A recent Pension Investment Review consultation by the Government proposes sweeping reforms that could fundamentally reshape Britain's pension landscape. While presented under the banner of efficiency and improved returns, these proposals risk undermining core market principles and individual financial autonomy. Ultimately, these reforms risk causing more harm than good.
The Government's proposal centres on stringently consolidating the pensions market through aggressive interventions. These include restricting default funds, establishing minimum Assets Under Management (AUM) requirements, and creating mechanisms to transfer savers between arrangements without explicit consent. The suggested £50bn minimum AUM threshold would effectively reshape the entire pension market landscape, potentially creating an oligopolistic environment dominated by a handful of large providers.
While the proposal aims to enhance investment efficiency and access to productive assets, research suggests that bigger is not always better. For instance, a study of Dutch pension funds by Broeders, van Oord and Rijsbergen (2017) found that large funds often "invest more in asset classes with higher investment costs" compared to their smaller counterparts. Similarly, research on American pension funds by Bauer, Cremers and Frehen, R. (2010) reveals that liquidity limitations can hinder large pension funds from outperforming market benchmarks -- something smaller, more agile funds often manage to achieve.
One of the most concerning aspects of the proposed reforms is their potential impact on market innovation and competition. By imposing arbitrary scale requirements and standardisation, the reforms risk creating significant barriers to entry for innovative smaller pension providers. This could effectively stifle competition and reduce the market's natural ability to adapt and evolve. Smaller pension funds frequently demonstrate superior performance through their niche expertise in specific market sectors, more targeted investment approaches, and more agile decision-making processes. They also show a better ability to exploit market opportunities that larger funds might find too small to be worthwhile.
The reforms risk creating significant barriers to entry for innovative smaller pension providers. This could effectively stifle competition and reduce the market's natural ability to adapt and evolve.
Another significantly overlooked factor in the consolidation debate is counterparty risk. In a diverse market, investors have options if they develop concerns about a particular firm's strategies, returns, fees, or conduct. Consolidation rapidly diminishes this choice. The global custody services market serves as a cautionary tale, in which a handful of institutions (JP Morgan, Citi, State Street, BNY) dominate the market, leading to homogenisation of services and reduced differentiation. This concentration has historically led to increased risks of cartel-like behaviour, price fixing, and potential corruption. Furthermore, the circulation of staff between a small number of major firms creates an echo chamber of ideas, stifling genuine innovation.
The proposed "contractual override" mechanism represents another troubling development. This would allow pension providers to make changes to individual financial arrangements without direct member consent - a dangerous precedent that contradicts the principle of personal financial autonomy that underpins a free and open market.
Rather than forcing artificial consolidation, the Government would be better served by focusing on structural economic reforms that naturally encourage investment and growth. The most effective pension market is one that empowers individuals to make informed choices about their financial future, encourages genuine competition between providers of all sizes, allows diverse investment strategies to emerge organically, and creates conditions where funds can profitably outperform market benchmarks based on merit rather than size.
The key to improving pension fund performance and increasing investment in the British economy lies not in forced consolidation but in making Britain a more competitive place to invest. This could be achieved through regulatory reforms that reduce unnecessary bureaucratic burden, tax policy changes that incentivise productive investment, creation of more attractive investment opportunities within the UK market, and enhanced transparency requirements that enable better informed decision-making.
The Government's proposals for pension market consolidation represent a fundamental misunderstanding of how efficient markets operate.
While the Government's proposals draw heavily on examples from Australia and Canada, such an approach risks cherry-picking evidence that supports consolidation while ignoring contrary findings. The success of pension systems in other countries often depends on specific local market conditions, regulatory frameworks, and economic contexts that may not translate directly to the UK environment. Moreover, the relationship between fund size and performance is far more complex than the simple "bigger is better" narrative would suggest. Each pension market has unique characteristics, and importing regulatory frameworks without considering local contexts risks creating market dysfunction rather than improvement.
The Government's proposals for pension market consolidation represent a fundamental misunderstanding of how efficient markets operate. True market efficiency emerges from individual choice and diverse competition, not from central planning and forced consolidation. Instead of pursuing heavy-handed market interventions, policymakers should focus on creating conditions that naturally encourage investment and growth. This means implementing structural economic reforms that make the British economy a more attractive investment destination, reducing regulatory barriers, and improving tax incentives for productive investments.
A critical misconception in the Government's approach relates to market valuations and investment decisions. The argument that the FTSE's undervaluation stems from insufficient pension fund investment reverses cause and effect. The reality is that UK companies are valued lower due to broader market conditions and environment, leading pension funds to seek better returns elsewhere. Investment managers have a fiduciary duty to generate optimal returns within their given risk parameters and cannot justifiably accept lower returns to invest in poorer quality assets, regardless of government preferences.
It's also crucial to understand that retail funds primarily operate in the secondary market, trading existing shares rather than providing direct capital to companies. The government's apparent desire to channel pension investments into new ventures misunderstands this fundamental market structure. High-risk investments in startup capital or early-stage funding rounds are more appropriate for specialised vehicles like Enterprise Investment Scheme (EIS), Venture Capital Trusts (VCTs), or angel investing, not pension funds responsible for securing retirees' futures.
The best way to encourage pension funds to invest in the British economy is not to force them into larger pools but to make British investments more attractive and profitable. This approach would improve investment culture by creating genuine incentives for UK investment, increase returns for millions of pension holders, drive economic growth while protecting individual financial autonomy, and maintain the diverse, competitive market that best serves savers' interests. The path to better pension outcomes lies not in constraining choice but in expanding opportunities. Any reform effort should prioritise protecting individual financial autonomy while creating the conditions for natural market evolution and growth.