New Clause 13 - Scale of pension schemes

Pension Schemes Bill – in a Public Bill Committee at 3:00 pm on 4th November 2014.

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‘(1) The fiduciary duty of pension scheme trustees shall include a duty to consider whether the scheme has sufficient scale to deliver good value for members.

(2) Where trustees take the view that the scheme has insufficient scale, they must consider whether merger with another scheme would be in the members’ interests.

(3) The Pensions Regulator shall have power to direct merger of pensions schemes where it would be in the interests of the members of each of the relevant schemes for merger to take place.

(4) The Pensions Regulator shall exercise this power in accordance with a methodology on which it has publicly consulted and which has been agreed with the Secretary of State.

(5) The methodology set out in subsection (4) shall be kept under regular review and revised when necessary, subject to further consultation and agreement from the Secretary of State.”.—(Gregg McClymont.)

Brought up, and read the First time.

Photo of Gregg McClymont Gregg McClymont Shadow Minister (Work and Pensions)

I beg to move, That the clause be read a Second time.

The new clause had an airing in the discussion on new clauses 5 and 14. It would give the Pensions Regulator, along with the trustees of such pension schemes, the power to encourage and make consolidation happen. The schemes we are talking about here are the 40,000 or so that the Minister mentioned in his response to our new clause 14. Let us be clear what we are talking about: there are about 200,000 pension schemes in the UK and about 150,000 are the type of scheme, such as group personal pensions and so on, that our new clause homes in on.

The issue around scale on the trust side is significant. It is true that on the trust side governance issues are usually around scale. There are also issues around the quality of trustees when there are so many pension schemes, as the hon. Member for Gloucester mentioned. Our answer is to encourage forcefully the reduction in  the number of pension schemes to increase that scale, which is widely recognised as an important aspect of getting value for money, and to clarify the issue around the number of trustees available.

What is the international and pensions landscape evidence? The Pensions Regulator gave evidence, I think to the previous pensions Bill; there have been so many pensions Bills that it is hard to remember. The Pensions Regulator was clear that scale must be encouraged. It is critical to delivering value for money because it enables higher-quality governance and the economies of scale that can make a big difference when there is a lot of money under management. It also encourages a focus on the pooling of risk so that returns are greater; one can take more risk and hedge against it with a larger number of assets under management. That is something we discussed this morning.

The Committee does not have to my word for it, or that of other Opposition Members. In the pension world elsewhere, scale is seen as important. The most obvious examples are Canada and Australia, where we often look, not just for a Governor of the Bank of England, but for the governance of pension schemes. New Brunswick was mentioned in a different context. That ability to get scaled pension schemes can make a significant difference on a number of levels. First, it can provide economies of scale and, secondly, deal with the issue of finding high-quality trustees. If there are fewer schemes there is less need to find a large number of high-quality trustees.

Thirdly and importantly, Canada shows that if a scheme can get sufficient scale it can substantially reduce the intermediation that takes place through the investment chain. By intermediation I mean the middle men and women who handle a pension saver’s money—the pension fund money—through the investment phase. John Kay’s report for the Secretary of State for Business, Innovation and Skills was clear on the need to reduce intermediation.

Probably the best way to do that is to get pension schemes that are big enough to do a lot of their asset management in-house. That is something that Denmark and the Netherlands do very effectively. I recall a pensions observer famously writing on the wider topic of why Dutch fund houses were under pressure, saying that Dutch pension schemes do not like to pay high charges. That is something that we need to get to in the UK. Although the pension cap is welcome, the governance has to be right to drive down further to an appropriate overall level.

Photo of Richard Graham Richard Graham Conservative, Gloucester

The history of in-house asset management in UK pension schemes is by and large not a happy one. There are few examples of where it has successfully taken place and there is the well known example of the BT scheme, which created its own in-house manager, Hermes. Over time, the pension trustees increasingly outsourced the management to external asset managers precisely because the in-house operation was not good enough. The argument that in-house asset management is a way forward for pension schemes should be strongly discouraged.

Photo of Gregg McClymont Gregg McClymont Shadow Minister (Work and Pensions)

The hon. Gentleman makes an interesting point and produces one example. I am not sure that I agree entirely with him about the BT pension  scheme; I will have to look at that in more detail. Certainly, my sense is that Hermes has been a pretty successful fund manager.

Richard Graham rose—

Photo of Gregg McClymont Gregg McClymont Shadow Minister (Work and Pensions)

Let me make a bit of progress. Let us be clear about the evidence from elsewhere. The Danish system always talks about rankings and the quality of pension schemes, for a number of reasons. A big part of that is that intermediation—agents taking a cut through the investment chain—is much reduced because so much of it is done in-house. In Canada, there is now sufficient scale that they do not pay private equity houses and agents to buy chunks of private equity. They do it themselves. The Danes do that too. If the hon. Gentleman thinks that the level of intermediation—people taking cuts—is acceptable in the UK asset management world, he is going against the findings of the widely respected Kay report, which was delivered to his own Government not that long ago.

Photo of Richard Graham Richard Graham Conservative, Gloucester

I am sorry, but the hon. Gentleman is not on a good track here. The reason is fairly straightforward. Fees paid by pension schemes to in-house asset managers, or indeed by insurers to in-house investment managers, are by and large not less than those they would pay to external managers. In fact, quite often they are more expensive. Most important is the element of competition. Asset management mandates have to be won by open and fair tender and they should go to the best managers who put themselves forward. Where there is an easy slide of appointing an in-house asset manager, I am afraid there are many examples of inferior performance and poor results for pension scheme members.

I would put the challenge the other way: name a good example of a pension scheme in the UK where an asset manager has delivered outstanding results. Furthermore, the vast majority of pension schemes should not even be looking at private equity.

Photo of Gregg McClymont Gregg McClymont Shadow Minister (Work and Pensions)

The hon. Gentleman is competing with me for the lengthiest intervention in Committee, but I think I am still winning from last week. He often makes good points, but sometimes he proceeds by assertion. That was mostly assertion, although it might be that we are not talking about the same thing. The Kay report, which looked at this in detail and was from a widely acknowledged expert, was crystal clear that significant detriment to savers and investors came from intermediation in UK financial services.

Richard Graham rose—

Photo of Gregg McClymont Gregg McClymont Shadow Minister (Work and Pensions)

The hon. Gentleman can accept that or not. He appears not to accept it, which puts him at odds with the report that his own Government endorsed. He is never slow to make his point whether through assertion or evidence. Let us be clear what we are talking about here: the Kay report, delivered to the Business Secretary, is crystal clear that there is far too much intermediation. It talks about pension schemes, which are a massive part of that asset management industry. Of course they are. The way that most people are invested in the stock market is through their pension scheme. The idea that intermediation is in asset management only outside the pension funds seems rather odd.

Photo of Richard Graham Richard Graham Conservative, Gloucester

With all due respect to the hon. Gentleman, I worked in the pension sector for well over 10 years and he is making a number of assertions from a position of not necessarily great experience in the sector. Intermediation in the financial services sector as a whole is vastly different from jumping to the conclusion that just because a scheme is bigger it will necessarily be cheaper and better run and produce better results than a smaller scheme. There will be examples where that is so and examples where it is not so. There should be some economies of scale from bigger schemes. They might also be able to negotiate better deals and lower prices, but there is little evidence to suggest a widespread, generalised conclusion that big is always better and small always more expensive, producing worse outcomes. That is simply not the case.

Photo of Gregg McClymont Gregg McClymont Shadow Minister (Work and Pensions)

Again, the hon. Gentleman makes a series of assertions in the absence of producing any evidence whereas I, in contrast, am placing the Government’s own report on the table as evidence on behalf of our case. Let members of the Committee make up their minds about it. He is behind the curve, in so far as the advantages of scale are now widely recognised in the investment sphere. Just a moment ago, I quoted the editor of MoneyWeek, who said there are far too many actively managed funds, which tend to be smaller, and the tide of opinion and the investing of assets is moving rapidly towards large, passively managed investments. However, we will let the Committee make up its own mind about that; we can disagree. I put the Kay report on the table.

Photo of Debbie Abrahams Debbie Abrahams Labour, Oldham East and Saddleworth 3:15 pm, 4th November 2014

As we are talking about evidence, it might be appropriate to mention the Work and Pensions Committee, which looked at governance. One of the recommendations, based on all the evidence submitted to the Committee in 2012, including from the Minister, was the favouring and support of super-trusts.

Photo of Gregg McClymont Gregg McClymont Shadow Minister (Work and Pensions)

I thank my hon. Friend for making an important point. I do not want to be sidetracked but there is a general view—it is certainly repeated weekly in the pages of the Financial Times, Fund Management, where this kind of issue is widely discussed by members of the investment community—that scale matters. That does not mean that there will not be boutiques that do a good job, but generally speaking, as a principle, scale is now accepted as an important part of getting value for money in pensions.

The architect of the Australian reforms is clear that the Australians are more scaled than we are, but now they feel they are not scaled enough, relative to places such as Canada, because they are not able, with a mature book, to make the variety of investment decisions, in the hedging and the risk-taking, that is necessary. However, we can disagree on that point and come back to it in future.

Photo of Richard Graham Richard Graham Conservative, Gloucester

The important thing—it is why this debate matters—is that the new clause the hon. Gentleman is trying to add to the Bill effectively requires pension scheme trustees, first, to take a view on whether the scheme has sufficient scale to deliver good value and,  secondly, to require the Pensions Regulator to direct the merger of pension schemes where that would be in the interests of the members. The point is that it is not easy to establish whether it would be in the interests of members to have a merger. It is not an easy thing for the Pensions Regulator to do, nor is it an easy thing for the pension scheme trustees in the first place to do. There is no proof of these things. Every single merger and acquisition in corporate history has started from the assumption that by merging two entities the combined entity would necessarily be better, and there is a mass of evidence to show that many mergers and acquisitions have ended in disaster.

Photo of Gregg McClymont Gregg McClymont Shadow Minister (Work and Pensions)

If the hon. Gentleman wants to make a speech, he should do so. I will just say that I do not accept his argument; he has not produced evidence to that effect. I say to him again that the Kay report—produced by the commission set up by the Government and endorsed by the Business Secretary—takes a different view from him. If he disagrees with Kay and with me, that is perfectly legitimate, although I will leave it there for the moment.

To sum up, I say again that in our view and the view of the Pensions Regulator, which was set out in evidence last year, there has to be a scaling up of the UK pensions industry. At the moment, there are far too many schemes—200,000. Our new clause would not reduce that number to a handful by any means, but it would make a start, by giving the powers to trustees and the regulator to promote scale. It is something the Australians have already undertaken, as they move to scale their auto-enrolment system, which we have learned so much from. It would be a sensible addition to the powers that trustees and regulators have, given the widespread consensus in the pensions world that scaling up will have to happen.

Photo of Steve Webb Steve Webb The Minister of State, Department for Work and Pensions

It is a pleasure to respond to someone else’s new clause for a change. Oddly enough, my little note has that word, “reject”, on it, for reasons I will explain.

Let me start with a point of agreement. Clearly, other things being equal, there are potential advantages to scale, but the hon. Gentleman talks as if scaling up is not happening. My first observation is that considerable consolidation is happening. “Organic” is probably not the right word, because we do a lot of intervening in the market, but substantial consolidation is happening. Scheme trustees and employers are deciding in certain circumstances that it would be better to be part of something bigger, and they are closing down existing schemes and merging and so forth.

To give a sense of the consolidation that is going on and the number of people who are actually in large schemes, in 2013 more than half of active members of private sector occupational defined-contribution schemes were in schemes with more than 10,000 members. The hon. Gentleman suggested—he did not say this exactly, but one might have inferred it from the tenor of his remarks—that lots of people are in tiny little schemes. More than half of all people in that type of scheme are in schemes with more than 10,000 members, so that is 700,000 out of 1.2 million active members. At the start  of this century, in 2000, the figure was only 100,000 out of a total of 800,000, so there is a clear trend towards consolidation. Active members in small and medium private sector DC schemes have decreased from 300,000 over the same period to 100,000, people are heading towards the larger schemes.

The numbers show that schemes are consolidating. In the past four years alone, the number of small and medium occupational DC schemes fell by more than 40%, from 3,300 to 1,950. The number of micros fell by 10,000, from around 45,000 to around 35,000, and the number of large schemes remained relatively stable, so consolidation is happening, which is an entirely good thing. Schemes proactively look at what they are doing and work out whether they could do things better. The hon. Gentleman goes much further than that. He proposes that we force the process, and that is where we have concerns.

Forcing scale does not automatically drive good governance, investment expertise or low costs. We are already driving up standards and making sure schemes are run at the right scale through our governance requirements and our charge cap. A scheme that is too small to deliver a default fund for less than 0.75% cannot be used for auto-enrolment. I often think that the hon. Gentleman’s contributions are slightly stuck in a time warp of pre-auto-enrolment, pre-charge cap and pre-governance. He is legislating for the future, not the past—or he should be. The 0.75% charge cap is a pretty tough test. If someone is running a sub-scale small scheme that cannot deliver, they will not be able to use it. We are making sure that the inefficient, badly governed small scheme cannot continue, but the efficient, well governed one can. Again, it is the blunderbuss approach against the subtle approach. It is going with organic consolidation, rather than forcing the pace; it is the heavy hand of regulation against the nimble, light-footed regulation that we are so famous for.

We argue that consolidation and scale have their place, but we object to forcing the pace. Agreeing with what sufficient scale means and policing it would be very difficult. My hon. Friend the Member for Gloucester made a powerful point. The new clause would require the regulator to force schemes to merge where the regulator thought they were not of sufficient scale, but merge with whom? How does the regulator look at the tens of thousands of schemes and spot one that is sub-scale? How do they force it to merge with another scheme that will probably have another set of trustees, who might not want to be merged?

Photo of Richard Graham Richard Graham Conservative, Gloucester

The Minister is absolutely right. Even the Reverend Moon in Korea has not gone into the game of actually finding marriage partners for the many thousands of people he obliges to marry.

Photo of Steve Webb Steve Webb The Minister of State, Department for Work and Pensions

I am grateful to my hon. Friend for his ever colourful analogies, which did not appear in my briefing pack. He is quite right: the idea that we have forced marriages, to extend his metaphor, but I will not take it too far—we might call them shotgun weddings—does not seem the right approach to regulation. There is a danger in confusing means and ends. The hon. Member for Cumbernauld, Kilsyth and Kirkintilloch East is focused on the means: scale is good, so we have to make things big. We are focused on the ends: we want good  quality, low-cost, well governed schemes; we are requiring schemes to be all those things. They might do it and be small, and that enables them to be bespoke.

Perhaps a firm would want a relatively small scheme, bespoke and tailored to the needs of their particular employees. The hon. Gentleman might say no to that, because the regulator might say they have to marry somebody else, because they are not big enough and they do not approve; but, beyond the limits of auto-enrolment, occupational pension provision is voluntary. Firms do not have to do such things at all, beyond the legal minimum, so where they do, they often do it for a reason. They provide schemes to meet the needs of their employees, and it seems to us that they should have the freedom, within the constraints of value for money, governance and costs, to do so at an appropriate scale. The regime we are putting in place is leading to consolidation and will do so further, and we welcome that. We do not believe it is right to force consolidation on unwilling schemes that are delivering value for money, governance and cost.

Photo of Gregg McClymont Gregg McClymont Shadow Minister (Work and Pensions)

The Minister has a tendency to draw caricature dividing lines. I also noticed that after saying that “organic” was not the right word, he lapsed back into saying it. That reflects a tension in the Minister’s mind. He again tries to paint a very black scenario. Why should the regulator be given the power to force schemes to merge? Well, in many other areas of pensions policy the Minister is giving the regulators more powers. As I understand it, he has previously agreed that scale matters. He now says that, all things being equal, scaling up could be the right thing to do. I did not quite catch his last words. He again lapsed into the use of “organic”, which does not seem to meet the argument.

Let us not overestimate the disagreement, as I think the Minister does. Our view is that it is perfectly sensible to give the Pensions Regulator the power to force mergers of pension schemes where in the regulator’s opinion they are too small to give value for money. That is not a revolutionary proposal. In the Minister’s desire to create a bigger divide between us, he is caricaturing the position. Giving trustees the power under their fiduciary duty to consider whether their scheme is large enough to get value for money seems a sensible move. If the Pensions Regulator thinks there are small schemes that cannot get value for money and takes the view that they should merge, we do not see that as a doomsday scenario. In fact, it is to the benefit of those who matter, the scheme members.

This debate comes down to a difference on the importance of scale. The Minister does not see scale as being as important as we do. He also argues that scale is emerging organically. Let us be clear: there are 200,000 pension schemes in the UK. There is no other system in the world with that level of fragmentation. Pension provision is not a cottage industry. There are some industries where it makes sense to proceed on a cottage basis. The Minister also lapsed into using the word “bespoke”. When I hear the word “bespoke” my ears prick up. It is one of those adjectives that people use when they want to make a certain sort of argument.

Our view, which is supported by the evidence, is that this is not a cottage industry. We think the Government and the Minister should recognise that and not be a little complacent about the moves towards scale. Our  new clause would be a sensible addition to the Bill. However, given the discussions that are still to take place and the serried ranks of Government Members, I beg to ask leave to withdraw the motion.

Clause, by leave, withdrawn.