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LATEST REGULATORY DEVELOPMENTS IMPACTING
THE FINANCIAL SERVICES INDUSTRY

UK Government to Modify Default Fund Charge Cap for Defined Contribution

Kwasi Kwarteng, the Chancellor of the Exchequer of the new UK government led by Prime Minister Liz Truss, presented his “Growth Plan 2022” to Parliament on 23 September 2022. The Growth Plan 2022 outlines the UK government’s plans to tackle inflation, the cost of living, and energy crises and expand the supply side of the economy. In particular, the chancellor announced new measures to unlock investment by UK pensions schemes in private assets.

Reform of the Pensions Regulatory Charge Cap

The Chancellor confirmed plans to remove “well-designed performance fees” (yet to be defined clearly) from the charge cap or ceiling applying to default funds of defined contribution (DC) pension schemes and introduced in 2015. The charge cap prevents pension providers from charging those who have been auto enrolled into pension scheme default funds more than 0.75% of the fund annually. However, fund managers charged with raising capital for and managing investment funds that invest in private equity and other illiquid asset classes routinely charge profit-based performance fees known as carried interest, which can be as high as 20% and are difficult to accommodate within the charge cap. This creates a barrier to investment by DC pension schemes in the private asset sector, thereby depriving pensions savers of exposure to the sector despite the strong returns private equity in particular has generated over the past 25 years. In late 2021, the government described this method of calculating the fees as “the largest barrier to trustees of DC schemes investing in long term, illiquid assets.”

In the words of the UK government, the reform will give DC pension schemes “the clarity and flexibility to invest in the UK’s most innovative businesses and productive assets creating opportunities to deliver higher returns for savers.” The government considers that removing this cap will ensure that pension savers benefit from higher potential returns achieved by private equity and make it easier for pension funds to invest not only in private equity, but also in UK infrastructure. The chancellor’s pledge to modify the charge cap delivers on the promise first made by the predecessor government in former Chancellor Rishi Sunak’s 2021 autumn budget.

This development opens up the opportunity for private equity and other private asset managers to offer products to DC pension schemes which have hitherto been inaccessible to such investors, broadening distribution opportunities for such managers.

Incentives for Tech Investment and R&D

In a further attempt to catalyze investment from pensions schemes, the government also announced in its Growth Plan an initiative to launch the Long-term Investment for Technology & Science (LIFTS) competition, which will provide up to £500 million ($548 million) to support new innovative funds and attract billions of additional pounds into UK science and technology businesses. With an ultimate aim to allocate funds in 2023, the government has called for “promising fund structures and vehicles” to apply for the competition.  

UK Long-Term Asset Fund

In November 2021, the UK Financial Conduct Authority (FCA) brought into force its new regime for UK FCA-authorized long-term asset funds (LTAF) with a specific view to facilitate investment in long-term, illiquid assets, including private equity, venture capital, private debt, real-estate, and infrastructure. This vehicle is available not only to qualifying retail investors, but also to institutions. The modification of the charge cap will facilitate investment in LTAFs by DC pension schemes and help secure their market success as a new type of FCA-authorized fund.

More generally, the chancellor also announced that the financial services sector will be at the heart of the government’s new program for driving growth across the whole economy and its plans to bring forward an ambitious deregulatory package “to unleash the potential of the UK financial services sector.” This will include the government’s plan for repealing EU law for financial services and replacing it with rules bespoke to the United Kingdom, and scrapping EU rules from Solvency II to free up billions of pounds for investment.