This article is a brief update on the one in the previous edition, Challenging times for UK institutional capital. Even before the change of government in July, UK institutional capital had been undergoing a period of dramatic change. The incoming Labour government arrived with a clear manifesto commitment to further institutional reform, a key component of which is increasing investment in illiquid assets.

This took a major step forward when Rachel Reeves, the UK Chancellor of the Exchequer, delivered her first Mansion House speech on the evening of Thursday 14th November 2024. A key area that she covered was the next phase of UK pension reform. To coincide with the speech, HM Treasury (HMT) and the Department of Work and Pensions (DWP) published their Pensions Investment Review: interim report, consultations and evidence.

The package of documents focussed on two broad areas, reform of the Local Government Pension Scheme (LGPS) in England and Wales and reform of Defined Contribution (DC) pension schemes.

Reform of the LGPS

The package of documents includes a consultation on proposed changes to the LGPS. The three aspects are:

Accelerating LGPS pooling

The 86 administering authorities for the LGPS have already combined, at least theoretically, into eight pools. Progress in actual pooling has been patchy and the consultation conveys the new government’s sense of disappointment. The proposals are not a doctrinal change from the reforms initiated by the previous regime, but a call for more vigorous flogging of the recalcitrants. Although this is set out as a consultation, the government view on each aspect is made clear, and the ultimate objective is for the investment process to sit with the pools. The LGPS will remain major investors in real estate as an asset class, but the way in which they invest will continue to evolve, with more expertise being hired in-house. This will represent a major challenge to the marzipan layer of consultants and multi-managers that currently sit between them and the ultimate investments.

Local investment

This has the potential to be the most controversial area, although at present the detail of how this will operate has yet to be published. The government want to encourage local investment by the LGPS. The local schemes will need to work with the pools and local authorities to identify suitable local investments. It is important not to lose sight of the overriding fiduciary duty to the members of the scheme, rather than to the infrastructure priorities of local politicians. The consultation recognises the potential challenges and seeks to move the. investment process and ultimate decision away from the individual schemes to the pools.

The government proposes to set out new requirements in regulations, so it remains to be seen to see how prescriptive these will be. It should create opportunities for investment in real estate, particularly for housing and regeneration and for investments that align closely with the government’s industrial strategy, for example in data centres and life sciences.

Governance reform

The government wants improved governance at the local scheme and pool level. It is hard to argue with this as a concept. We await the practical detail.

Reform of DC

As we covered in the previous article, the most significant change in UK institutional capital is the transition from defined benefit (DB) to defined contribution (DC) pension provision. UK corporate DB pension provision has been waning for decades. The long-term decline was accelerated by the Liz Truss mini-budget in September 2022. Although it had taken them over a decade to get there, the previous government had finally made progress before departure in creating a new legislative framework for DC pension investment that should improve outcomes for policyholders and facilitate deployment of capital into illiquid assets including real estate.

There is general consensus for the need for scale and consolidation in DC schemes. The report makes it clear that the government sees this applying to a lot more than just the smallest schemes. This is also particularly important for real estate as an asset class as it is easier for larger schemes to have an allocation to illiquid assets.

A key objective of the Pensions Investment Review is to promote a greater focus on the value provided by workplace DC pension funds rather than their cost. The move to a focus on Value for Money (VFM) has been a work-in-progress for several years. The framework is to be included in the forthcoming Pension Schemes Bill. This is an important step for investment in real estate and other illiquid assets that are relatively costly to manage.

There is an elephant in the room. Significant practical obstacles to investment in illiquid assets by DC schemes, particularly the role of the platforms, remain unsolved. Much of the market is not set up to accommodate funds with notice periods. This is a problem for investment in underlying funds investing in illiquid assets. This is not addressed in the consultation. It is not clear when and how the government plans to address this.

There is also a role for the real estate industry in educating those running DC schemes on the long-term merits of investment in real estate as an asset class and how this might be effected in practice. The Association of Real Estate Funds and the Investment Property Forum are currently working on plans for this.

Conclusion

There is nothing fundamentally new in the proposals. For both the LGPS and DC schemes, the new government seeks to increase the pace of implementation of steps initiated by the previous government. The detail will be in legislation and other proposals that are yet to be published. The elephant is still very much in the room with respect to practical implementation, particularly for DC.