Minutes of the Productive Finance Working Group – April 2021

Minutes

Item 1 – Competition law reminder by Simmons & Simmons LLP

1. Simmons & Simmons LLP set out the legal obligations of all members of the Working Group relating to competition law. They reminded members that it is their responsibility to meet their legal obligations and to take their own legal advice.

Item 2 – chair’s opening remarks

2. One of the TEG co-Chairs thanked members for their work to date and set the objectives for the meeting: in particular, to discuss comments on the draft paper put together by the TEG that would be the focus on the next SC meeting on 4 May.

Item 3 – presentations on and discussion of the draft SC paper

3. One of the TEG co-Chairs gave an outline of the draft SC paper, noting that it summarised the work of the TEG sub-groups to date and that it would be updated in line with comments received at the meeting and afterwards in writing. The sub-group chairs then talked through their sections of the paper.

4. The chair of the first sub-group^{footnote [1]} explained that the paper contained an overview of the sub-group’s work on designing a fund structure that is commercially, operationally and legally viable. It was noted that the structure being designed is to complement, rather than replace, existing structures in the hope that it can unlock investment in longer-term and less liquid assets from a broader range of investors.

5. The focus of the work to date has been on the development of a ‘blueprint’ for the long-term asset fund (LTAF), including in relation to:

1. Alignment of the fund’s liquidity with that of the underlying assets.
2. Principles-based requirements in relation to the assets in which the fund would be permitted to invest, to ensure viable products can be launched.
3. The importance of disclosure given the nature of the investor base.
4. Leverage, appropriate levels of which are still being considered.
5. Valuation frequency that reflect the nature of the underlying assets.
6. Focussing initially on DC schemes as possible investors due to the size of the market.

6. The sub-group chair then walked through an example of what an LTAF investing in infrastructure might look like. The example envisaged both direct and indirect investment in UK and European sustainable energy infrastructure. Fund features included annual redemptions/quarterly subscriptions, full annual valuations/quarterly manager valuations, a 12 month notice period and up to 20% leverage.

7. A member of the second sub-group^{footnote [2]} summarised the section of the draft SC paper relating to operational barriers to distributing non-daily dealing funds. A significant amount of external engagement had been undertaken, resulting in the following feedback:

1. There are barriers to delivery operationally – for example, [x and y] – but none is insurmountable if there is sufficient demand.
2. Most providers would not look to allocate to a fund like the LTAF for people over the age of 55.
3. Governance requirements mean that an allocation of less than 10% to less liquid assets is unlikely to be worthwhile.
4. Pricing issues in relation to legacy pension schemes, which are priced at or very close to the cap.
5. Small pot consolidations may lead to less appetite from providers until consolidation has taken place. Consolidations will likely require the liquidation of all scheme holdings, which may be difficult for schemes holding illiquid assets. Thus, they are more likely to postpone illiquid investment until consolidation has taken place.
6. Commitment vs subscription model will have an impact on how easily the LTAF might be distributed to certain retail investors. Commitment models (where calls are made by the manager for capital from the investor when investment opportunities arise) are not currently used in the retail market and would be difficult to implement operationally. Traditional fund subscription models are more likely to be preferred for retail investors, but initial feedback from DC scheme providers suggests that a commitment model is their preference.
7. A more detailed blueprint for the design of the LTAF is needed in order to get into a position to discuss some of the issues faced by operational experts at pension providers.

8. The chair of the third sub-group^{footnote [3]} explained that the group has been looking at removing the barriers that exist around demand for less liquid assets. It has also undertaken a significant programme of external engagement with chief investment officers, trustees, consultants and providers to understand the hurdles that prevent them from making these investments, resulting in the following feedback:

1. Productive finance can be a confusing term that should be defined more clearly.
2. These types of investments would lead to price rises for schemes, which Master Trusts were particularly concerned about given the competition on cost in the market, as well as performance fees. If the potential increased returns are realised, it could help to overcome this concern.
3. Greater awareness of and support for decision makers on the benefits, risks and trade-offs involved in investing in less liquid assets is important.
4. There may be a role for regulators to play if these investments are going to be taken up in any meaningful way.

9. The chair noted that the stakeholders the group had spoken with were, generally, open to these investments if the barriers previously mentioned can be overcome.

10. The Department for Work and Pensions (DWP) representative^{footnote [4]} then gave a short presentation on the work of the department on defined contribution (DC) pension scheme investment in private assets, including on performance fees and the charge cap. The presentation noted:

1. The charge cap serves an important role in what is a very young DC market, and recent surveys have shown that support for the cap is high.
2. Liquidity management and fee competition remain important drivers of DC investments.
3. The DWP consultation on performance fee smoothing^{footnote [5]} has just closed.

11. The Pensions Regulator (TPR) representative^{footnote [6]} then gave a short presentation on an aspect of TPR’s recently launched consultation on a new code of practice.^{footnote [7]} The presentation noted:

1. The consultation had proposed limiting the proportion of less liquid assets held to not more than a fifth of all scheme assets, unless there were exceptional circumstances
2. TPR was aware of some concerns, the consultation would remain open until 26^th May and views were welcome.

12. One of the TEG co-Chairs opened the meeting for discussion on the SC paper.

1. Target investor group: some members commented that the LTAF should be available to retail and not just DC investors, and that the design of the fund should be investor agnostic with distribution rules being revisited in the future. Others stated that it should be a purely institutional vehicle until much later. One member said that DC schemes would be unlikely to wish to invest alongside retail investment in the same fund. On balance, the TEG agreed to continue its sequential approach by focussing primarily on DC schemes, with retail investors as a secondary consideration subject to appropriate protections being put in place.
2. Liquidity management: members commented that the general consensus from the external engagement was that liquidity needed to be managed predominantly at DC scheme level rather than within the LTAF. It was noted that other vehicles such as investment trusts offer daily liquidity, albeit often at a premium or discount to NAV and that this should be reflected in the paper.
3. Increasing DC demand for illiquid assets: Comments were made around the need to strike an appropriate balance in the DC market between the cost of investments and the value they add through returns. DWP commented that they are introducing regulation on schemes reporting net returns not just cost, but that there was also a role for industry to play in driving the focus towards value.
4. Commitments from the private and public sectors in the final report: The chair commented that this was likely to be an important part of the second phase of the work and further discussion on the types of commitments (that is, the actions the relevant stakeholders will need to take to implement the agreed solutions to the barriers to investing in less liquid assets) that may be needed will take place over the coming months. Some noted that commitments from asset managers may be difficult before the FCA rules on the LTAF are finalised.

Item 4 – next steps and closing remarks

13. The secretariat talked through the timelines for providing final comments on the SC paper.

14. The chair thanked the members for their contributions and drew the meeting to a close.