Pension schemes need more carrot and less stick to back the UK
The Pensions Scheme Bill currently going through parliament will empower the government to tell pension schemes where to invest. But telling always ends badly, writes Richard Stone
If you want someone to do something do you tell them, or incentivise them? Having raised two teenagers I know ‘telling’ often has a counterproductive effect, but ‘incentives’ can be very powerful.
The government believes that pension schemes are not investing enough in UK equities, private assets, infrastructure and other investments that would help drive growth. So it would like them to invest more.
It is true that UK pension funds lag most international comparators in terms of the amount invested domestically or in private assets. For a government that is desperate to drive growth, the sizeable and growing pension pots of millions of UK workers provide an attractive source of potential capital.
Most of these workers invest passively through their workplace scheme, the majority into default funds, which invest in global equities and bonds. Few of them will be watching the passage of the Pension Schemes Bill currently before parliament which will give the government the powers, in certain circumstances, to tell trustees where some of our pension pots should be invested.
Interventionist pensions policy crosses a line
But telling schemes what to do crosses a critical line. Pension trustees are tasked with acting in the best interests of the beneficiaries of their schemes. That fiduciary duty will be shot through if they are forced to invest in certain assets against their better judgement.
It is unsurprising that many in the pensions industry, and more widely, have kicked against this. The mandation powers were struck out of the Bill by the House of Lords. The government has reintroduced them and parliamentary ping pong looks set to ensue from today. But surely the government is missing a trick – one that could also have a financial upside for the public purse.
It is true that the UK lags behind in terms of the amount invested domestically. But the government could learn from places like Australia which are leading the way in terms of pension savings, have large superannuation schemes and a more engaged public.
Rather than telling, I believe government would achieve far more by incentivising, as Australia and other countries do. Incentivise the trustees to make a different decision rather than tell them. Incentivise the trustees to favour UK equities and private assets.
Incentives proven to work
Unlike mandation, incentives do not undermine the independent role of pension trustees. If they choose to invest more in UK markets or private assets, it will be because it is in the interests of their beneficiaries.
One possible way to achieve this would be to use the tax system. For example, the government could tax dividends received from foreign investments and funds without a sufficiently high UK weighting. Differentiating the tax treatment of dividends to favour domestic investment works in Australia where it is done through tax credits on domestic dividends. Levying a charge on foreign dividends would encourage trustees to invest domestically by improving the relative return on domestic investments. As an added bonus, a tax charge on foreign dividends could also be a revenue raiser at a time when the public finances are stretched.
Others will no doubt be able to think of different or more effective incentives the government could employ. Leaving the details aside, using the tax system to nudge trustees into making different decisions is far preferable to government turning itself into the nation’s pension asset manager.
The government should incentivise, not compel. It should withdraw its mandation proposals and instead look at ways it can encourage the behaviour it is seeking. This would be more likely to achieve the desired result without undermining the fiduciary principle that lies at the heart of our pension system.
Richard Stone is chief executive of the Association of Investment Companies (AIC)