DC Pension Schemes’ Access to Private Capital Funds

With defined benefit pension schemes increasingly closing to new members, the BVCA has been working for a number of years on making it easier for UK defined contribution pension schemes (whose combined AUM is expected to top £1tn by 2030) to invest into private capital funds. Three policy developments have brought this goal closer to being realised.
 

Productive Finance Working Group

The Productive Finance Working Group (“PFWG”) is a Bank of England, FCA and HM Treasury sponsored industry forum that was created in late 2020 to identify practical steps towards addressing the barriers preventing certain types of investors, particularly UK DC pension schemes, from investing in illiquid (or ‘productive’) assets like private capital funds.

The BVCA is a member of the PFWG, alongside other leading industry associations, including the Alternative Investment Management Association (AIMA), the Association of British Insurers (ABI), the Association of Investment Companies (AIC), the Investment Association (IA) and the Pensions and Lifetime Savings Association (PLSA). The group also comprises around 20 large DC pension schemes, investment managers and consultants.

The PFWG, with input from the BVCA and all of the above, has produced two important documents: ‘Recommendations’ to industry and policymakers, that were cited by the Government in its decision to revisit the inclusion of carried interest and performance fees within the DC charge cap rules; and more recently, a detailed set of guides to the key considerations for DC schemes that are considering investing in illiquid assets such as private capital funds. These are available below:
 

PFWG Guides: Investing in Illiquid Assets: Key Considerations

'Investing in Less Liquid Assets: Key Considerations’, published in November 2022, is intended to give DC pension fund trustees, their sponsoring employers and their investment consultants the tools to consider investing in assets such as venture capital, private equity, private credit, real estate, and infrastructure, where appropriate and in scheme members’ best interests.

We believe the guides offer a useful perspective for BVCA member firms wishing to deepen their understanding of the key considerations and risks that DC schemes face when investing in illiquid asset funds. They cover the following key issues related to investment in illiquid assets within default arrangements:

• Value for money: To help shift the focus from minimising cost to a more holistic value assessment, the guide outlines a process for assessing value for members from investing in less liquid assets and provides case studies on how that could work in practice for different types of DC schemes.
• Performance fees: To help DC schemes select, negotiate and co-create performance fee structures that could meet their members’ needs, the guide sets out key principles and maps them to specific features of performance fees to highlight their implications for DC schemes.
• Liquidity management: To support robust liquidity management and give DC scheme decision makers the necessary tools, the guide outlines how DC schemes can meet the liquidity needs of their members, while investing in less liquid assets, by managing liquidity at two levels – the DC scheme and underlying fund levels.
• Fund structures for less liquid assets: To help DC schemes select a route for investing in less liquid assets that meets their specific needs, the guide overviews the key features and considerations around the fund structures potentially available to UK DC schemes.
• Legal guide to the Long Term Asset Fund (LTAF): To help DC scheme decision makers become more familiar with the LTAF as a new fund structure, the guide highlights the key features of the LTAF, including its legal structure and a summary of the key terms.
• Due diligence: To facilitate high standards around investment in less liquid assets, this guide highlights the key considerations around due diligence on the investment managers and products.

To support implementation in practice, investment and employee-benefit consultants have also published a joint commitment to shift the focus from cost to value when advising DC decision makers, and a call to action for DC investment platforms to evolve their processes and systems.

PFWG Roadmap and recommendations

In September 2021, the PFWG published a report entitled “A Roadmap for Increasing Productive Finance Investment”. Several of the Roadmap’s recommendations are now being taking forward via a number of ongoing PFWG industry workstreams. The BVCA remains particularly engaged in this continuing work as it relates to liquidity management, performance fees and raising awareness about investing into the asset class.

The BVCA has previously participated in HMT’s pensions taskforce which had looked into this issue as part of the Patient Capital Review.

Changes to the charge cap for DC schemes

A critical barrier preventing DC schemes from accessing private capital funds was, until recently, a regulatory requirement for them to include carried interest when calculating whether the costs and charges attached to their investments are below the mandatory charge cap of 0.75% for default/auto-enrolment arrangements (for a fuller explanation of how the charge cap presents a barrier to DC investment in PE/VC funds please see our May 2021 Technical Bulletin below).

The BVCA continued to make the case, in the PFWG, to the FCA, HMT and DWP, and through various political channels (including the Taskforce on Innovation, Growth and Regulatory Reform), that appropriately designed profit-share arrangements, like carried interest and certain performance fee structures, contain inherent protections for DC pension savers as they are only paid when there is strong performance over the long term for investors. We repeated our belief that these incentive structures are consistent with the policy objective of the charge cap, and as such could safely be excluded from the cap’s calculation methodology. DWP consulted in Q4 2022 on removing “well-designed” performance fees from the charge cap. The BVCA response, which supported the Government’s principles-based approach but suggested drafting amendments to clarify that carried interest and funds of funds should be covered by the exemption, is available below.

Our suggestions were broadly followed by the Government, when it removed “specified performance-based fees” from the charge cap from 6 April 2023 (through legislation and supported by statutory guidance).

Long-Term Asset Fund

The perceived need for an authorised fund vehicle designed specifically to help DC schemes invest in illiquid assets was a major driver behind the FCA’s decision to consult on a new Long Term Asset Fund (“LTAF”) authorised fund category. The BVCA put forward the industry’s perspective on this proposal, welcoming it whilst expressing concerns in some areas, such as the potential for liquidity mismatch inherent in using an open-ended structure for highly illiquid PE/VC fund assets. The FCA’s Policy Statement and final LTAF rules came into force in November 2021, allowing firms to become Authorised Fund Managers and then market LTAFs to both DC schemes and certified high net worth investors. In August 2022, the FCA consulted on broadening retail access by re-categorising the LTAF as a Restricted Mass-Market Investment (RMMI) and increasing pension scheme coverage. The BVCA’s policy response was submitted in October 2022 (see below), and we expect the FCA’s final rules to be published in 2023.