It is useful to consider the wider economic and political environment which any Labour government would inherit. The public finances would be in a fragile situation. Government debt is approximately 100% of GDP; debt interest is one of the highest items of government expenditure; public spending projections require substantial cuts in unprotected departments; and taxes are already at the highest level for 70 years. Calls for higher spending may be irresistible, but there is little scope for additional borrowing and higher taxes would be politically challenging.
According to Labour itself, however, save for a handful of tax reforms aimed at wealthier taxpayers, that is not the solution. “We cannot tax our way to prosperity”, says Shadow Chancellor, Rachel Reeves, the answer instead, she says, is to deliver higher economic growth. This is where the opportunities arise for private capital, even if – as we discuss below – this may come with strings attached.
Some elements of Labour’s growth plan are of broad application, such as planning reform, an industrial strategy, and a closer relationship with the European Union. Some elements, however, are of particular interest to the private capital industry.
Most obviously, Labour is keen to divert a greater share of the assets of pension funds into higher risk investments. This is not very different to the agenda set out by the current Chancellor, Jeremy Hunt, in his Mansion House speech in July 20231. Reeves has promised to review the entire pensions landscape – including private sector defined contribution and defined benefit schemes as well as local authority pensions - to ensure it delivers “full potential” for savers and companies. She is reportedly keen on a “French-style scheme” under which DC funds and the British Business Bank would come together to channel money into UK firms with growth potential. Labour, like the current Government, is wary of mandatory targets on pension funds investing in UK assets but the ambition is clear, pension funds are expected to invest more in growth assets. How that is to be achieved is still to be answered, but there is already momentum to build on and in the wake ofJeremy Hunt’s speech, nine of the UK’s biggest defined contribution scheme providers made the “Mansion House Compact” agreeing to try and allocate 5% of default fund assets (up from 1%) to unlisted equities by 2030 – including for example venture capital and buyout funds.
Labour has ambitions to replicate the French Tibi scheme launched in 20192. The scheme’s objective is to finance French tech start-ups/scale-ups and make France the leading centre for international investment in technology companies in Europe.
Under this scheme, the Government asked institutional investors (mostly insurers) to pledge a portion of their capital to be invested in French venture capital and buyout funds (both listed and unlisted). To receive the Tibi label, funds must be approved by the Treasury. The approval criteria established that a fund’s management company must be primarily established in France and the management team must at least be partly located in France. There is also a preference for French fund structures. The underlying fund strategies must have a French presence but can invest in start-ups outside the country.
The Tibi initiative has been considered a success with over 20 institutional investors pledging to commit €6bn to these funds. In 2023, the initiative was extended, and is to provide an additional €7bn over the next three years. Whilst there is a clear direct benefit for the French asset management industry, the impact on French start-ups/scale-ups is less direct. According to Cedrus and Partners’ analysis, only one quarter of the funds with a Tibi label have a strong geographical focus in France, suggesting that a significant portion of this capital may instead be growing European or US companies. If Labour followed this same approach with its own UK scheme, this could allow UK-based managers to benefit from this scheme even if they don’t operate UK-centric investment strategies.
Source: Cedrus & Partners 2020.
The Tibi scheme was not targeted at defined contribution pension schemes (these schemes still make up a small portion of the French pension system) but rather French insurance companies. Whilst several of the insurers that pledged capital to the Tibi scheme do operate their own defined contribution style funds, there is no indication that commitments would be made on behalf of these funds. Evaluating fiduciary duties has therefore been less relevant for those institutional investors assessing the French Tibi programme, but this will be an important issue for defined contribution pension providers, were a new Labour government to try and introduce a similar scheme here.
Pension fund reform is likely to result in additional funds being diverted towards high growth investment opportunities. Another of Labour’s policies may create additional opportunities for those funds investing specifically in the green economy. Labour has set out its intention to establish a National Wealth Fund (NWF), initially announced in the Labour conference in Liverpool in September 2023. Reeves again referred to the plans at the World Economic Forum in Davos this year. The intention is that this NWF will invest alongside the private sector in “gigafactories, clean steel plants, renewable-ready ports, green hydrogen and carbon capture along with supporting service industries, as well as in at least four industrial clusters in Scotland, Wales and England”, with every £1 of Government money being leveraged by £3 from private capital.
A NWF is a new departure for the UK and may assist in making certain investment opportunities viable. At this point, it is unclear how exactly it will operate, and sceptics will fear that it will lack independence from government. For example, will its objectives be purely commercial, or will its investment decisions be driven by wider social, environmental, labour relations and even party political (tilting investments towards marginal seats, for example) considerations? This may be unduly cynical but dealing with a potential NWF will be different from dealing with a strictly commercial co-investor.
In a tougher fundraising market, fund sponsors will cautiously welcome any further capital provided by a NWF or coaxed out of existing pension fund investors. When quasi-governmental investors interact with private capital, or when asset allocations from pension groups are encouraged by government, this often leads to:
As hinted above, commitments from a new NWF or from enhanced pension fund allocations will likely come with noncommercial requirements.
Fund sponsors may also come under pressure to change the way in which they make, operate and exit, their investments.
UK defined contribution pension schemes have operated with a blended fee rate cap of 75 basis points (the “charge cap”), and the conventional wisdom has always been that such schemes will struggle to reconcile the charge cap with the management fee levels charged by private capital funds. However, the reality is that given the preponderance of lower charging passive funds in some of these schemes, trustees may have a bit more wiggle room to allocate to more expensive private fund investments, especially if they can also negotiate headline fee discounts for making earlier and larger commitments to fundraisings. Performance fees have also been excluded from the charge cap since April 2023, which also gives managers more freedom in how they structure compensation. There is undoubtedly still some work to be done by fund sponsors to convince pension fund trustees that private fund investments represent real value on a risk-adjusted and liquidity-adjusted basis, but the Mansion House Compact demonstrates that the larger pension fund providers are coming around to that position.
A NWF will potentially face internal pressures to achieve “value” for the UK taxpayer especially in a tougher fundraising market where it is making an early cornerstone commitment. An easy way to achieve that is obviously to condition larger commitments on fee and carried interest discounts. More interestingly, a NWF may also be obliged to invest only in “structures” which are UK domiciled. This may extend not only to the fund vehicle itself, but to elements of the sponsor structure. Fund sponsors who, for a variety of reasons, operate their business or hold carried interest through offshore entities, may be obliged to simplify these arrangements before their funds accept NWF commitments. Alternatively, bespoke structures may need to be created for NWF investment vehicles separate to the main fund vehicle, with their own carried interest and co-investment entities.
Irrespective of the outcome of the next General Election in the UK, the incoming government will face spending decisions and investment requirements which cannot be satisfied out of the public purse alone. The private capital industry should already be thinking about if and how it can adapt to the new priorities investors may have. We expect to see many more conversations in this area, and in particular, a growing interest in running fund programmes through multiple vehicles, which can cater for different investor bases with their own investment policy or economic provisions.
