15th March 2001
SPEECH BY THE ECONOMIC SECRETARY TO THE TREASURY, MELANIE JOHNSON MP, AT THE NATIONAL ASSOCIATION OF PENSION FUNDS INVESTMENT CONFERENCE
Introduction
I am pleased to have this opportunity to speak to such a wide range of representatives from the pensions industry. I would like to talk about the Myners Review, and as Paul will be speaking to this conference tomorrow, I?ll leave discussion of the Review's details to him. Today I would like to talk about how the Review fits in with the Government's objectives, and how we see our role in relation to the pensions industry.
Pension funds are vital to the millions of people to whom they give security and comfort in old age. Pension funds represent the savings of millions of people, and as Paul Myners says, the ability of funds to invest these assets effectively has a profound impact on their economic well-being. Because so many people depend on pension funds to provide for their futures, ensuring the funds serve the needs of their members is a priority for Government.
Pension funds are not only vital to the pension holders they provide for. They are also key players in the economy as a whole, with a vital role in the UK's capital markets. £800 billion of assets are managed by pension funds. UK pension funds own nearly 20% of quoted UK equities. And Pension funds in the UK are a success story: Pension fund investment in the United Kingdom secures high and stable retirement incomes for millions of people.
Over recent decades, pension assets have grown very rapidly, and the process of investing them has become increasingly complex, and increasingly professionalised. As Paul Myners rightly says in his report, our strong funded pensions system, our highly-developed equity culture, and the professionalism of investment in the UK are key national assets. So I want to pay tribute to the great success of the pension fund industry, and to the skill and professionalism of those who work in it.
But Paul also sets out the future challenges for the industry. An ageing population, a different and still changing labour market, and a corresponding change in employers? attitudes all mean that the environment in which pension funds now operate is very different to that of twenty, or even ten years ago.
So the time is right to examine how these changes have set new challenges for the industry, and how we will need to respond to these challenges if we are to ensure continued and greater success for the industry in future. Paul Myners? report sets out a clear and consistent package which will help the pensions industry respond to the challenges it faces, and which all of us - Government, the consumer, and the industry - stand to benefit from.
Our task at the Treasury is to put in place the policies which will build a stronger economy and a fairer society. We must make sure markets are open and transparent, and that customers needs are met, without stifling the opportunity and innovation of Britain's financial services.
Our priority is establishing a clear and transparent environment in which people can have confidence that financial services providers will look after their customers interests. So as Gordon Brown said in his Budget speech, the Government strongly supports Paul's report, and we will take forward his recommendations.
The Myners Review
The report finds a series of distortions in the decisions made by the industry, but its analysis makes it very clear that none of these distortions are to be laid at the door of any particular group within the industry.
Individuals, fund managers and trustees have been doing their best, and fulfilling their objectives effectively, within the structures and incentives which govern the industry.
It is in the complex interactions of these structures and incentives that the roots of the distortions lie, and this makes the task of correcting them so important.
The Government believes that the Myners Review's proposals are the right way to go about removing those distortions. His proposed principles of investment decision-making are a simple and sensible statement of good investment practice. But though these principles are simple and sensible, they have the potential to drive positive change.
Driving this change means paying attention to all aspects of the decision making process: the roles of trustees and their advisers, the role of fund managers, and the objectives and incentive structure within which they work, to ensure that the decisions made are in the interests of fund members. It also means paying attention to the clarity and transparency with which pension funds are run, and with which these decisions are made.
A theme which recurs throughout Paul Myners? report is the need for greater transparency in the way pension funds are managed.
This applies to the objectives and incentive structures followed by fund managers, the role of advisers and consultants, and how they are paid, but also in assessing the how effectively all of the elements of the decision making process have performed. Funds should not only ensure their decision-making structures reflect their objectives; they should also be prepared to set out these structures to their members.
Decision making process
At their heart, Paul Myners? recommendations are that funds should make investment decisions with the primary aim of meeting their obligations to their members; that those making these decisions should have the skills, expertise and advice they need to do so effectively, and that decisions should be carried made transparently and accountably.
The ultimate purpose of a pension fund is to pay the pensions that its members need and expect, and pension funds? objectives should reflect this at all levels, both in the funds? overall objectives, and in the objectives set for trustees, advisers, and fund managers. If fund managers? objectives differed from those of the fund as a whole, it would be no surprise if the fund's overall purpose is not met.
Ensuring that the objective of meeting pension liabilities is properly cascaded down to fund managers is a first step to ensuring funds? objectives are met; and these objectives should be reflected in measures of fund managers performance.
And focusing on these objectives should mean that pension funds pay more attention to strategic asset allocation. Decisions about strategic asset allocation are crucial to pension funds ability to meet their liabilities, but these crucial decisions are rarely given the careful consideration they deserve. Many funds do not have the capacity to make these decisions properly in-house, but they are unwilling to spend the money on outside help that making these strategic decisions properly requires.
Many of the distortions the review found in investment decisions arise specifically because the overall objectives of pension funds are not followed throughout the decision making process. To avoid these distortions, the objectives of pension funds and their managers should also be reflected in the approach they take to fund management. In particular, the funds? objectives should affect their decisions on whether active and passive management is appropriate for each asset class, and whether appropriate index benchmarks and limits have been set.
As well as ensuring that fund managers? objectives and incentives reflect the funds? objectives, there is a need for greater clarity about the timescale over which fund managers? performance is measured. We have no intention of setting any minimum timetable for assessing performance: that is and should be a matter for the trustees of each fund to decide.
But it is for the trustees to ensure they have in place a clear and explicit mandate, so their fund managers can be certain over what timescale their performance will be assessed. It is the fund that suffers if objectives are confused and hazy.
The ultimate responsibility for ensuring pension schemes are run in the best interests of their members is with trustees; but the Myners report found that many trustees are able to devote only limited time and expertise to investment decisions.
Many trustees undertake their role with skill and dedication, and we should give more recognition to the complexity and the importance of their work. But it must be right that investment decisions should be taken by people with the skill, the information and the resources they need. This means that trustees should generally be paid for the work they do, and that they should have support from sufficient in-house staff.
Of course we do not expect all trustees to become investment experts, or to cease to use outside advisers - of course they should continue to do so. But it is important that where trustees do choose to take investment decisions they should at least be capable of understanding, and critically evaluating, the advice they receive.
Trustees are legally responsible for making investment decisions, and if they are unable to use the advice they receive effectively, they cannot make those decisions with the care they owe to their members. Trustees should become sufficiently familiar with investment issues to make these decisions effectively, and should delegate those decisions they are not in a position to make.
Finally, funds need to ask hard questions about the way they pay their fees. Fund managers currently outsource research and execution: both important elements of the work of managing a portfolio. In most cases this makes good sense, and we would not wish to change the practise.
However, this outsourcing is a business cost like any other, and fund managers should ensure the price they charge their clients covers their business costs. Instead of doing this, fund managers simply pass on the cost to their pension fund clients, in the form of commissions paid on buying and selling shares.
The Government believes that Paul Myners' proposal - that fund management fees should include the cost of commissions - is the right way to deal with this issue, and this arrangement would serve the interests of pension fund members better.
Where Paul Myners' proposals involve additional costs - for instance from paying trustees - it is important to bear in mind the scale of the potential benefits which should result from the improvements he proposes.
Paying trustees and advisers more will have little impact on funds costs, but the benefits it will bring - a more skilled and professional approach to investment; activist fund management; and a careful consideration of all asset classes, including alternative assets - could generate significantly improved returns. Some of the review's proposals, such as those on commissions, also have the potential to reduce costs - perhaps substantially.
The Government believes the principles in the Myners review are correct, and it is in the best long-term interests of fund members, and of the industry, to follow them. But Paul proposes, and we agree, that it is right to seek a voluntary approach if it can be made to work. There are several reasons for this.
Firstly, there may be times when funds have good reasons to depart from the Myners Review principles, and where it would damage funds interests to follow them. Of course, in these cases, funds will owe an explanation to their members.
Second, though the review involved very widespread consultation with the industry, we are open to suggestions for improvements and clarifications to the text. Today we are launching a short consultation to provide the industry and others with an opportunity to comment on the precise formulation of the principles recommended in the report. We would welcome your views, and would be grateful to receive responses by 15 May.
So as the Review recommends, we will be giving the industry two years before we look again at how these recommendations have been implemented.
The Myners review is not proposing more regulation of pension funds; on the contrary it is cutting it. As recommended by the review, and following useful suggestions from the National association of Pension Funds, we are abolishing the Minimum Funding Requirement.
It was clear from our consultation that there was a widespread lack of support for the MFR. We have decided to replace it with a long-term scheme-specific funding standard and a regime of transparency and disclosure. This will provide protection for members of defined benefit schemes while encouraging a thought-through approach to investment and contributions policy.
Pensions regulation
In addition to this, we are working in other ways to reduce the burden of unnecessary regulation on the pensions industry. I understand there is widespread concern within the industry about the complexity of the current tax rules, and I have been looking at what could be done to make it easier for people to understand and work within the pensions tax system.
We have already introduced administrative simplifications to the rules governing defined contribution schemes by relaxing the link between contributions and earnings and allowing people to hold occupational and stakeholder pensions at the same time. These initiatives have been widely welcomed.
Today, I am happy to announce the next stage in pruning pensions regulation. I have asked the Inland Revenue, in partnership with experts from the pensions industry, to examine whether a package of practical options can be developed to simplify the administration of defined benefit schemes.
The aim of this project will be to ease the complexity of scheme administration, so the team will not be considering any changes to higher rate relief, the earnings cap level or maximum benefit accrual rates. Instead, staff from the Inland Revenue and the Industry will be working together to find ways to improve both the existing tax rules governing scheme administration and communications between the Inland Revenue and pension schemes.
Reviews like this have been made in the past, and too often they have made systems more complicated by trying to deal with special and hypothetical cases. This is one of the reasons this initiative will be run in partnership with industry.
I want this review to base its recommendations on objective evidence rather than supposition. So it is important that we find suitable candidates from the industry to be seconded to work on this project, and that industry bodies share their management information so we can develop a sensible, risk based regime.
I have asked a joint steering group to oversee this project and this will be sponsored by Dave Hartnett, Director of Inland Revenue Policy. I hope that representatives of the Pension Schemes Joint Working Group, including the NAPF, will join the work of this group.
Of course, both Government and the industry will need to make compromises to develop the package of reforms. But this project will reduce the burden of red tape on both the industry and Government, and it is in both our interests to make it work.
Conclusion
The Myners review, and our joint project to simplify pensions taxation, are great opportunities for the pensions industry. The changes Paul proposes, and the simplification we will be working on, will help pension funds serve the needs of their members more effectively. That is good news for fund members, and also for Government and for the industry.
Over the course of this review, Government and the industry have worked together effectively. I hope to see that cooperation continue in our joint simplification programme and in implementing the Myners review recommendations. A future where Government and the industry continue to work in partnership for the good of the consumer.