Consolidation from Consolidation

‘The UK has been regulating for risk, but not regulating for growth’, post-2008 financial regulations have ‘gone too far’, said the Labour Chancellor. Yes, indeed. 

It seems the government is not totally committed to economic masochism. On City regulation at least - a sector responsible for 10% of tax receipts and employing 1.1 million people - it is moving in the right direction. Vowing to rip up red tape and build on existing Mansion House reforms is a welcome relief from the policy churn present elsewhere in government. 

The consolidation of the UK’s 86 local government pension schemes, comprising assets of £354 billion, into 8 ‘mega-funds’ is a good move for British pensioners and British growth. Bigger, agglomerated funds will be able to invest in a wider range of assets, benefit from lower per unit costs and attract top management talent. Importantly, pooled pension pots will have the necessary scale to invest more in infrastructure. This is demonstrated by Canada’s single fund for public sector pensions, the Canada Pension Plan Investment Board, which invests 4 times more in infrastructure than the UK’s defined contribution schemes. 

Given the UK’s significant infrastructural deficit, such investment is sorely needed. EY estimates that private sector investment in infrastructure would need to double over the next 15 years in order to meet a projected £1.6 trillion funding shortfall by 2040. This is vital for the UK’s social, energy, and defence objectives as well as increasing labour mobility and reaping the resulting productivity gains. 

Loosened fiscal rules means more taxpayer money for infrastructure, but also more crowding out (gilt yields climbed from 3.75% to 4.41% between mid-September and Budget day) and a heightened risk of government waste. Look no further than the previous governments attempts to revive battery manufacturing in Northumberland. Despite a significant injection of government funds, the BritishVolt factory in Northumberland collapsed into administration with the majority of its 232 staff made redundant. Private sector investment, in a free market, is clearly preferable.  

But reorganising pension funds won’t lead to more investment in infrastructure unless infrastructure is actually ‘investable’. The UK doesn’t exactly have a brilliant record of delivering infrastructure in a timely or cost-efficient way. Remember HS2? 

The projected cost of the Phase One Line from London to the West Midlands increased from £30bn to £59.7bn in 2022/23 (accounting for inflation!) and is still under construction. Supply side reforms to the planning system are a big part of the answer, enabling meaningful returns to be realised from such investments. 

To her credit, the Chancellor has (for now) avoided the temptation to mix objectives: seeking both to maximise pensioner returns and compel domestic investment. The attraction is undeniable – numerous delistings and long-term LSE stagnation has left the entire FTSE 100 smaller than a single American company, Apple, meanwhile just 4.4% of UK pension assets are held in our own equities (compared to a 10.1% global average). More investment here would obviously be welcome, but compulsion is no substitute for competitiveness. Given the state pension could become financially unsustainable in just 10 years (as our paper Up in Flames: The State Pension by 2035 highlights), it’s important that funds are seeking to maximise returns, without being constrained by geography. 

The government meanwhile could set about dismantling the many self-imposed disincentives on inward investment. 

Funds plucky enough to buy British equities are hit with a 0.5% stamp duty levy, in contrast to a 0.3% fee on French equities, a 0% fee on Japanese equities, or the miniscule 0.002% transaction cost on American shares. More broadly, overhaul of the obscene levels of tax and regulatory burdens facing UK companies might make them attractive for overseas and domestic investors again. Needless to say, the Chancellor’s budget, hiking costs for businesses on hiring workers, raising capital gains tax, went the other way.

Culturally, there is much need to redress the increasingly risk averse culture among British investors, which leans towards old legacy industries such as oil and mining at the expense of dynamic tech and AI firms. Funds have also shifted to low-risk debt instruments, with the portion of Defined Benefit pension plans invested in bonds having more than doubled since 1997 and now comprising the majority of their £1.4tn asset portfolios. The small size of existing funds also limits their ability to invest in high return venture capital and life sciences.  

Figure 1: The increase in bonds as a percentage of British pension scheme holdings 1997 to 2021 (Jeremy Hunt’s ‘Mansion House reforms’ seek to channel pension savings into unlisted firms- The Financial Times) 

In an era of ‘predictable volatility’, where market volatility is the norm, the renewed emphasis by politicians and regulators on sector (not regulation) growth is a prerequisite to ensure the City remains globally competitive. The government’s querying of FCA proposals to more aggressively ‘name and shame’ firms investigated for misconduct, plans to ease the financial services redress regime and the shortening of the deferral period by 3-years for bankers bonuses, suggests this is not merely rhetorical. The FCA, with its new ‘mandate for growth’, is also considering adjustments to bank capital requirements for smaller lenders to increase contestability and boost investment. 

16-years on from the financial crisis, a growth-oriented agenda may at last triumph over ideological bank-bashing by the left. Awareness that in a post-Brexit context, with the benefits of passporting and free movement consigned to history, financial services deregulation isn’t just ideal but essential, does not seem to have eluded even them.