Investment regulations: an obstacle to greater private asset allocations by pension schemes?

In this latest blog on the Government’s Mansion House reforms, we consider regulatory restrictions on pension scheme investment and what they mean for the Government’s agenda. So, what are the implications for the recently announced Manion House Accord and the new Pension Schemes Bill? 

Alongside trustees’ fiduciary duties (more on which you can read in our previous blog post), trustees of pension schemes are also subject to regulations that restrict how they invest. Among other things, these mean that trustees must: 

• Invest in the best interest of members and beneficiaries.
• Invest in assets that “consist predominately of investments admitted to trading on regulated markets”.
• Keep those assets which are not admitted on such markets to a “prudent” level.

Regarding the first point, it should be noted that scheme sponsoring employers are not included as part of the “members and beneficiaries” class. What this means is that the regulations disregard any interest that a sponsoring employer may have in surplus generation and greater risk tolerance. 

The second and third points present a different challenge. With “predominantly” and “prudently” subject to interpretation, trustees have every reason to be cautious and err on the side of less private equity, infrastructure investments and the like. Arguably, this could mean less investment in assets than would be in the best interest of members and beneficiaries.

So, how could the Government reassure trustees and help them invest in more assets off regulated markets? One way could be to remove or clarify restrictions on investment characteristics. Removal may sound drastic, but trustees must already take investment advice and are subject to fiduciary duties, which together provide a significant but flexible degree of legal control on scheme investments. 

What would a landscape without such restrictions look like? Australia shows what may be possible. Of the c. AUD 4.2 trillion of Australian pension assets in 2024, AUD 500 billion was invested in unlisted assets such as property, infrastructure, private credit and private equity, with amounts expected to grow significantly. Australian policymakers see pensions as playing a key role in funding Australian infrastructure. 

However, a word of caution may be in order. Higher returns often mean higher risk. Take a look at Australian investments. One scheme holds stakes in UK airports such as Heathrow, Birmingham, and Bristol; another owns infrastructure assets, such as toll roads, in 30 US states; and a third has added the Canada Water urban regeneration project and data centres to its UK portfolio. These are not just illiquid but are also often subject to regulatory conditions and priorities abroad, and these risks are difficult to price. Australians are relying on an increasingly complex set of assets for their retirements. 

There is little immediate risk in the UK; the Mansion House Accord is only a first step towards greater private asset allocations. At some stage, if it wishes to take a second step, the Government may need to consider whether current investment regulations are in fact an obstacle in their path.

But what about the new Pension Schemes Bill? One of its most notable provisions (and in the eyes of many, controversial) is a power to make auto-enrolment status for DC master trusts and group personal pension schemes dependent on meeting asset allocation requirements. The legislation explicitly targets private equity, private debt, venture capital and land and gives scope to discriminate in favour of British assets and assets linked to economic activity in the UK.

Although failure to comply would lead to the severest of consequences for a master trust, as a condition for being an auto-enrolment scheme it is not truly a “mandate”. It certainly would not override trustee obligations under the investment regulations, so trustees could find themselves caught between a rock and a hard place. Interestingly, the legislation floats the possibility of pension schemes applying for exemptions on the grounds of savers’ interests. Even if the “mandate” power (as currently drafted) were used, the investment regulations may still prove a complication. 

For more resources on Mansion House, please visit the Pensions Hub.

Many thanks to Matthew Greenhill for his help in preparing this post.