Blain’s Morning Porridge Nov 15th 2024: Mansion House, Brexit Unwind, Financial Deregulation and Megafunds.
“I don’t know what London’s coming to – the higher the buildings, the lower the morals!”
Oh, to be a fly on the wall while they wrote the speeches for last night’s Mansion House dinner. The Bank’s Bailey railed against Brexit, while Chancellor Reeves plans to deregulate financial services and refocus UK investment through new Megafunds. What could possibly go wrong?
Last night’s Mansion House Dinner in London – the annual event hosted by the new 696th Lord Mayor of London, Alastair King, for the great and the good of the City’s financial glitterati at the beginning of his one year tenure – was particularly significant. Chancellor Rachel Reeves and Bank of England Governor Andrew Bailey presented their vision and tone for the future of the City with set-piece speeches on growth and investment. I am hopeful they have recognised the need to finally reverse 2 decades of decline… but I do have concerns.
I was very fortunate to meet the former Lord Mayor (No 695); Professor Michael Mainelli, a distinguished scientist and economist. Far from the Lord Mayor being a stuffy throw-back to the age of Dick Whittington and ancient traditions (including the frankly ridiculous stockings), it remains an important and influential post – linking London’s trading and financial past with its’ future. Prof Mainelli was very clear about the possibilities for London’s past and future mercantile successes intertwining to create a new hub for dynamic knowledge-based innovation.
He had taken me to task for writing about my oft expressed belief the City of London’s position at the forefront of financial markets was in terminal crisis. Over a nice cup of tea, (a polite invite for tea is the clearest signal the English establishment can send warning you have said the wrong thing), Prof Mainelli made a succession of powerful points about how the UK’s innovative strength, including our universities and entrepreneurs, could connect new ideas with finance through the City to drive growth for the future. He’s spent the last year as the City’s very effective ambassador to the world.
At last night’s Mansion House bunfight, Governor Bailey will have upset the remaining hardline Brexiteers. (Yes, they still exist.) He said what the rest of us are thinking – the US will be in no rush, nor particularly minded, to give the UK a trade deal and will likely be increasingly isolationist. As the USA turns it back, our future lies in creating a better, lasting relationship with Europe now – while we still have the chance.
Chancellor Reeves made an astute comment – something everyone in the City has known since the dark day of 2008: “The UK has been regulating for risk, but not regulating for growth.” That’s a critical admission – but can she deliver the much needed change that will restore leadership and relevance to the UK’s financial industry?
Since the Global Financial Crisis, the overriding concern of the “Regulatariat” has been the prevention of a repeat pivotal event like the collapse of Lehman Brothers. The multiple bank bail-outs, the mistakes of over-easy interest rates and QE fuelling the (largely growthless) rally in financial assets, the business of finance has been hit with successive waves of over-regulation were designed to avoid that last crisis ever happening again. The cost of the increased regulatory burden has been huge – over-regulation has crushed much of the entrepreneurial free-market spirits of London’s financial businesses. (The problem, of course, is the regulators have been preparing to fight the last war, addressing the causes of the last crisis (risk concentration and leverage) rather than the likely causes of the next!)
I see it every time I meet younger bankers, financiers and investment professionals. They don’t have the same piratical gleam in their eyes my cohort of. young traders, bankers and financial technologists had in the 1980s and 90s. Their careers are bound up in rules and by their outlook calendars, and the tyranny of completing “learning modules” to ensure their compliance and mindset alignment to the regulatory blob.
The decline of the City’s spirit has been magnified with financial wokery – the cult of compliance (it’s always easier to say no), by ESG and sustainability professionals commanding the highest salaries, and the ever-increasing demand from the financial regulatory racket for more and more complex reporting. (That’s because any halfway competent regulator/bureaucrat knows the best way to avoid blame is to show they demanded information – even if it will never be understood.)
The most significant shifts in the structure of finance were post GFC reactive rules on banking capital and trading that effectively enforced the transfer of risk from banks into the investment sector. These rules have made banks look safer, but risk can’t be willed away through rules – all its done is move risk out of banks. It now resides in investment firms, from hedge funds to dull, boring, predictable pension funds.
The City, and global financial markets in general, are overly relaxed about these transferred risks. We mistake risk transfer as risk mitigation. There haven’t been any significant bank crashes in London since 2008 (Fog in Channel, Continent and USA cut-off remains the default mindset.) Risk is buried in asset books – meaning it no longer matters?
We know banks are very vulnerable to short-term liquidity crises – when crisis hit banks die fast. Liability crises are assumed to take longer to metastasise , and that there will be time to address any crisis. (Much as happened in 2022 during the Trussterf*ck when it was highly leveraged long-term Liability-Driven investment plays on Gilts nearly crashed the market as solvency risks came into focus. It was addressed by swift Treasury/BoE action.) The regulators think they are doing well – since 2008 there have been interest rate “tantrums” and few corrections, but generally a financial crisis has been avoided through the expectation governments and central banks will step into to rescue/bail out financial markets through easy monetary policy. That is massive risk, creating a complete misunderstanding of market risks.
Chancellor Reeve’s big plan is drive a “growth-focus” across the investment management sector. She is going to publish a strategy for financial services growth and competitiveness. That will be interesting – in the 1980s, UK financial institutions dominated global finance. Today, there is not a single UK firm in the top tier of banking or investment management. Undeniable Fact.
She also plans consolidation of the UK’s 82 local government pension funds into Eight New Megafunds – similar to the Maple 5 Canadian Funds and Australian Supers (Superannuation Funds) that prowl the global markets looking to snap up annuity-like infrastructure projects. While these foreign funds have scale to place between 5-8% of their assets into infrastructure, the UK’s proliferation on tiny local funds barely touch any private asset markets, constrained by advisors and other financial parasites urging them to keep buying gilts and lever them up.
I rang round some mates in the city to ask them what they thought about Reeves plans and the Megafund idea. I’ve wrapped all the responses together to present a picture of the what the current fund management and financial sector really thinks:
- There is a need for change. The current schemes are all too small, costly and staffed by council workers rather than investment professionals. (Many do very good jobs, but are not paid like City professionals.)
- The UK fund management sector is in crisis – “it has been complianced and woked to death!” The best British investment professionals are already working for US firms or understand the future lies in Dubai, Abu Dhabi and Singapore.
- Combining funds may simply combine existing bureaucracies – there is too much focus on risk, never ending discussions on “strategy”, and analysis paralysis over returns, that nothing will ever be decided on complex investments where national interest and returns converge!
- Turning round the bureaucratic mindset is critical. Simply take away the funds, close them down and hand the money to professional investors to manage.
- Big does not equal better, except in terms of cheaper operating margins. Big comes with costs. Warren Buffet says: “Once you have achieved size, it becomes much harder to find really good investment opportunities.”
- There is massive risk that government pressure on them to invest in UK firms and infrastructure will be misdirected. There are already great UK funds (like Shard Credit Partners) investing in UK SMEs. They need more capital to invest and have the skill sets to do so.
- Amalgamating funds does not guarantee success. It may just perpetuate misallocation of resources.
- Combining them means these people will be lost, and replaced by professionals, who will want to be close to markets, living and working in London, nullifying cost savings, and losing local connections. (There is even a letter in the Times this morning claiming the strength of local government funds is that they are locally based.. really? Check out the losses at some funds.)
- The Tories tried to create economies of scale by combining all the funds, but it was done in such a half-heated manner all it did was create 10 new “megafunds” and left all the other funds still doing their own thing. London CIV tried to combine some 30+ London Borough schemes. The employees – who don’t want to become “synergies” – naturally oppose any merger.
- The future megafunds, at £25 bln plus, will remain tiny by global standards. They will be beset by the financial parasites looking for consultancy and management contracts. “Why not just ask on the Canadians or Ozzie to run the money instead?”
Whatever happens, the plan to create Megafunds will be “interesting” but will it change the picture? I am unconvinced.
My Windshift Capital business is focused on finding private capital investors into alternative real assets. Much of what I do is financing small and mid-sized UK opportunities. I don’t bother calling any of the local government investment funds. I would be completely wasting my time. Even the established UK funds tend not to respond to the opportunities I show – great deals are bounced from desk to desk and end up in Limbo.
In contrast I can call German, French and US funds any amount of times and be told “go replicate yourself far away” or sometimes.. “that is really interesting, let’s chat.”
Funny old world.. finance.
Out of time, have a great weekend, and back to the day job..
Bill Blain
Author of the Morning Porridge, founder of Wind Shift Capital
2 Comments
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Interesting. I spoke with financial professionals actively involved in fund management and got a serious of sceptical outlooks for the megafund idea.
Anything that allows UK pension funds to increase their allocations to private capital to increase risk adjusted returns is good – and larger funds with significant pools of capital will, perhaps, encourage that.
This is what Pitchbook wrote this morning – very positive spin:
The UK government is bringing in a new rule to combine pension funds into eight mega-funds, with the hope of unlocking £80 billion (around $102 billion) in investment capital—a measure broadly welcomed by the private markets. Labeling it the “biggest set of pension reforms in decades,” UK finance minister Rachel Reeves plans to introduce a new Pension Schemes Bill that will consolidate defined contribution schemes and pool assets from the 86 separate Local Government Pension Scheme authorities across England and Wales.
The combined schemes are expected to manage around £500 billion in assets by 2030.
According to the government’s analysis, pension funds begin to deliver better returns once the size of assets they manage reaches between £25 to £50 billion, as they are then better placed to invest in a wider range of assets, including private equity and venture capital. The new proposal is largely welcomed by the private capital market.
Alliott Cole, CEO at London-based VC Octopus Ventures, is among those who have welcomed the news, saying it would benefit UK companies. “Providing additional sources of funding for these talented entrepreneurs will drive economic growth,” he said.
BVCA, the industry body for the venture capital and private equity sector, also said the move would likely boost domestic investments in the UK.
“Larger, consolidated pension schemes have greater opportunity to invest in higher growth assets, like private capital funds that drive investment into exciting UK businesses whilst delivering strong-returns for pension savers, ” said BVCA chief executive Michael Moore.”Moving quickly from consultation to concrete proposals and implementation will be key.”
Cautious optimism
Anne Glover, CEO at UK firm Amadeus Capital Partners, responded positively to the development albeit with caveats. “I cautiously welcome the consolidation […] as long as further conditions are also met. This includes [the funds] being able to recruit and compensate high-quality asset allocators who know how to invest in riskier asset classes such as venture capital, and not just default into infrastructure,” she said. “The pools should also find a way to accommodate the industry standard fee structures and compensation mechanisms of venture capital, which rely on successful outliers to deliver outstanding performance for underlying investors.”
She also noted the consequential increase in ticket size could drive the exclusion of smaller funds, including those looking at early-stage investments.
Comment from email:
What are the real issues?
To protect pensioners against the very small (but highly newsworthy) possibility that a private pension fund might fail to pay out the full promised pensions, the government set up the Pensions Regulator and the Pensions Protection Fund.
The new system has been a disaster.. Pension funds have been forced to ‘de-risk’ – switching from equites to ‘less risky’ bonds. This has pulled the rug from under the London Stock Exchange and investment in ‘low-return’ bonds has made pension schemes too expensive for companies. Most ‘final salary’ pension schemes have closed. Most British workers now have much worse pension expectations.
2. Will Supa-sized funds invest better? The model here is something like the Ontario Teachers Pension Fund. It has $255 billion and invests globally in many asset classes. A lot goes into infrastructure – and quite a lot of that is in Britain. The fund seems to have earned good returns. Infrastructure comes in big chunks and requires expertise. British funds are, currently, not players.
3. They new system probably won’t be cheaper. But it will expand the range of investment assets and may give a better risk/return trade-off. Reeves seems to be reversing policy and suggesting that local authority (and other) pension funds should be allowed to take more risk.
4. Pension fund managers may need to become more specialist. And giant funds may do more in-house. There will still be jobs. Since these are local authority funds that are being amalgamated, I expect their headquarters will be in the regions.
5. The elephant in the room is whether the government will direct the new Supa-funds to invest in UK infrastructure. Direction would be expected to lower returns. It would be resisted. But the government wants infrastructure investment and it might not happen without direction.