Size Matters
Despite plans to follow the example of Australian and Canadian ‘megafunds’, a consolidated UK pensions sector may not be a more sustainable one.
Chancellor of the Exchequer Rachel Reeves is mulling reforms to the UK pensions landscape that could prompt sweeping consolidation with the intention of encouraging investment into UK assets, including green ones.
In November, Reeves used her first Mansion House speech – an annual address issued by the UK’s chancellor – to talk up the advantages of consolidating the UK’s Local Government Pension Scheme (LGPS) funds and its defined contribution (DC) schemes.
Predicting that there will be assets of £800 billion in occupational DC schemes and £500 billion in the LGPS by the end of the decade, Reeves spoke of the need to enact reforms that will encourage schemes to invest this vast wealth into UK assets, mirroring the approaches taken by foreign regimes.
Scale is viewed by the government as a key factor to promoting and leveraging scheme investment, with consolidation of LGPS funds and DC schemes potentially unlocking £80 billion in investment in areas including domestic energy infrastructure, Reeves said.
Institutional investors across the world remain interested in environmental and social infrastructure. Over 80% of 700 of the world’s biggest institutional investors told a recent survey by Australian asset manager IFM Investors that environmental and social infrastructure are priorities for equity and debt investment.
The report revealed that 54% of institutional investors will invest in infrastructure equity by 2029, up from 46% over the next 12 months while 50% will invest in infrastructure debt in five years’ time, up from 45%.
But “for too long, pensions capital has not been used to support the development of British start-ups, scale-ups or to meet our infrastructure needs”, the UK Chancellor insisted.
Drawing comparison with the Australian pension system, she noted that superannuation schemes invest approximately three times more in infrastructure investment compared to UK DC schemes. As well as the Australian system, Reeves is also known to be a fan of the Canadian setup, in which large public sector pension funds – known as the ‘Maple 8’ – hold the necessary scale to invest in big infrastructure projects.
Coinciding with her speech, the UK government published an interim review of UK pensions investment, which Reeves said “sets out our plans to create Canadian and Australian style-’megafunds’ to power growth in our economy”.
The government published several papers in November concerning UK pensions investment, none of which made much reference to sustainable investment.
It did, however, suggest that LGPS administering authorities may wish to consider ESG factors with regards to their investments, which “may contribute to the government’s key missions including making Britain a clean energy superpower and accelerating to net zero is one of the key missions of the government”.
This would reinforce UK efforts to attract investment into areas of strategic significance, as highlighted through the establishment since July’s general election of GB Energy and a National Wealth Fund, as an international investment conference held in October.
Australia’s consolidation challenges
International comparisons make the case for UK consolidation, in some respects. According to a recent analysis of the world’s largest pension funds by the Thinking Ahead Institute, the UK is third largest pension market globally, with US$3.2 trillion AUM, just ahead of Canada and Australia. But while there where two Canadian schemes and one Australian in the top 20 by AUM, there were none from the UK. However, the institute found that the top ten UK pension funds represent 15.7% of total UK pension assets versus 8.3% in the US.
In its consultation, the UK government has earmarked a £25 billion threshold for DC consolidation, which it says is the starting point for schemes being able to access a wider set of asset classes. “Our analysis also shows that real benefits from an investment capability and economic growth perspective come into effect when funds reach over £50 billion,” the government said in its consultation.
James Alexander, Chief Executive Officer of the UK Sustainable Investment and Finance Association, believes that consolidation “could also start at the smaller end” of pension schemes.
“Just focusing on the really large pension funds…misses a big part of the market that could do with consolidation,” he says, suggesting that some smaller schemes, such as single company trusts, are not providing adequate value for savers. “That is an area that the government has missed, and perhaps could look at again.”
Australia has played host to consolidation in recent years. In 2014, a review conducted by its Treasury concluded that the Australian pensions system was “not operationally efficient due to a lack of strong price-based competition and, as a result, the benefits of its scale [were] not being fully realised”.
The Australian Prudential Regulation Authority (APRA) has subsequently encouraged consolidation among schemes, particularly with those holding assets of less than A$30 billion (£15 billion). At least 13 mergers were completed in the year to June 2022, according to investment consultants Barnett Waddingham.
In 2023, APRA confirmed that schemes should consider ESG risks. “It is too soon to conclusively determine the effects of APRA’s guidance on ‘super’ funds’ intentions to take action on sustainability outcomes,” the UN Principles for Responsible Investment said in an April 2024 briefing note.
“Nonetheless, the permissive environment for considering ESG risks that has existed for well over a decade has contributed to ESG integration becoming the industry norm.”
But Brett Morgan, lead superannuations funds analyst at non-profit Market Forces, is unconvinced by Australian schemes’ approaches to sustainability so far.
“We’ve seen an extraordinary wave of consolidation in the Australian pensions sector,” he acknowledges.
“While that scale comes with obvious benefits for members in some areas, the responsible investment practices of large funds haven’t actually kept up.”
Market Forces research indicates that most of the sustainable or socially responsible-branded investment options of large pension funds are still investing in some of the largest companies with fossil fuel expansion plans, including oil and gas majors, he points out, while schemes are also failing to use their leverage as shareholders to pressure listed Australian oil and gas companies to align with global climate goals and end their expansion plans.
There is “a large gap between the commitments of large pension funds, such as their net zero targets or claims of alignment with the Paris climate goals, and the actions of those funds, such as implementing effective climate-related stewardship programmes”, Morgan says.
Nevertheless, the 2024 Responsible Investment Benchmark Report for Australia recorded a 24% rise in assets managed responsibly since 2022, citing growing demand from institutional investors as a key factor. The report also noted that policy and regulatory actions taken by the Albanese government since 2022 to orientate the Australian economy toward net zero goals had driven demand.
Canada’s need for expertise
Unlike in Australia, Canada’s megafunds are not viewed as the product of consolidation. But Canadian pension schemes are increasingly channeling capital into sustainability.
Sustainable investments increased from C$163 billion (US$115 billion) to C$276 billion in 2022, according to The Canadian Pensions Dashboard for Responsible Investing, representing nearly 13% of the country’s 14 largest pension funds’ combined C$2.2 trillion in assets.
In 2020, the Maple 8 issued a joint statement urging companies and investors to improve their ESG information provision, also pledging to better their own disclosures.
Adam Scott, Executive Director at non-profit Shift, which produces an annual Canadian Pension Climate Report Card, believes that when it comes to investing in climate solutions, “the pensions sector is starting to do OK”.
“They are moving in pretty large quantities in that direction, and they are starting to get a bit more sophisticated in their approach,” he says.
Scott highlights a recent announcement by the Investment Management Corporation of Ontario in which the scheme pledged to invest 20% of its portfolio in climate solutions by 2030.
“We still see lots of areas where they don’t have the required expertise in-house to really maximise the opportunity available to them,” Scott continues, noting that despite the vast amounts of capital available to schemes, “they’re still finding it very challenging to find places to put it…they tend to be taking the easier route still [with] large, publicly-traded companies”.
The Canadian economy has deep roots in extractive industries, which poses challenges to achieve net zero commitments. The government recently announced plans to deliver a national sustainable finance taxonomy and introduce mandatory climate-related disclosures. Canada’s pension funds have established a national initiative, Climate Engagement Canada, to facilitate dialogue with large domestic corporates on their decarbonisation strategies.
The risk to Canadian funds posed by climate change is stark, according to research by Ortec Finance. In November, it published findings revealing that US and Canadian pension funds are expected to experience the heaviest impact from transition and physical climate risks.
Owing to their substantial exposure to assets such as equities and alternatives, these schemes could suffer investment return declines of up to 50% by 2040 should climate policies stay unaddressed, with more declines anticipated through 2050, Ortec said.
Consolidation ‘a double-edged sword’
While Canadian and Australian biggest pension funds are undoubtedly larger than the UK’s, there is a case for suggesting policy drivers and economic realities are as much a factor in their orientation toward sustainable investment opportunities, including in infrastructure.
Further, the Thinking Ahead Institute’s research shows that most major markets have seen a decline in pension funds’ allocations to domestic equities, with Canada faring worse than the UK (the institute does not track allocations to infrastructure).
The UK is expected to lay rules that require all 86 LGPS administering authorities to consolidate their assets into eight pools. To date, they have handed over investment responsibilities for just under half of their assets under management to these centralised organisations, who have greater resourcing and purchasing power.
“With regards to making meaningful sustainable investment, the consolidation proposed is a double-edged sword,” Columbia Threadneedle’s Multi-asset Head of Dynamic Real Return, Christopher Mahon, warns ESG Investor.
“Scale can of course bring more resources and allow more tailoring and more specificity,” he continues. But “aiming to consolidate on a very select handful of schemes may reduce competition and incentives to create differentiated approaches,” Mahon warns, observing that “consolidation and scale is an argument that can be taken too far”.
Just three of the UK’s DC master trusts meet the £25 billion threshold floated by Reeves, he notes. There are 35 authorised master trusts in the UK. “The proposed floor will mean consolidation around a handful of surviving DC trusts,” Mahon says.
Gregg McClymont, Executive Director of IFM Investors, a private assets and infrastructure investor established to invest on behalf of superannuation funds, believes that Australia and Canada, as well as the Dutch and Danish systems, serve as evidence that scale is necessary for promoting scheme investment.
“The Dutch historically have focused a lot on impact investing,” points out McClymont, a former Labour MP, with emphasis on the United Nations’ Sustainable Development Goals.
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