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Pension Funds

Volume 520: debated on Tuesday 14 December 2010

Motion made, and Question proposed, That this House do now adjourn.—(Mr Vara.)

Somewhat earlier than I anticipated, I rise to make a few comments about the operation of pension funds and their transparency.

Everyone knows that the world of pensions is changing fast. With the decline of defined benefit schemes and the shift to defined contribution, pension savers are shouldering more and more of the investment risk to their savings, and with the advent of auto-enrolment in 2012, even more people’s future well-being will be bound up with the capital markets through their pension funds. These trends make greater transparency of pension fund investments an urgent imperative for three reasons. First, if ordinary savers are bearing the risk to their investments, it is only right that they should be in a position to scrutinise how their agents are managing those risks. If we expect individuals to take more responsibility for providing for themselves in old age, they should at least be given the tools to hold accountable those on whom their retirement security depends.

Secondly, the huge—and hugely profitable—industry charged with looking after people’s savings has an extremely poor record. In recent decades, we have seen the growth of an enormous cadre of agents and intermediaries who extract huge fees at the direct expense of ordinary savers at the bottom of the investment chain. For instance, a report published last week by the Royal Society for the encouragement of Arts, Manufactures and Commerce—known as the RSA—found that the total fees charged by pension funds swallow up an astonishing 40% of the end value of the average British pension, which is much more than in our European counterparts. One might at least expect that this is paying for superior skills and therefore higher returns on investment, but pension fund returns are actually declining: between 2000 and 2009, they collapsed to an average of 1.1% per year. Paul Woolley at the London School of Economics has calculated that excessive short-termist trading in shares is likely to erode rather than enhance the long-term value of pension pots. Pension fund investment strategies are a very real issue for any Government who are serious about tackling the looming pensions crisis, which we all acknowledge.

The third reason transparency matters is that pension funds are huge institutional investors with enormous collective influence on the financial markets and the wider economy. If the financial crisis taught us anything, it was the danger of handing over ordinary people’s money to financial institutions and assuming that they will take care of it without the need for further scrutiny. The interests of pension savers are, by definition, long term, yet in the build-up to the financial crisis, many pension funds engaged in the same short-termist strategies and herding behaviour as the rest of the market.

The American academic Keith Johnson has described the influence of these investors as akin to unleashing

“a flock of 900-pound lemmings”

into the economy. There is, therefore, a legitimate public interest in how pension funds behave, including in how they exercise their ownership rights. The financial crisis exposed the dangers of share owners acting like what Lord Myners dubbed “absentee landlords” or, worse still, actively encouraging their investee companies to pursue short-term profit at the expense of the long term. Ultimately, it is millions of ordinary people who provide the capital and suffer the economic consequences when that capital is not used responsibly. The case for greater transparency is compelling.

So what should that mean in practice for the Government? Earlier this year, the Financial Reporting Council published a stewardship code for institutional investors aimed at encouraging responsible ownership. It is far from perfect, but it is a start. In particular, its strong focus on transparency, including transparency in the exercise of voting rights, is welcome. However, there is a danger of the interests of pension savers being forgotten in this process. The code’s provisions on voting disclosure are a tacit recognition that people have the right to know how the voice of shareholders is being used on issues such as executive pay, takeover bids or environmental resolutions. However, the code is largely aimed at asset managers.

Ordinary people cannot be expected to know which asset manager their pension fund uses and proactively to seek out that manager’s disclosures. Improvements in fund manager transparency will give savers the accountability and visibility that they deserve only if pension funds play their part too. Disappointingly, although the FRC has stated that pension funds have an important role to play, the pensions regulator has not yet produced any official guidance for pension funds on how they should apply the stewardship code. The role of pension funds has often been left to the National Association of Pension Funds, which is an industry body—a less-than-ideal situation, I tentatively suggest. Does the Minister agree that it would be appropriate for the pensions regulator to look into the matter? Will he raise it when he next meets the regulator’s newly appointed chair?

Notwithstanding what I have said so far, it is clear that the stewardship code will not be a panacea when it comes to accountability and transparency. FairPensions, the campaign for responsible investment, yesterday published an analysis of fund managers’ performance on transparency, including their reporting under the stewardship code. Although it showed some improvements, almost one in six asset managers surveyed still did not disclose any information about their voting records. One manager justified that by saying that it was up to the clients—that is, the pension funds—to disclose such information. However, recently published guidance from the National Association of Pension Funds makes it clear that it thinks that disclosure is up to the asset manager and is not the pension fund’s responsibility. There is a real danger that such buck passing will result in nobody disclosing and the pension savers at the bottom of the chain remaining in the dark about how their money is being managed.

The Government could avoid that danger by doing two things. First, they could make voting disclosure mandatory for asset managers by exercising their reserve powers under section 1277 of the Companies Act 2006. I understand that this is not within the Minister’s gift, but I hope that it will be considered by his colleague the Secretary of State for Business, Innovation and Skills, as part of his review of economic short-termism. Secondly, the Government could clarify pension funds’ obligations in this area by amending the regulations, which already require pension funds to disclose their voting policy, to make it clear that they should also disclose information about their voting practices. Alternatively, that could be included in the pensions regulator’s guidance.

I do not believe that either approach would impose an unreasonable burden on pension funds. If their fund managers are already required to report on their exercise of voting rights, it should be sufficient in most cases for pension funds simply to provide a link to that information on their websites. That would be a small matter for the fund in question, but a huge improvement in accountability for the pension saver. It would also make information directly accessible to the pension saver—instead of them being expected to go hunting for it—and would help to embed transparency right down the investment chain. In the US, the duty of disclosure is now a recognised part of pension funds’ fiduciary duties towards their beneficiaries. That is right, and I hope that we can move down that road here.

Those in the investment industry who are unwilling to open themselves up to scrutiny in that way have come up with various arguments over the years to defend their secretive business models. Most such arguments—the idea that such a proposal would be enormously costly, or compromise commercial confidentiality or even damage relationships with the company—have been comprehensively discredited over the years. The latest argument appears to be that it is pointless to require investors to disclose such information because nobody would read it. The Minister should be able to tell us that this argument is nonsense. I understand that in June he received some 1,500 e-mails from supporters of FairPensions asking him to support their right to access such information.

Earlier this year, more than 6,000 people contacted their pension funds to ask how they would be voting on shareholder resolutions about tar sands at BP and Shell’s annual general meetings. As it turned out, those savers’ concerns about the risks of unconventional oil extraction proved well founded, at least in the case of BP. Those pension funds might have found themselves in a better position financially if they had listened to their members a little more. There is clearly a growing movement of people who want to know what is being done with their money—a movement that is being held back by a pervasive lack of transparency and a culture of hostility to the people whose money is at stake having the impertinence to ask questions.

That brings me to the final point that I want to stress. It is vital that any moves towards greater transparency pay enough attention to environmental, social and governance issues—sometimes known as ESG. Survey after survey has shown that savers care about such issues. The rise of socially responsible investment products and the success of campaigns, such as that on the tar sands resolutions, show that people want to act on that concern, but they must be given the information and the tools to do so. The previous Government sought to give them that information some 10 years ago, by introducing regulations requiring pension funds to state the extent to which they take environmental, social and ethical concerns into account in their investment policies.

Since then, the G in ESG—governance—has received a huge amount of attention, after it became obvious that conflicts of interest, excessive pay and poor risk management contributed to the financial crisis. Yet with typical myopia, many investors still neglect the E and S of ESG—the environmental and social. The Deepwater disaster, which forced BP to cancel its dividend for the first time since the second world war, should have been a wake-up call for anyone who still doubted that companies that ignore such issues face serious financial risks. It should also have been a wake-up call for pension funds—for which the BP dividend was a significant source of steady income—to pay attention to such issues as a key part of their fiduciary duty to pension savers, as the legal opinion obtained for the United Nations Environment Programme confirmed some five years ago.

The challenge of climate change makes recognition of that duty even more urgent. Climate change is not only an investment risk, which it clearly is; it also has innumerable ramifications for the retirement security of the next generation of pensioners. A 25-year-old pension saver clearly has a broad interest in ensuring that his or her savings are reducing rather than increasing the risk that they will grow old in a world ravaged by catastrophic climate change.

The Ministers responsible for the 2000 regulations clearly intended to nudge pension funds into taking account of non-financial issues. To some extent they were successful, as the UK Sustainable Investment and Finance Association noted, in marking the 10th anniversary of the regulations. ESG integration is more mainstream than it was 10 years ago, but there is clearly still a long way to go. It would be wrong to say that the objectives of the 2000 regulations have been achieved. A 2009 United Nations report expressed “disappointment” that investment consultants still advise pension funds to include boilerplate statements on environmental, social and ethical issues that

“meet the letter but not the spirit of the law.”

Members who ask about specific voting decisions are often directed to such generic statements, which are of little or no use to them. Indeed, that is exactly what happened to Members of this House who inquired about their own pension fund’s stance on the tar sands resolutions earlier this year.

Research by FairPensions also suggests that such box ticking is often not accompanied by much substantive action. Its 2009 survey of pension funds showed that almost all had a policy stating that they took non-financial issues into account, but around a third did not integrate the policy into their agreements with fund managers or assess their fund managers’ ability to implement it, nor did they require them to report on its implementation. It is reasonable to ask what those funds were doing to implement their stated policies. It is also reasonable to ask how those policies gave any meaningful insight to the curious member wanting to know what their fund was doing about environmental and social issues. As the UN report concluded,

“the time may have come to review how”

the disclosure regulations’

“effectiveness could be improved with additional reporting and disclosure requirements that will supersede mere ‘tick box’ compliance.”

In other words, perhaps we need a further nudge, some 10 years on from the initial regulations.

I understand that the Minister’s official position is that the existing regulations are adequate, but in a recent parliamentary answer, his colleague Lord Freud confirmed that his Department has made no assessment of how the regulations are operating. Given that so many others who have done such analyses have concluded that change is needed, will the Minister commit to exploring how the situation might be improved? Guidance from the pensions regulator on stewardship could provide an opportunity to clarify what constitutes an adequate policy under the 2000 regulations, encouraging pension funds to go further than boilerplate positions.

Perhaps more importantly, the Government could require pension funds to report on a regular basis on how they were implementing that policy. That could be helpful in focusing minds and ensuring that these policies are not, as one fund manager described them, a “dead document” but a genuine commitment that is given full weight in investment decisions. Again, this is not an unreasonable thing to ask. Pension funds are already required to produce an annual report, including an investment report. Under the stewardship code, it is reasonable to assume that this should include a summary of their stewardship activities during the year. It is also reasonable to assume that the report exists to give pension savers meaningful information with which to judge the fund’s performance. Environmental and social issues should be no exception to this. There is popular demand for such information, and that demand should be met.

I hope I have shown that pension funds’ behaviour as responsible investors, including with regard to environmental and social issues, is neither a trivial sideshow nor an issue that concerns only policy makers dealing with corporate governance or financial services. It has real implications for our ability to meet the challenge of providing a decent pension, and a decent standard of living, for all our citizens across the country.

To recap my questions to the Minister: will he discuss these matters with the pensions regulator? Will he encourage the regulator to produce some guidance? And will he look again at the disclosure regulations and explore ways in which they could be updated or supplemented to ensure that pension savers are getting the levels of transparency that they deserve?

I congratulate the hon. Member for Dagenham and Rainham (Jon Cruddas) on securing this debate and raising such an important issue for many of our constituents. Pensions are sometimes seen as a bit of a minority sport for anoraks, but the issue of what is happening to our money, and of whether it is being invested well, and in an environmentally and socially beneficial way, matters very broadly, and the more we can do to reduce the barriers that people face in obtaining that information, the better.

As the hon. Gentleman was speaking, I was reflecting on the fact that I bank with Smile, the internet arm of the Co-operative bank. As a member of the Co-operative movement, I periodically receive mailings about ethical investment issues and about the policies of the bank and how they could change. I have some interest in those matters professionally, but even just as a private citizen I find that process quite engaging. The process of raising such issues directly with individuals to enable them to make informed choices without always having to be proactive and to go and dig them out, makes me feel more positive about the institution that I am dealing with.

The hon. Gentleman is right to raise these issues. He mentioned the organisation FairPensions, and I congratulate it on its research, which is often thorough and careful. It is neither broad-brush nor high-level, but it examines the detail of the law and the regulations to determine how things might incrementally be improved. I welcome the fact that he has brought to the House’s attention some of the issues that he and Fair Pensions are concerned about.

I want to respond mainly on the questions of corporate governance and accounting transparency, but I also want to touch briefly on charges. The hon. Gentleman mentioned a figure of 40% of pensions going to pay charges, and that is a figure that we often hear quoted. It is worth correcting the record on what that does and does not refer to. It is certainly not an average or a norm. Someone who pays 1.5% charges through the life of their product might end up losing 40% of the fund on retirement, but there is no reason why anyone with a standard product need pay those charges. The stakeholder cap would start at 1.5% and fall to 1%. The new National Employment Savings Trust—NEST—pension will have an equivalent average management charge of 0.5% a year. Every charge represents a bit coming out of the final return, but people are paying for a service and charges are therefore legitimate provided that they are transparent. It is important not to overstate the extent of charges.

One thing that we hope will happen as a result of introducing the NEST corporation into the market next year, and more fully in the coming years, is that it will have a downward impact on charges across the market. When stakeholder pensions were introduced there was evidence that some charges—which might have been even higher than the figures quoted by the hon. Gentleman—were brought down, and we think that the same will happen again.

That raises the issue of the relevant roles of regulation, on the one hand, and of alternative strategies, on the other. I find a lot of common cause with the points that the hon. Gentleman raised. He is an intelligent and thoughtful contributor to these debates. One of the paradoxes that he raised is illustrated by asking whether further regulation is the solution to regulation that is not achieving what we want it to achieve. Or should we consider better enforcement of existing regulation, or alternative strategies? I suspect that the answer might be a mix of all three. He used powerful terms such as “boilerplate”, “paragraphs”, “dead documents” and “tick-box” mentalities. We do not want to create new tick-boxes. We want to ensure that the spirit of the law and the guidance is adhered to.

The NEST corporation has done some interesting work on attitudes to ethical investment, which is worth sharing with the House. It was actually the predecessor body to NEST, the Personal Accounts Delivery Authority, that conducted some public consultation on how NEST should invest its members’ money. NEST will be a pension fund with the potential to cover millions of people, many of whom will never have had a pension before and who might not be financially sophisticated investors. The target market was asked whether NEST should offer

“an ethical or socially responsible investment fund”.

As the hon. Gentleman might imagine, the research evidence suggests that there was very strong support for NEST offering such a fund, and the corporation is thinking about how it will do that. At the moment, about 40% of defined contribution schemes offer an ethical fund. I appreciate that there is a difference between an ethical fund and transparency in pensions, but there are links between the two.

Back in 2007, my Department looked at the NEST target group, and more than a quarter said that they would invest in an ethical fund regardless of the return. So they thought that they were interested in that idea even if sacrificing a bit of their return was involved. Also, a whisker under half of those surveyed said that they would invest ethically if the returns were equal to other investment types. Perhaps that reinforces the hon. Gentleman’s point that there is a big market out there for such investment funds, and that people are concerned about such things. They might not understand every detail of what is happening to their money or what is going on in the financial markets, but they want to know that their money is, as it were, doing good wherever possible. Some are willing to make a financial sacrifice to achieve that, and many more would rather be in that position than not. That suggests that the issues that the hon. Gentleman has raised are important and mainstream, as he said.

One of the challenges in dealing with this issue is that there are many links in the chain. We have the individual investor who puts money into a pension fund, along with their employer. Then we have the pension fund trustees, the investment managers and the businesses in which the money is invested. At each stage there are issues of transparency and reporting that need to be addressed, as the hon. Gentleman rightly says.

The present legislation on occupational pension schemes is contained in the investment regulations of 2000. It will not be entirely helpful to my case to do so, but I am going to quote exactly what they say. They require a scheme’s statement of investment principles to

“disclose the extent (if at all) to which social, environmental, or ethical considerations are taken into account in the selection, retention, and realisation of investments.”

The regulations also require schemes to disclose

“their policy (if any) in relation to the exercise of the rights (including voting rights) attached to the investments.”

As the hon. Gentleman has pointed out, however, that is a requirement to disclose a policy, but not necessarily individual votes on individual issues. I know that many shareholders do not just want information on a boilerplate policy that might be cut and pasted from somewhere else; they want more specific information on how the scheme approaches its position.

The figures change from month to month, but latest figure that I have seen shows that British pension funds own about £1 in every £7 or £8 of the UK stock market, so they are powerful players. Obviously, they do not often speak with a single voice, so they are perhaps more fragmented than that single figure suggests, but the idea that vast numbers of billions of pounds are not having an influence on company behaviour seems implausible. We therefore have an incentive to have a proportionate regime that maximises the beneficial impact of that activity.

There is a lot going on in relation to corporate reporting. In looking into this in preparation for the debate, I identified at least three different Government consultations and calls for evidence that are now going on, and that are relevant to this area. I shall update the House on where we are with those, starting with the Department for Business, Innovation and Skills, which has been consulting on the future of narrative reporting in order to address the coalition commitment to reinstating an operating and financial review. That policy was dropped a while ago, and the intention is to reinstate it. That consultation has closed and our BIS colleagues will shortly publish a summary of responses with a view to outlining the next steps in the new year.

The three key objectives, with which I think the hon. Gentleman would agree, were as follows. The first was to improve the quality of company reporting to shareholders, the second was to empower shareholders to hold directors to account on their performance, and the third was to ensure that any measures we as the Government introduce will improve the quality and relevance of disclosures; that relates to the point that the hon. Gentleman made.

Our colleagues at BIS are, as they say, exploring all the options—regulatory and non-regulatory—to make sure that companies report on matters that are material to their business and their shareholders, including consideration, where relevant, of social and environmental issues. What our BIS colleagues say is that where existing regulation is not meeting its aims, they will be looking at options to facilitate better and more relevant reporting and to empower shareholders to hold companies to account where the needed information is not provided. There is a welcome and ongoing commitment to empowerment of shareholders and to relevant reporting, not just box-ticking exercises.

That is the first exercise, which in a sense is more mature, within the few months for which the coalition has been in power. The second relates to the point that the hon. Gentleman made in his speech about short-termism. The Department for Business, Innovation and Skills published in October a call for evidence on the extent of short-termism and market failures in UK equity markets, looking at issues and causes and whether the current law is suitable. A whole range of issues is covered by that, including whether investors are increasingly short term and whether—to use a bit of economic jargon—there are principal agent problems in the investment chain.

In a sense, that is how I started my remarks, by saying that we do have a chain: there are concerned citizens, perhaps pension funds, financial intermediaries, and then the companies in which they invest. At each stage, as the hon. Gentleman said, the danger is that each thinks it is the other’s job to do what is necessary: “Is it my job to report or your job to ask?” There is certainly scope for greater clarity on that subject.

One reason why I mentioned the consultations across government and the calls for evidence is that there may be more openness on such issues early in a new Parliament or new Government than when a Government have been in power for a long time and have a settled and rigid position. Clearly, the present Administration has a strong emphasis, where possible, on deregulation, so it would be fair to say that there is not an appetite for net additional regulation. That much is true, but where goals can be achieved proportionately by non-regulatory measures or by a mix of regulation and deregulation so that there is no overall increase, there would be much more openness. I would therefore encourage the hon. Gentleman and, through him, Fair Pensions and others, by saying that if they can suggest measures that have no regulatory burden or minimal regulatory burden, or identify other regulations that could be repealed because they are not effective, their ideas would find more favour, particularly with my colleagues in BIS who have overall responsibility for regulatory policy. I hope that that provides a helpful steer.

Continuing the theme of Departments listening and consulting, the Department for Work and Pensions and I have recently published consultation on guidance on default funds. Once we are in a world of auto-enrolment, people who do not make an active fund choice will end up in a default fund, so it is pretty important to see what such a fund looks like. The guidance that we put out for consultation sets out the standards by which default investment options should operate. The hon. Gentleman will be reassured to know that the key standards are about robust governance, review of the default investment option, transparency of charges and providing appropriate information to members about investment decisions. Those things will help.

In connection with the hon. Gentleman’s comments about the parliamentary scheme, I can tell him that another scheme of which I have been a member is the universities scheme. I recall speaking at a recent conference where a representative of that scheme was present. I raised the issue of scheme members wanting to know what was being done with their money. I mentioned that as a member of that scheme, I did not recall ever getting any very useful information. His answer was, “It’s on the website.” I feel that there is occasionally a need to remind those who manage our money that it is our money. That should make them proactive in communicating with scheme members: asking them what they want would be a positive factor in that respect.

The hon. Gentleman mentioned the Financial Reporting Council and its stewardship code. As he said, it has taken a step in the right direction. Fair Pensions’ own report “Stewardship in the Spotlight” found that the UK stewardship code had already helped to encourage voting disclosure. Examples are provided of several asset management firms that have improved their practices. I think that that is progress, but I take the hon. Gentleman’s point that although it is another link in the chain where things are perhaps improving, we need to look at the whole system. A stewardship code should, in the view of the Financial Reporting Council, be based on the idea of “comply or explain”; in other words, investors should either get on with it and comply, or at the very least explain why they have not done that, so that people can form a judgment on that.

The Financial Services Authority has expressed its belief that the principles of the stewardship code are as applicable to occupational pension schemes as to other types of pension and that, ultimately, occupational pension scheme managers will still be answerable to the scheme’s trustees. The FSA does not consider it unreasonable to require scheme managers to disclose their commitment or otherwise to the code, given the nature of the disclosure requirement.

Finally, the hon. Gentleman asked whether I would raise these issues with the new chair of the pensions regulator. I will be very happy to do that—although obviously, the new chair and the regulator itself are operationally independent of the Department and will form their own judgment. I know that they take a risk-based approach to what they do, so one of their top priorities is ensuring that funds are adequate and deficits are dealt with. They prioritise some pretty basic things like making sure that schemes have proper records of who is in them and how much money they have put in. There is a lot on their plate, but the issues that the hon. Gentleman has raised are important as well. I will certainly flag up his and the House’s interests in such matters when I meet—as I hope I will before too long—the new chairman whom we announced last week.

In conclusion, I reiterate my thanks to the hon. Gentleman, to Fair Pensions and to other campaigners on these important issues. The Government are doing a lot of listening, consulting and calling for evidence. I hope that the hon. Gentleman and others will feed into those consultations so that the feedback that we get will help to shape the way in which we take forward this important agenda. I am very grateful to him for placing it before the House this evening.

Question put and agreed to.

House adjourned.