seems a decent place to start.

The consumer wants to make their money matter and if its pension fund money can turn round Thames Water, both financially and in terms of its environmental reputation, then we should welcome it as the alternative to the  Australian “vampire kangaroo” Macquarie

If pension funds and investors want evidence of water utilities  environmental records, they should take to their rivers. This picture was taken yesterday morning on the Thames at Hurley.

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It’s just not cricket

Posted on July 3, 2023 by henry tapper

I was happily floating up and down the Henley Regatta Course as the fifth day of the Lord’s Ashes Test played out. Of course I had my buds in and was following events but the distractions of rowing and the perils of navigation kept me from getting sucked into the action.

Carey throws down the stumps

Stuart Broad told the Australian wicket keeper “you will always be remembered for this”. As a very poor wicket keeper I know the temptation to throw down the stumps, with or without giving the batsman a warning for straying out of the crease.

Most keepers are tempted but don’t because they know they will be regarded as a cricketing pariah, not just by their opposition but by their own team “it’s just not cricket”.

But our interpretation of the game of cricket has taken a different turn in the past five years, not least with the arrival of Baz-Ball and the emergence of IPL as the predominate cricketing competition in the world.

If Australia greatest contribution  to make test cricket great again is from  their unflinching determination to win (rather than just “entertain”).

This determination has left England 0-2 down at home in a series where they arrived on one of their best runs in recent times.

I admire Cummings & Co for not showing the slightest compunction about taking Johnny Bairstow’s wicket as Carey did.

It is undoubtedly good for the game that Australia approach it in a different way than us pub-cricketers and this England Baz-ball team should wake up and smell the coffee.

From WG Grace , through Bodyline to the antics of Sidebottom against New Zealand, England have always had a nasty side.

At the start of this test, the English team were behaving like pub cricketers , taking on the short-ball despite not being good enough to get it the boundary. They wanted to be mates with the Australians and Carey , Cummings & Co told them what they thought about that.

England will not now be sharing a drink with this Australian side any time soon!

Ashes series involve cricket but a whole lot more. If you’re in the Hollies or in the Lord’s Tavern Stand, you are in the business of pantomime, where your opponents are villains and your team heroes, it’s the other way round but the same in Australia. Panto maybe – but we all have Australian friends – there will be some serious joshing around town in the next  couple of weeks.

We have three matches to go and a great series has just got greater. If we carry on playing like we’ve done , we will continue to lose. But Ben Stokes showed what can be done. COME ON ENGLAND!

It’s just cricket – but what game!

It’s just cricket, but it can take your breath away while out at the rowing, Yesterday I was loving both! Thanks Australia and England for reminding us just what sport can do.

Thanks to my crews over the last few days

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The ABI look to seize the high ground on pension investment

Posted on July 3, 2023 by henry tapper

Big picture stuff

The Treasury is softening up the British Public for change

This weekend, the softening up of the British public to the idea that pension schemes can invest for Britain gathered further momentum. The Times ran an article headlined

Can pensions be unleashed to rebuild Britain?

The Telegraph carries the same message

The FT runs with

Call for UK to use co-investment with pension funds to drive backing for riskier assets

The Calls are from the Association of British Insurers which today is indeed “calling” for more help/incentives from the Government to allow insurer to invest in private illiquid markets.

Everywhere, Treasury spokespeople seem to be offering comment , trailing the likely announcements by Jeremy Hunt at this week’s Mansion House speech that pension schemes will be encouraged to invest more heavily in assets that matter to the UK economy.

This kind of coordinated campaign only happens when the Government is serious. While we will see no “law-making” this week, we can expect a clear indication of the political direction of travel and it is towards

  1. Further consolidation of pension pooling vehicles – whether in LGPS, Corporate DB or DC workplace pensions
  2. Pressure to encourage a shift from price to value in the procurement of investment services
  3. An encouragement for  long term investment in patient capital.

Relative to other developed countries such as Australia, Canada and the Netherlands, , Britain is under-investing its £4.2 trillion of funded pensions in its local economy making it hard for fast growing companies to find finance at home. Many UK companies seek funding overseas, especially from the USA while many of the large capital-intensive projects in the UK are being funded by overseas pension schemes.

In view of the heavy investment from the UK tax-payer in tax-breaks for UK pension funds, the Treasury clearly does not think that the country is getting value for its money.

Taxation will be key

While the Treasury has made it clear that the current Government is not looking to legislate to make investment in the UK growth sector compulsory for pension schemes and funds, it has not ruled out reorganizing the incentives that influence the deployment of capital. The Treasury’s usual means of reorganization is to change the rules surrounding the taxation of pensions. We have had one minor tweak in pension taxation this year and many expect a further one to be indicated in this year’s Autumn Statement – perhaps to be followed through in the Spring Budget.

Headwinds from the non-insured pension sector

Opposition to Treasury pressure focusses on what is known as the “fiduciary duty”, the requirement on those who look after other people’s money to ensure that that money is managed in the interests of members rather than other stakeholders – including the Treasury.

Fears are that centralised pooling vehicles , as is happening in the Local Government Pension Scheme will disempower local pension funds from taking decisions appropriate to member needs and leave the LGPS regional funds open to political interference.

Similar fears are expressed from the corporate sector , where many companies still sponsor their own pension schemes arguing that pension funds are better run by and for the companies who sponsor them by relatively anonymous master trusts and insurers.

Again there are fears that Government interference will lead to the wrong kind of risks being taken by the wrong people. This is particularly strong with DC pensions where the risks are taken by ordinary people who have little financial resilience

A difficult task for Government

Balancing the natural conservatism of the pension industry with a need for change in pension fund investment is no easy task.

The Department of Work and Pensions has set about reforming the way in which procurement of DC pension services through its proposed Value for Money Framework.

It has clearly signaled to its regulator, the Pensions Regulator, to change tack on DB pension funding to encourage rather than discourage their investment in “growth assets”.

The Treasury’s regulator the Financial Conduct Authority, has established a new funding vehicle – the Long Term Asset Fund – which it hopes will be adopted by pension investors that cannot invest directly into patient capital, so they can do so using insurance platforms.

But it looks unlikely that these reforms will be enough to move the scale of assets into productive capital, required by Treasury models.

Insurers to the rescue?

This strategic shift in policy is coming at the right time for the insurance industry which is looking to re-establish the rules it operates under with regards insurance solvency.

While the non-insured pension sector worries about fiduciary duty, the insurers see an opportunity to take further control of parts of pension funding they have little control over.

The likely transfer of risk from corporate DB pensions to insurers and others “buying-out” guaranteed pensions, will see large flows of capital into insurance companies own funds. These funds area potential source of productive finance for the nation.

The Association of British Insurers are aware of the opportunity and will today be releasing a report on what it feels the Government should be dong to encourage insurers to come to the rescue.

This blog is published too early for details, but expect the tone to be as reported in the FT

….state backing for riskier, illiquid investments would help make the UK a “more attractive” destination for its members.

“By developing further initiatives that use co-investment as an incentive, the government could create opportunities for pension funds to put more money behind assets that align with its wider policy objectives,”

it said.

“For any investments that are expensive and/or riskier, such incentives would shift the balance of risk and reward, improving the value for savers, and making them more attractive to schemes.”

 

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The fate of Thames Water is in the pension funds’ hands.

Posted on July 2, 2023 by henry tapper

As this collection of headlines shows, the FT places the importance of Thames Water’s future at the top of its weekend agenda. The article, which I reported on yesterday, makes it clear that USS – the university pension scheme, is key to the ongoing financing of this major utility.

This is a much happier state of affairs than might seem to be the case. Although the short term valuation of Thames Water’s shares must be considerably below what they are marked at in USS’ valuation, the long-term prospects of this utility are based on a 15m captive customer base who want value for money as much as USS trustees and members.

In short, there should be an alliance of interests between a pension scheme and the assets it owns – both should be looking for long-term returns and stakeholder value to both customers and shareholders.

So, though I question whether USS has properly managed its shareholding so far, I see every possibility that it, along with BT pension , Ontario Municipal’s pension and other institutional shareholders, can turn this company around through the exercise of good governance and the establishment of new management under a better social contract.

As part of this, the price of water needs to go up, but extra burdens on consumers must be linked with improvements in the management of sewage and the leakage of pipes. The pension schemes can be a part of this contract.

In short, I see the challenge facing USS, BT , Ontario and others as one of being effective stewards of the asset they own.

This is an important aspect of the diversification of large pension funds into private markets and one I have read little about. If superfunds such as USS are to take 20% stakes in firms like Thames Water, they need to recognise they are no longer silent partners but crucial to the future of the assets they co-own.

Simon Pilcher , USS CIO, is paid a lot of money to manage a lot of money. But with that pay, comes responsibility.

What happens over the next few weeks to Thames Water is to a large degree down to the way that USS and others manage the asset. They must be integrally involved with negotiations with Government and its regulators. It must be a party to whatever solution happens going forward.

If it fails to step up to the challenge and just awaits a Government bail-out , it deserves to be treated brutally and for that brutal treatment to be the responsibility of USS and its investment team.

If it succeeds , creating a better long-term future for Thames Water, USS can rightly point to it using the power of its £90bn fund to make not just its money, but our utility – matter.

The Thames above Harleyford

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