The previous government had been slowly moving forward its proposals for over a decade, before the Liz Truss mini-budget in September 2022 inadvertently accelerated the decline of corporate DB schemes, prompting a renewed sense of urgency in the Rishi Sunak era. The incoming Labour government has picked up its predecessor’s proposals and accelerated implementation, after having arrived with a clear manifesto commitment to further institutional reform, a key component of which is increasing investment in illiquid assets.

The most significant element is the DB to defined contribution (DC) pension transition, on which we have now had four consultations since the summer, often with very short deadlines to respond. These have now been reflected in policy proposals, covered at the end of this article. DB schemes are de-risking, heading into run-off and transferring liabilities into the insurance bulk annuity market. This has a number of important impacts:

• As mentioned above, DB pension investment has historically been a mainstay of UK institutional real estate investment. Many schemes are now selling their direct real estate and interests in funds. Open-ended funds with a large exposure to corporate DB schemes have seen very significant redemptions and UK corporate DB schemes can be pretty much ruled out as a source of capital for new real estate investment. As DB declines, it is slowly being replaced by DC pension provision. 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. Four aspects are key:
• Consolidation of smaller schemes. There is a recognition that many are sub-scale and too inefficient to run DC schemes.
• The introduction of a “Value for Money” framework to focus more on policyholder outcomes and less on simply controlling the level of management fees. Historically, DC schemes have been beset by knowing, in the words of Oscar Wilde, “the price of everything and the value of nothing". This is important for real estate and other illiquid assets that are relatively costly to manage compared to, for example, an index tracker.
• The development of regulation to allow collective defined contribution (CDC) pension schemes in the UK. The legislation was developed specifically for the Royal Mail, and the Royal Mail Collective Pension Plan (RMCPP) received approval from The Pensions Regulator (TPR) in April last year. The Royal Mail scheme launched in October. We believe that the development of CDC is a significant step forward and should facilitate investment in illiquid assets. This is because, in CDC schemes, investments are pooled across all policy holders. The investment horizon of a CDC scheme can be longer than the lifetime of individual policy-holders. The big step forward will come with the introduction of multi-employer schemes, providing an alternative to the Master Trust route for pooling the investments and achieving scale for DC. Immediately after the Royal Mail announcement, the Department of Work and Pensions (DWP) published its detailed consultation, including draft legislation. This runs until 19 November.
• The introduction of the Long-Term Asset Fund (LTAF), which has been introduced specifically to facilitate investment by DC default funds in illiquid assets. The first few LTAFs have been launched but, at this point, take up is very limited as practical and operational matters need to be resolved. We covered the LTAF in an ICAEW Construction & Real Estate Community webinar in April, New UK real estate fund vehicles. This webinar also covered another new fund vehicle suitable for investing in real estate, the Reserved Investor Fund (RIF). The final details of this are awaited but in the Budget there was a commitment that the secondary legislation to implement it will be brought forward before the end of the tax year.
• Not all DB schemes are heading straight for the exit. What happens to current surpluses in DB schemes that may continue? This was covered in a Department of Work and Pensions (DWP) consultation that closed in April. The Association of Real Estate Funds (AREF) in its response suggested that an approach that would enable sponsors ultimately to benefit from surpluses whilst also encouraging investment in the real economy and providing scheme members with a greater buffer against market volatility, would allow partial withdrawal of surpluses on an ongoing basis spread over time funded by investing current surpluses in higher returning illiquid assets, including real estate. The outcome of this consultation is awaited and will no doubt be picked up in the new government’s broader pension review.
• When schemes transfer assets and liabilities into the insurance bulk annuity market, some of the investment may be in real estate but, for regulatory reasons, there are significant differences to investment by the DB schemes themselves. Insurers benefit from a much better capital requirement treatment if they use investments that fall within the Solvency II Matching Adjustment (MA) rules to match the liabilities that they have been acquiring. Shortly after the LDI crisis in 2022, it was announced that the rules would change such that assets that can be included in the MA are those with returns that are “highly predictable” rather than “fixed”. This came into effect on 30 June this year. This theoretically significant change in the MA rules is undermined by a large number of restrictions added by the regulator and we are therefore sceptical that this will make much of a difference in practice.

Reform of DC pension provision and the Local Government Pension Scheme were key topics in the recent Mansion House Speech. 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. We have prepared a summary, which you can find here:

• UK pension reform post Mansion House speech