Memorandum submitted by the London Stock
Exchange
The London Stock Exchange is one of the world's
foremost equity exchanges and a leading provider of services that
facilitate the raising of capital and the trading of shares. The
London Stock Exchange is the most international equities exchange
in the world and has Europe's largest pool of investment funds
and liquidity. The market capitalisation of UK and international
companies on the London Stock Exchange's markets is £4.2
trillion. [1]
SUMMARY
1. The London Stock Exchange has been active
in the pensions debate. We made an initial submission to the Pensions
Commission consultation and held a subsequent meeting with Lord
Turner. We have made it clear that in order to encourage individuals
to save and in order to meet society's liabilities, a funded pension
system must invest in assets that offer a return greater than
the no-risk rate of return.
2. However, we believe that such a system
must be constructed in a way that the cost of sales and management
do not eat into its value. Furthermore, in a defined contribution
environment, the risk being borne by savers may lead to poor choices
unless investment understanding is improved.
3. There are many aspects of the NPSS that
deliver an effective framework for individual pension saving.
This briefing will focus on these positive aspects first before
moving on to the challenges.
BENEFITS
3. The workplace is the most important and
useful place to encourage people to save. In the most part, employers
are trusted by their workforce and employees are more likely to
save if the employer is making a contribution. That is why we
recommended that employees opt-out rather than opt-in to occupational
pensions. We were pleased that both of these principles are recognised
in the NPSS.
4. We support a choice of funds being offered
to savers. We believe that such a choice is necessary to suit
the risk tolerance of the general population. However, we remain
concerned that savers do not understand the concept of risk and
return sufficiently to put their pension in the best performing
asset class. A recent Populus poll for the NAPF found that more
than half (57%) favoured "accounts paying a low rate of interest
but where you were guaranteed not to lose money". A quarter
chose "the property market" whilst only 14% selected
equity. This can also be seen from the investment in Child Trust
Funds where most people who have selected an account have selected
cash funds. More needs to be done alongside the NPSS to educate
savers about risk and return.
5. We support the lifestyling of the default
fund. The Pension Commission report acknowledged that "people
have difficulty making rational, long-term savings decisions without
encouragement." As a result the default fund (for those people
who don't chose an explicit fund) recommended in the report will
be made up predominantly of equities, moving to bonds as retirement
approaches. This is significant as in the case of Sweden the default
fund contains around 90% of all funds under management. However,
as pensioners are living longer in retirement the definition of
lifestyling may need to change to take into account the need for
better investment returns over a longer retirement period.
6. As pensions are held for the long term,
exposure to equity will be crucial in delivering superior returns.
Annualised real return on UK equities, dividends reinvested over
106 years, is 5.5% whereas annualised real returns on UK gilts,
coupon reinvested over 106 years, is 1.4%.[2]
Based on these figures it is easy to see the consequences of two
long term investment strategies: For equities, £100 invested
over 40 years at a compounded rate of 5.5% leaves a saver with
£851, the same £100 invested in Bonds would yield just
£174.
CONCERNS
7. Concerns have been raised about employers
using the NPSS "minimum standard" as a means of reducing
their pension benefits. We do not believe this will be the case.
Currently pension remuneration differs widely across companies
on our markets and we do not believe that the NPSS will cause
a major shift downward in the levels of provision. Many companies
use pension payments as a competitive advantage in much the same
way as other workplace benefits.
8. Affordability is an issue for smaller
companies where pension provision is less generous. We believe
that the employer contribution rate should be set at a level that
takes into account UK competitiveness and which would be affordable
for smaller companies. However, the decision to impose this cost
on business is essentially one for Government who should bear
in mind the broader business taxation environment when deciding
upon the contribution rate.
9. We have raised concerns about forced
saving as it creates a false comfort by providing a Government
approved "minimum" level of saving. It may also force
people to save who may be better off making other lifestyle choices
(for example paying off debts and mortgages). There is a challenge
for Government to ensure workers understand the need to save in
a pension and the appropriate age for the NPSS to start.
10. Although the NPSS envisages low scheme
costs, Stamp Duty will continue to be levied at 0.5% every time
a pension fund purchases UK equity. This is a significant cost
and, over the lifetime of a policy, Stamp Duty will take thousands
of pounds out of an average fund. As intermediaries are exempt
from Stamp Duty it is largely paid by individuals and pension
funds. Its effect is to guarantee UK pensioners a lower income
in retirement. We believe that it is not possible to focus on
overall scheme costs without looking at the effect of Stamp Duty
which, is effect, a stealth tax on pension fund saving.
March 2006
1 Source: London Stock Exchange, Main Market Factsheet,
February 2006. Back
2
Source: Global Investment Returns Yearbook, London Business School/ABN
AMRO, 2006. Back
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