By Steve Webb
In the first few hours after the result of the EU referendum became known, savers could have been forgiven for being in a state of shock. Stock markets slumped, Sterling crashed and long-term interest rates fell to their lowest level ever – hardly the most propitious backdrop for investment. But once the immediate turmoil is over – and stock markets have already recovered much of their early losses – what does this mean in the long-run for different forms of pension savings?
The first thing to say is that strong pensions depend on a strong economy. A strong economy will generate the tax revenue to pay decent state pensions, will see investors in businesses get good returns and will enable employers to pay good wages and provide decent workplace pensions. Regardless of the short term volatility of markets in response to the EU vote, the key question is whether, in the long-run, the UK economy performs better or worse outside the EU.
Supporters of the Remain camp argued that bigger trade barriers will reduce inward investment and will damage growth, while the Brexit camp argued that the UK will prosper as a more lightly regulated nation, able to sort out its own trade arrangements with the rest of the world. The consensus of most economists was very much in the former camp, and there can be little doubt that the current period of uncertainty is bad news for the economy, but it is too early yet to see what the lasting impact will be.
The impact of Brexit on pensions will depend on the sorts of pension rights which people hold and the things that they are invested in.
Starting with state pensions, which remain a major part of most people’s retirement plans, the main uncertainty surrounds the relatively generous ‘triple lock’ arrangement for uprating pensions. If there is pressure on public spending then it has been suggested that commitments such as this will be pared back. However, if the referendum reminded us of anything it is the power of the ‘grey vote’. I am therefore rather sceptical of the argument that politicians who want to get re-elected will choose to balance the books by breaking a manifesto commitment to the group most likely to turn out and vote.
In terms of private pensions, those who had their money invested in UK companies clearly took a hammering in the early hours of 24 June. But relatively few people have all of their money invested in this way, especially if they are benefitting from financial advice. The fundamental value of diversification or ‘not putting all your eggs in one basket’ has been shown to be true again. A well-diversified pension pot will include a wide range of assets (such as government bonds, corporate bonds, equities, commodities, property etc.) and in a range of markets at home and abroad. While any one of these investments might take a hit, a balanced portfolio should be able to withstand a shock.
In this context, it is vital to remember that pensions are a long-term business. A new worker starting out today will be enrolled into a workplace pension at the age of 22, will probably not retire until they are 70, and will probably live into their mid 90s. Over that period they are likely to see a series of stock market booms and busts, and the important thing is not to over-react. Private investors notoriously sell after a slump (hoping to minimise their losses) whereas history suggests that this can often be the best time to invest. Kneejerk reactions to volatile markets are unlikely to be the best response.
There are however two key areas where the fall in interest rates, reinforcing a prolonged period of unusually low returns, is likely to cause problems.
The first of these is in company pension schemes. While relatively few workers in Britain today are building up new rights in salary related pension schemes, there are still thousands of such schemes in operation and the vast majority of these were already in deficit even before the latest events. When interest rates fall, the rate at which future pension liabilities are ‘discounted’ is reduced. In simple terms, you have to put more money aside today to pay for a pension liability in the future because today’s money will not grow as quickly as you previously thought. The fall in interest rates since the referendum has already added tens of billions of pounds to the deficits of UK pension schemes.
The consequences of the rise in deficits will not be felt immediately. In general, companies are given a decade or more to fill any hole in their pension fund. But large employers are already spending billions of pounds topping up pension funds and those bills will increase. This will mean less money for investment or wages and will increase the chance of more firms going to the wall with a hole in their pension fund. Fortunately there is a lifeboat ‘Pension Protection Fund’ which covers most of the rights of pensioners in these circumstances, but it does not provide full compensation.
A second knock-on effect of low interest rates is a further fall in annuity rates for those wanting to turn a pot of savings at retirement into an income for life. Annuity rates have been falling steadily for years, partly because people live longer, and partly as rates of return have fallen. Since the referendum, the rates available to those planning to buy an annuity have fallen further. Again, fortunately, savers are no longer forced to buy an annuity with their pension pot, but people with modest means may have limited options.
It is very hard to see recent events as good news for pensions. If Brexit brings long-term damage to our economy then pensions of all sorts will inevitably suffer. But those who invest for the long term and who diversify their savings probably stand the best chance of riding out the storm. Steve Webb was pensions minister 2010- 2015 and now works as director of policy at Royal London
By John Hunter
So we face the most fundamental structural change in this country’s commercial and trading relationships for three generations. What does that mean for private shareholders?
The first surprise, maybe, is that there is nothing that can be usefully said about whether, or what, to buy or sell. With modern markets a British citizen can invest in almost any business in almost any major country with a few taps at a terminal. What general statement can we make about such a diverse activity? Are the prospects for the $60trn worth of companies listed on the world’s exchanges reflected in prices? And if not, why not? If your answer is that the market has got it wrong, then by all means back your judgment, but don’t expect me to recommend that you do so.
A better question to ask is: has Brexit changed the fundamental relationship between shares and the other asset classes – the relationship causes us to decide how much to spend and how much to save, and within that how to distribute our savings between different asset classes? Have shares become more risky relative to cash, making them a less desirable asset to own? Well possibly, but with gilt yields falling maybe the risk premium of shares over cash (the compensation that investors receive for owning a risky asset) has widened. In other words, maybe it’s in the price.
In short, who knows?
But there is an aspect of Brexit that is more important for private shareholders than the direction of markets; and that is the legal basis of their shareholding. And Brexit could potentially have a profound and adverse impact on this.
Some digression is necessary. If you own a picture there is no ambiguity about its status, your rights to do with it what you want, or your needs to protect it. But if you own a share all you’ve got is a piece of paper (or, more likely, some bits in somebody else’s database). Four things give those bits value: the nature of the obligations that others have undertaken in your favour (called ‘shareholder rights’); the degree of certainty that those obligations will be honoured (usually called ‘counterparty risk’); the security of the ownership chain connecting you to the bits in the database (‘transaction risk’); and the underlying regulations and law that secure this structure.
The UK has one of the most sophisticated, powerful and influential financial services industries in the world. The taxes on its earnings amount to £66bn – over 10 per cent of tax revenue. This position of political and economic power gives the industry leverage with government, translated into a reluctance to regulate in favour of the individual and against the interests of the industry.
Individual investors increasingly invest through online accounts. But, uniquely for the UK, such a private investor does not become a shareholder. ‘Shareholders’ are those whose names are on the Register of Shareholders. But in the UK the broker buys shares on behalf of the investor using what’s called a nominee account, and not in the name of the investor. The investor has no rights as a shareholder and no right of action against the company. What he has is a contract with his broker. He has taken on counterparty risk (mitigated by segregation rules but dependent on the broker’s internal systems of segregation) and transaction risk. He has no voting rights. Some brokers offer to vote their shares according to the investor’s instructions, but even here there is no third-party control of the process and no check on whether it has done so.
You’ll not find this properly explained in any public arena that I have seen. Brokers ignore it if they can. The London Stock Exchange describes nominee account investors as ‘legal owners’ and does not mention the voting issue.
Why does this matter? Because the votes are left in the hands of financial institutions who have no skin in the game and may have less-than-worthy reasons for exercising that vote in ways that reward the suppliers of financial services at the expense of the best interests of long-term investors.
This is where Europe comes in, or would have. Through the Shareholder Rights Directive (SRD) the EU is pursuing a course of harmonising basic principles. This requires rules of behaviour for the intermediation chain – the trail of transactions that links the shareholder (the ‘name on register’ in UK terms) with the beneficial owner (the investor, who carries the financial risks and rewards of ownership). Broadly, financial institutions in the EU are less influential than in the UK and concern for the individual investor is correspondingly stronger. (In the UK campaigning groups for private investors can boast 4,000 members. In Sweden the figure is 65,000.) Consistent with that spirit, the SRD set out a basic principle of intermediation: that intermediaries should be able to identify the ultimate owner. This would ensure that the company could identify its real investors (a UK quoted company cannot, except via a laborious one-off discovery routine) and would remove all barriers to prompt shareholder communication and to voting.
This would have changed the tenor of the debate. As it is we must hope that the new attention to be paid to the ‘disregarded middle’ of voters following the Referendum might be matched by a new consideration for the rights of real shareholders. John Hunter is chairman of the UK Shareholders’ Association (UKSA)
Your savings and your house price
By Robin Fieth
It is hard to predict how the UK economy will react to the Brexit vote over the next few months, but economics do have some effect on consumer confidence. One thing we do know is that leaving the EU will be a long, slow process taking two years once notice is served under Article 50. This means there is plenty of time to prepare: Life goes on and it is business as usual. People still need somewhere to live, so the need to buy, sell or rent property remains. The supply of mortgages is good, rates are attractive and the approach to assessing how much a customer can afford to borrow is unchanged. There may be blips in demand if confidence causes some consumers to put decisions to buy or move on hold for a while, but so far there is little evidence of consumers in the process of buying changing their minds.
House prices reflect developments in the wider economy, and the market is sensitive to a number of local variations, not just the UK’s position in the EU. Prices are primarily a function of supply and demand though, and in many areas of the UK we don’t have enough homes so prices will be supported. If demand falls, prices may move down a little but there is no reason to expect anything dramatic. Fixed rates, which account for about 80 per cent of new lending are likely to remain popular, although shorter terms around the two year mark may become the period of choice.
We anticipate that the next change in the Bank Base Rate will be down, with a clear signal from the Bank of England that this is may happen over the summer. With savings rates low and some mortgage rates under 1 per cent already, it is unlikely that we will see any wholesale rate changes from providers as a result. Savings are just as safe today as they were before the Referendum result. The Financial Services Compensation Scheme continues to operate as it has done for years and protect the same level of savings as it has done since December 2015 – £75,000 cover for single name accounts and £150,000 for joint accounts. Interest rates on savings, including cash ISAs, have continued to move on individual products since the Bank Base Rate moved – to 0.5 per cent in 2009. Variable rates on ISAs and other savings products are affected by many factors including competitor rates, levels of liquidity and the appetite to lend of individual institutions. Cash ISAs remain a valuable part of a savings portfolio and we do not forsee any change in the tax advantages they have. Robin Fieth is chief executive of the Building Societies Association