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(Bloomberg) — The UK could claw back pension tax breaks from asset managers that fail to invest enough domestically, the head of the British Business Bank said in a warning about the stakes for the industry as the government pursues a key growth initiative. 

Louis Taylor, effectively a government official in his role as chief executive of the state-owned lender, insisted that he was not endorsing the idea but pointing out how the government can boost funding for growth-enhancing projects at no cost to taxpayers and without resorting to full compulsion. The industry prefers Australian-style tax reliefs to incentivize investment.

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Prime Minister Keir Starmer is counting on the private sector to deliver the faster growth his new Labour administration has promised. Funds deemed to be investing too little in the UK are under scrutiny because they already gain considerably from tax relief on worker pension contributions, which boosts assets under management. 

So far, the government has stopped short of setting minimum allocations to UK assets but Pensions Minister Emma Reynolds this week refused to rule out more draconian measures.

“We’re not talking about it for now, but let’s see where we get to,” Reynolds told the Financial Times when asked about the controversial step of mandation. “Investment in pensions is, as you know, very generously provided for in terms of tax relief.”

In an interview with Bloomberg before Reynolds’ comments were published, Taylor said that rather than providing additional tax breaks, the government could instead strip funds of some of the benefit they currently receive.

“It is open to the exchequer to say, unless your scheme has invested a proportion in the UK, we will recoup the tax benefit you’ve got. You could recoup it from the pension plan,” he said. “That would be fiscally positive for the Treasury – in the sense that the deduction is happening anyway, but anything they claim back is a positive.”

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Pension contributions are deducted from earnings before they are taxed, in a relief worth around £50 billion ($63 billion) a year at a time when the public finances are stretched. For a basic-rate taxpayer, it amounts 20% relief on contributions and 45% for a top-rate taxpayer. A levy on pension funds that underinvest in the UK would not quite amount to mandation because they could still invest overseas if they judged doing so outweighed the cost of higher taxes.

Starmer has pledged to deliver sustained growth of 2.5% a year and improve living standards, a challenge for an economy plagued by near-stagnant productivity since the 2008-09 global financial crisis. The malaise is widely blamed on chronic underinvestment in infrastructure and start-ups.   

Ministers would like pension funds to commit at least 5% of their assets to the UK and are hoping a disclosure regime will be enough to ensure it is achieved voluntarily. Taylor said the threat of recouping tax relief could encourage investment in infrastructure and venture capital but might also damage the UK’s “reputation among international investors of an open economy where there is a lot of freedom.” 

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He added: “This is difficult for the government. There are no easy answers here. It’s got to be quite gradual. But it has the ability to change the growth rate of the economy. Venture capital requires a bit of patience, infrastructure investment requires some patience, and pension money is patient capital.”

The BBB, an independently managed development bank set up to help small and medium-sized enterprises, has £7.9 billion to co-invest with private-sector partners. It also manages state loan guarantees and the emergency Covid business loan portfolio, including the bounce back loan scheme for small firms. 

For the moment, the government is moving cautiously. Last week, Chancellor of the Exchequer Rachel Reeves promised new laws to consolidate the UK’s fragmented pension fund industry into fewer, larger players that have the scale to invest in major projects and riskier scale-up companies. She hopes the move will unlock £80 billion of productive capital for domestic investment. In an interview with Bloomberg TV, she said the government was “not looking at mandating pension funds.”

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Taylor said UK pensions funds perform more poorly than those in the US, Canada and Australia because they are managed in “a very risk-averse way.” Canadian funds invest 15 times more in private equity and venture capital start-ups than their UK equivalents and deliver better returns for scheme members, according to BBB analysis.

“We have the second-biggest pool of pension money in the world, and it’s not investing in productive assets in our economy,” Taylor said. “You should want to be overweight the UK, because it is a disproportionately strong ecosystem for innovation.” UK pension funds allocate just 4.4% to UK stocks, compared with 50% at the turn of the millennium, according to the think tank New Financial.

Not all investors oppose mandation, Taylor claimed. Trustees face tough oversight on fees that drives money toward safer asset classes that are cheaper to manage. “Some feel that if they were mandated, then the question of whether they get into venture capital or not is taken away. It’s just how they get into it. They may feel that would be a good thing. Others would feel that’s outrageous. They’re telling me what to want to invest in,” he said.

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