Squaring the circle – LIFTS and how to unlock greater DC pension investment into private capital
A key priority for the BVCA in recent years has been unlocking the UK’s ever-growing defined contribution (DC) pension schemes, which are forecast to reach £1 trillion AUM by 2030, to invest in UK VC, growth and broader private capital funds. An uncertain global economic outlook and pressures on the fundraising environment more generally, mean that unlocking greater pools of domestic capital to invest in UK VC funds is now more important than ever.
VC funds have historically provided diversification and strong returns for various UK and international institutional investors. For example, the successes of Canadian and Australian schemes investing in alternative asset classes is well known. So, there is a powerful potential for DC pension schemes to improve the retirement outcomes for scheme members through greater allocations to VC funds, as well as boosting economic growth. However, there are many hurdles that need to be overcome before this capital can be unlocked.
DC schemes in the UK are structured very differently to traditional defined benefit schemes, with the result that as investors they are very different to, and essentially more complicated than the average LP. The DC model transfers much more choice, and ultimately responsibility for their own retirement outcomes, onto individual savers. This brings a range of liquidity, structuring, commercial, regulatory and other considerations that need to be addressed for DC schemes wishing to invest in traditional private capital fund structures (see the work of the Productive Finance Working Group for more detail).
One of the biggest hurdles to address is the regulatory “charge cap”, which aims to prevent excessive fees being charged to disengaged savers automatically enrolled in “default” occupational pension schemes. This presented a barrier for these schemes to invest in VC and growth capital funds, which typically charge higher fees and potentially incur carried interest. This, I’m glad to say, has now been addressed, after many years of patient lobbying from the BVCA (and others).
The removal of carried interest from the charge cap came into force on 6 April 2023 (in regulations accompanied by statutory guidance). Essentially, this carves out “performance fees” from the charge cap calculation where they meet certain conditions, which were designed to cover standard carry arrangements as well as NAV-based performance fees. The charge cap of 0.75% itself remains and includes fixed ongoing costs such as management fees, but investments with higher fees can be offset by lower fees elsewhere as long as total fees across the investors’ portfolio remain below the cap. April’s change removes the key regulatory barrier that firms faced in offering funds with carry arrangements to UK DC schemes, although standard venture and growth funds will remain “expensive” from the perspective of cost-sensitive DC schemes, which typically aim for an aggregate fee load of under 0.4% across their portfolios.
So, with that issue (largely) solved, conversations move onto the issue of how to invest in an asset class and what vehicles are required to do it. This goes way beyond unlocking investment into VC, growth and the wider private capital sector, and there are many competing ideas. The FCA authorised LTAF vehicle and the Lord Mayor’s Future Growth Fund proposal are already in the mix. The government has also allocated £250m to help unlock DC pension investment into UK science & technology scaleups and VC funds via the Long Term Investment for Technology & Science Companies, otherwise known as LIFTS, which HM Treasury recently consulted on.
In the BVCA response to this consultation, we argue that the government can help support DC schemes to upskill and better understand VC (and vice versa). We also outline options for the creation of a new fund of funds vehicle for knowledge-intensive scale-ups that works with the DC model. It’s been a process of “squaring a circle” to propose a vehicle that works for all sides and is essentially only the first step. The BVCA will continue to engage directly with the government on this issue as it also feeds into a wider discussion about how to unlock greater domestic institutional investment into the broader UK private capital industry. Consolidation of DC pension funds and other approaches must be taken in the medium term to fully unlock the capital at the scale necessary to really fully realise the potential of this growing pool of capital. We believe that LIFTS has the potential to lead the way.
Safe to say the BVCA will be at the forefront of all of this, and expect further updates from us in the near future.
Chris Elphick
Senior VC Policy Manager, BVCA
