For good reason, pension funds are highly regulated and decision-makers are understandably cautious. Beneficiaries, most of whom are not themselves sophisticated investors, have to know that their savings are invested prudently and in accordance with their liquidity needs. However, it is crucial to get this regulation right, because an overly conservative approach could depress returns, concentrate risk and make it harder for socially valuable long-term investment projects to get funding.

This is especially relevant in the United Kingdom now. The market is rapidly moving away from “defined benefit” schemes, where an employer and its pension fund trustees effectively assume responsibility for paying out pensioners a pre-agreed sum, and towards “defined contribution” (DC) schemes. In DC schemes responsibility shifts to the beneficiaries – and those who manage money on their behalf – to ensure that expectations can be met in retirement. There are a number of reasons why private fund managers (and other illiquid asset classes) have found it hard to access this growing pool of capital in the past, but regulation is certainly one of them. Now there are laudable efforts to change that, given extra impetus by the Patient Capital Review, published by the UK Treasury in 2017 and led by private equity veteran, Sir Damon Buffini.

Two important consultations issued by one of the UK regulators, the FCA, closed last week. The first consultation proposes a relaxation to the strict rules that regulate the types of investment that can be included by UK insurers in so-called “unit-linked” funds when the policyholder or underlying beneficiary is an individual who bears the investment risk. These funds are an important way in which DC pension funds access investment opportunities and the current restrictions on the type of assets an insurer can invest in for the purposes of these linked fund products make it hard for long-term, illiquid investments to feature in them. The UK’s regulator is proposing to change that, so that insurers would be able to invest a greater proportion of their linked funds in assets “that are illiquid or offer higher expected returns to compensate for higher risk”. In return, they would be required to comply with enhanced investor disclosure and transparency requirements, to ensure that the investments were suitable for retail investors, and to manage liquidity requirements. There will also be an overall limit on illiquid assets. Specifically, this change would allow investments in certain illiquid unlisted securities, as long as the fund as a whole meets liquidity requirements.

The second important paper is related, but it looks at the rules applying to UK FCA authorised funds that are suitable for retail investors, and certain “specialised” funds, which are recent creations of European law. This paper seeks views on how the UK regulator could adjust its rules on authorised funds to reduce barriers to investment in “patient capital” and, in particular, discusses the liquidity, diversification and valuation requirements for such funds. All FCA authorised funds are open-ended, and there is little precedent for private equity investment under this model, given the liquidity concerns – but the FCA leaves the question open as to whether authorised funds can invest in wider types of “patient capital”, including private equity. The FCA then explains the three types of “specialised” funds that, in theory, facilitate investment in patient capital – European Long Term Investment Funds (ELTIF), European Venture Capital Funds (EuVECA) and European Social Entrepreneurship Funds (EuSEF) – and seeks views on why so few of these funds have been raised in the UK.

Not surprisingly, the UK’s private equity industry association, the BVCA, has welcomed the broad thrust of these proposals, and the openness they demonstrate to finding a way forward. They certainly give some hope that, in future, more capital might be unlocked for private equity and venture capital investment. The process of overcoming the barriers will be a long one, and regulation is not the only change required. But things are moving, slowly, in the right direction.