The UK government has announced today probably the longest awaited policy change in the LGPS investment world, with a proposal to remove the limits on asset allocation that have been in place since the 1980s. The consultation proposes moving to a prudential supervisory regime of the kind which has operated well in the private sector, as reinforced by the IORP Directive in the UK since 2005.
Having campaigned for this reform for so long and been a member of the review group established by DCLG, this is indeed a happy day for pensions in the UK (not a statement one can often make!).
So what has brought about this dramatic change of heart within government?
There are two main drivers for change:
- the desire to see economies of scale via pooling of investments, which would in turn result in cost savings but where arbitrary limits on the legal form of some (but not all) investments may frustrate the ability to pool; and
- developments in governance and fiduciary duties and the shadow of the IORP Directive, which has been hanging over the LGPS ever since the Trade Unions invoked it when arguing for a greater say in the operation of LGPS funds.
The consultation document glosses over the importance of the IORP Directive, although the Law Commission’s recommendation that Article 18(1) of the Directive (which requires investments to be made in the best interests of the beneficiaries) is duly acknowledged since “Ministers are satisfied that the Scheme is consistent with the national legislative framework governing the duties placed on those responsible for making investment decisions.”
The separate debate over the IORP Directive’s application to the LGPS was put on hold before today’s consultation document, since the work that the Scheme Advisory Board has undertaken in relation to the legal separation between the funds and their administering authorities is not seen as a key priority, certainly when compared with the push from the Treasury to ensure that pooling really gets started in 2016.
One other IORP issue that is skilfully addressed in the consultation, however, relates to the implementation of pooling. The new draft investment regulations will require funds to have an investment strategy statement that includes their attitude to risk, diversification, suitability, ESG and voting rights, plus the authority’s “approach to pooling investments, including the use of collective investment vehicles and shared services.” It must also reflect the fund’s own asset allocation limits.
The Directive is relevant to these new investment strategy statement requirements in that the new draft regulations give the Secretary of State the power to intervene if he believes that the authority is not having regard to government guidance. Intervention includes directing that the fund must invest in assets or descriptions of assets prescribed by the government. However, the IORP Directive (Article 18(3)) prevents EU Member States from requiring pension funds to invest in particular categories of assets, unless more stringent investment rules on an individual basis (where they are prudentially justified) are prescribed. This appears to square one particular legal circle quite neatly, even if the power to intervene may never be used.
Other welcome reforms include confirmation that derivatives are to be regarded as an investment (at last!) and removal of an anomalous provision whereby an administering authority could advise itself on its own investment strategy.
We expect there to be universal support for the government’s liberalisation of the LGPS investment regulations. Deregulation in this area is long overdue; it should reduce the burden on financial reporting and the need to get advice on interpreting the LGPS Investment Regulations. Moving to a prudential regime within the new environment of pooling should surely not be a problem for LGPS funds, since the recognition of their fiduciary duties as institutional investors is not a new concept for the funds.
What will require a lot more thought is how governance structures will need to be adapted to the new pooling proposals, but the government has sensibly not prescribed how such pooling must be achieved. It has accompanied the consultation document with the eagerly awaited pooling reform criteria and criteria and guidance, supplemented by a detailed technical paper from PwC (to whom Squire Patton Boggs provided legal advice) on the options available. Funds will be studying that guidance paper to ensure that their initial plans are ready for submission to Government by 19 February 2016 (the date when the consultation on the new regulations closes). The government has suggested allowing funds to adopt their new strategy by 1 October 2016.