The root and branch reforms of the work and pensions system and the investments held within them have opened a can of worms for employers, advisers, providers and regulators, while also leaving Labour facing off against the Coaliton on charge transparency.
Yesterday’s House of Commons rejection of pension shadow Gregg McClymont’s amendment calling for an in depth review of fund management charges within auto-enrolment pensions also leaves Labour challenging the effectiveness of the Coalition’s attempt to clean up the charges matter once and for all.
That means some still question whether we have accurate figures on what the charges in a fund actually are.
“Although it’s finally listened to Labour’s calls for a charge cap, the Government still doesn’t get it on pensions, and this week the Tory-led government voted down Labour’s amendments to the Pensions Bill which would have ensured for the first time the full disclosure of all costs and charges on pensions. That matters because it is very difficult to move rapidly towards a cap unless the government actually knows what costs and charges it is capping,” says McClymont.
“Only today the FCA has announced a crackdown on some hidden investment charges and without full transparency on all transaction costs including bid-offer spreads, including bid offer spread on currency transactions, the transaction costs incurred by underlying funds, the profits made by funds when stock-lending is undertaken, and interest retained by fund managers on cash balances, the government will not have full sight of costs and charges accruing on pensions.”
The DWP paper instead adopts a much softer line, asking whether turnover costs should be included within the cap, and seeking views from the industry as to whether it would be better not to tell people what their true charges are.
But the DWP consultation paper on charges and commissions does give a clear steer that active member discounts are likely go, in line with repeated public statements from pension minister Steve Webb. That has left the industry questioning where scheme AMCs will settle, how employers will communicate possible increases in charges to existing employees, if indeed they want to, and who will pay for communicating any changes or any further rebroking.
Pre-September 2013 consultancy charges also look holed below the waterline, making their eight-month tenure surely the shortest-lived remuneration structure of all time.
That leaves two key areas up for serious debate – how a charge cap will work and the abolition of commission.
The industry and other stakeholders will be asked for their views on which of the three options they prefer – 0.75 per cent, 1 per cent or a comply-or-explain system between the two. But we may still expect some serious debate as to whether any charge cap at all is desirable.
The OFT report pointed out that a charge cap can create a risk of unintended consequences. ‘Set too high, a cap can become a target for providers. Set too low, a cap can create incentives to lower quality’, says the OFT report, a view shared by Andrew Warwick-Thompson, TPR’s executive director for DC, governance and administration, in an interview to be published in the November issue of Corporate Adviser.
Buck Consultants principal & head of defined contribution & wealth Philip Smith says: “Capping will distort the market and could actually reduce the options available to consumers as commercially-driven organisations can reduce aspects of their offering, such as active management, or ultimately exit the market altogether. Stifling innovation and driving funds towards passive only investments is a big concern.”
Assessing whether charges meet the cap will also present difficulties, not least since Nest broke the 10-year consensus on monocharge AMCs with its contribution charge model. Someone auto-enrolled into Nest one year before retirement will pay over 2 per cent, while anyone joining with less than seven years to retirement will pay over 0.75 per cent, assuming 6 per cent fund growth according to figures from Hargreaves Lansdown.
Advisers are also concerned that a cap could effectively outlaw active management. Hargreaves Lansdown head of corporate research Laith Khalaf says: “Politicians could effectively ban default funds from being actively managed. Passive strategies are cheaper, but after charges they are guaranteed to underperform the markets they are tracking, if they are doing their job properly. If default funds have to be passively managed, more emphasis will need to be given to providing active fund choices outside of the default.”
With thousands of employers already well advance in their preparations for auto-enrolment, the DWP’s proposals could be a serious spanner in their planning.
Jelf Employee Benefits head of benefits strategy Steve Herbert says: “Whichever of the above options is finally acceptable, the document suggests that this will apply for all employers who stage from April 2014 onwards. Those employers who have already staged, and may now find themselves in excess of the charges cap, are likely to have a window until April 2015 to rearrange their offering to fall in line with the proposed cap.”
The debate on commission meanwhile looks set to raise serious issues for some corporate IFAs, with a full ban on commission floated by the DWP paper. The OFT paper was silent as to who should benefit financially from a ban from commission. Advisers will clearly lose out. Consumer groups are likely to demand savings are passed on to members, while some providers have already indicated they expect them to keep commission.
Deloitte partner Andrew Power estimates at least £200m a year is currently paid out to intermediaries through existing commission arrangements.
“The question for intermediaries therefore is will the thousands of employers reaching their staging date be prepared to pay fees that will replace that income that they had been expecting.”
The removal of that revenue for work already done, say some advisers, could lead to enforcement of contractual clauses that require equivalent fees to be paid by employers. How employers respond to such demands, having never paid for workplace pensions advice before, says Power, remains to be seen.