European Funds Comment: Unlocking UK Pension Fund Money for Private Equity

23 November 2018
Issue 58

The UK government’s policy towards private equity and venture capital could, at times, be characterised as schizophrenic. For instance, in 2017 it finally responded to industry requests to update the UK’s main private fund vehicle, the limited partnership, with a helpful package of reforms. Unfortunately, the government also simultaneously announced a consultation on some unhelpful limited partnership law reforms (consideration of which is still ongoing). And, whilst apparently wanting to pursue policies that enhance the UK’s position “as a centre for asset management”, its implementation of tax rules does not always support that stated objective – and sometimes undermines it.

But such a characterisation would, perhaps, be too harsh. The UK government does have an active dialogue with the industry and has been looking for ways to stimulate investment – especially where the ultimate recipients of the investment are “innovative, high-growth companies”. Progress is somewhat slower than the industry would like, but perhaps the distractions of Brexit could be blamed for that, and the ongoing Patient Capital Review could well lead to some helpful changes.

An update on that project was published last month, and much of the focus was on removing any barriers to pension funds investing in “patient capital”. Although UK-based pension funds do already invest in European private equity and venture capital funds – around €1.85 billion in 2017, according to Invest Europe figures – there is undoubtedly scope to increase allocations. And the rapid growth in defined contribution schemes – expected to have over £1 trillion of assets under management by 2025 – certainly presents an opportunity, but a challenging one. Against that backdrop, the UK government is keen to look again at various regulations, as well as ways in which its own delivery arm, the British Business Bank, can work with others to facilitate pooled investments.

Various clarifications of trustee duties – including guidance issued last month – have made it abundantly clear that long-term investments can make suitable investments for pension funds as part of a diversified strategy that takes proper account of liquidity requirements. But there are some more specific barriers. For example, the cap on fees imposed on default defined contribution schemes of 75 basis points automatically rules out most alternative investment funds, and encourages funds to invest in more passive strategies. Not only could that default rule dampen net risk-adjusted returns, but it is not compatible with policies that seek to encourage more responsible and active investment. Worse still, inclusion of performance fees within that cap is a further barrier to a model which seeks to align upside rewards between managers and investors. The government has confirmed that it will, at least, review that latter issue (although the charge cap on default schemes looks set to remain in place for the time being).

But perhaps more promisingly, the government is looking hard at how it could establish a pooled investment vehicle for patient capital investments. Building on a recommendation of the expert group that looked at these questions last year, the government wants to establish a pooled vehicle to facilitate investments by smaller pension funds into a larger and more diversified pot. Some funds of funds already offer something similar, but the idea is that a larger scale vehicle could drive down costs and increase diversification. The government’s recent update says that several of the largest defined contribution pension providers in the UK have committed to explore options. This group, chaired by the British Business Bank, is undertaking a feasibility study in collaboration with the wider pensions industry “with the aim of establishing a design for pensions investment in patient capital and other forms of finance for innovative, growing companies”.

The government’s update also details various other welcome projects to facilitate investment in the businesses of the future. These include wider changes to the pensions market to facilitate greater consolidation of assets to enable more investment in longer-term assets, the launch of British Patient Capital as a commercial subsidiary of the British Business Bank with resources of £2.5 billion to invest in venture and growth capital funds, and other funds programmes, including one specifically aimed at investment in advanced technologies.

The catalogue of initiatives being actively progressed or under consideration is impressive and demonstrates a clear will to support the sector, as well as an active engagement with the BVCA and investment firms. Sometimes the detail of policies delivered falls short of these stated aspirations, and progress is slower than many would like, but it would be churlish not to commend the government for the progress made so far and its laudable aims for the future.