Treasury Select Committee homes in on DC default funds in net zero report

The government has been urged to resolve the “apparent contradiction” surrounding the integration of sustainable investments into defined contribution (DC) default funds in a report from the Treasury Select Committee, with increased reporting also suggested.

The report, Net zero and the future of green finance, noted that there was a “high level of inertia” amongst DC contributions, with most (96 per cent) members remaining in the default fund.

It explained that whilst the Treasury has been "robust" in its view that default funds should not be required to move to more green alternatives, it has also maintained the view that consumers should not have to switch out of a default fund to invest sustainably.

In light of this, the report called on the government to resolve this "apparent contradiction".

The report also noted that, at present, the Treasury is relying on a blend of disclosure, regulation and public investment to foster a transition towards more sustainable investment.

It suggested, however, that the Treasury should instead report regularly on the proportion of pension holders in DC pension schemes who remain in the default fund, and the extent to which those default funds are aligned with a path to net zero.

Commenting on the report, LCP partner and head of ESG, Claire Jones, said: “Default funds are already required to manage material financial risks and opportunities to members’ pensions savings – and this includes risks and opportunities relating to sustainability.

“We support measures that ensure DC pension schemes are meeting this requirement.

“The default option is chosen to be appropriate for most members, with considerable effort taken to ensure it remains fit for purpose, so we would expect to see high proportions of members invested in the default”.

In addition to this, the report has flagged the Chancellor's recently announced plans for a long-term asset fund (LTAF), which is expected to help DC schemes invest in infrastructure projects.

However, it noted that whilst the fund was expected to launch within a year, the Investment Association recently confirmed that a regulatory consultation from the Financial Conduct Authority would be required prior to launch.

In light of this, the report recommended that the Chancellor and regulators set out a timeframe for the launch of the LTAF to allow pension savers to invest in long-term projects, as well as providing further clarity as to who will have access to the LTAF.

It also noted that whilst industry experts have historically raised concerns around offering sustainable funds as a default fund option for auto enrolled pensions in light of issues around the charge cap, recent government plans may mitigate this restriction.

However, industry reaction to the government plans has suggested that the proposed changes could prohibit access to private markets and illiquid.

The committee has also raised concerns over the lack of member choice over investments in defined benefit (DB) pension schemes, stating that consumers have “no choice” as to how their assets are allocated and must instead rely upon their trustees.

It argued that previous attempts to get DB schemes to acknowledge environmental, social and governance (ESG) concerns have "not been entirely successful", warning that smaller schemes may represent a further challenge.

It stated: “In its phased approach to implementing the regulations, The Pensions Regulator will need to consider how to reach smaller pension schemes.

“The draft regulations appear to exclude the smallest trust schemes. However, when their effects are aggregated, they may still have an impact on meeting the net-zero target."

Considering this, the committee has also called on the government to set out how these smaller funds will be encouraged to integrate climate governance and reporting requirements.

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