Hidden among the Autumn Statement back up documents was the announcement that LGPS pooling guidance had been released. What do trustees need to know?
The Local Government Pension Scheme (LGPS) has been in turmoil since the Chancellor of the Exchequer announced that councils would be required to pool their funds into six British wealth funds worth £25bn-£30bn at the Conservative Party conference.
The government is inviting administering authorities to come forward with their initial proposals for pooling by 19 February 2016.
The proposals must meet four criteria outlined by the guidance:
i) Asset pool(s) that achieve the benefits of scale
Authorities must outline the scale benefits that their chosen pooled arrangements are expected to deliver and explain how those benefits will be realised, measured and reported.
ii) Strong governance and decision making
The proposed governance structure for the pools should provide authorities with assurance that investments are being managed appropriately at a local level - in line with the fund’s stated investment strategy and in the long-term interests of their members.
At the pool level, funds must ensure that risk is adequately assessed and managed, investment implementation decisions are made with a long-term view, and a culture of continuous improvement is adopted.
iii) Reduced costs and excellent value for money:
The government is asking funds to adopt more transparency when it comes to fees. In particular it will be expecting funds to report on “hidden costs that are difficult to ascertain and so are rarely reported in most pension fund accounts”.
Proposals should explain how the pool(s) will deliver substantial savings in investment fees, both in the near term and over the next 15 years, while at least maintaining overall investment performance.
iv) An improved capacity to invest in infrastructure:
Only a very small proportion of Local Government Pension Scheme assets are currently invested in infrastructure and the government is expecting pooling of assets to facilitate greater investment in this area.
Proposals should explain how infrastructure will feature in authorities’ investment strategies and how the pooling arrangements can improve the capacity and capability to invest in this asset class.
What do trustees need to know?
1) Active vs. Passive
The pressure on the LGPS to ‘go passive’ has existed for a while, but the new guidance will intensify it. The document states that:
“Active fund management should only be used where it can be shown to deliver value for money, and authorities should report how fees and net performance in each listed asset class compare to a passive index.
Active fund management should only be used where it can be shown to deliver value for money”
“In addition authorities should consider setting targets for active managers which are focused on achieving risk-adjusted returns over an appropriate long term time period, rather than solely focusing on short term performance comparisons.”
2) Holding on to assets
The Government’s presumption is that all investments should be made through the pool, and has asked funds to declare “any assets they propose to hold outside the pool(s), and the rationale for doing so”.
One expected exception is direct investment in property.
Directly held property is often used by authorities to match specific liabilities or to generate regular income.
A number of consultation responses stressed the importance of retaining direct ownership of property outside of any pooled arrangement.
The Government’s presumption is that all investments should be made through the pool”
The concern is that if a fund’s property assets are pooled the returns may no longer correctly match liabilities or meet the cash-flow requirements that had underpinned the decision to invest in property directly in the first place.
The government has said that authorities may therefore explore whether to retain a small proportion of their existing investments outside of the pool.
However exemptions should be minimal and funds will need to demonstrate clear value for money.
3) Backstop legislation
The government has announced it will be consulting on ‘backstop legislation’ giving the Secretary of State the power to force the Local Government Pensions Scheme to pool its assets.
According to the new draft consultation announced in the Autumn Statement: “The power has been left intentionally broad to ensure that a tailored and measured course of action is applied, based on the circumstances of each case.”
In particularly concerning cases more substantial action might be required”
The document states that while in some cases it may only intervene over certain parts of an investment strategy, in “particularly concerning cases”, more substantial action might be required.
The proposed intervention might include, but is not limited to:
- Requiring an administering authority to develop a new investment strategy statement that follows guidance published under draft Regulation
- Directing an administering authority to invest all or a portion of its assets in a particular way that more closely adheres to the criteria and guidance, for instance through a pooled vehicle.
- Requiring that the investment functions of the administering authority are exercised by the Secretary of State or his nominee.
- Directing the implementation of the investment strategy of the administering authority to be undertaken by another body.
Authorities are asked to submit their initial proposals to the Government to LGPSReform@communities.gsi.gov.uk by 19 February 2016.
Submissions should include a commitment to pooling and a description of their progress towards formalising their arrangements with other authorities. Authorities can choose whether to make individual or joint submissions, or both, at this first stage.
Submissions should include a commitment to pooling”
Refined and completed submissions are expected by 15 July 2016, which fully address the criteria in this guidance, and provide any further information that would be helpful in evaluating the proposals.