Jeff Houston, Head of Pensions, LGA.
It sometimes seems a mere moment ago, but it is almost four years to the day that the concept of mergers in the LGPS was raised at an industry conference by the then local government minister. Since then we have seen two further ministers come to office, a Scottish referendum, a new government, Brexit and the Donald. No doubt there will be more surprises in the wider political landscape to come before the task is done.
So a quick journey back to May 2013 to set the scene. Remember 2013? When we had a final salary scheme, when coalition government was an exciting experiment not the end of the Lib Dems, the days before political populism and before Lance Armstrong fell off his bike-shaped pedestal Yes it seems like a different world.
In that world the minister introduced a ripple of uncertainty through the conference audience and a glimpse of the journey to come with these words:
“…the clear message from me this morning is that I am not wedded to the existing number of 89 funds in England and Wales. If it takes a smaller number of funds to improve the efficiency and cost-effectiveness of the Scheme, I shall not shy away from pursuing that goal.”
As with all potentially radical policy concepts it had already been the topic of a round table and was now to be the subject of a consultation to which all stakeholders where invited to respond.
Pooling in principle
Suffice to say the concept did not survive unscathed. Alternating through periods of feverish activity and moribund silence, it eventually emerged in November 2015 as a set of principles against which authorities were invited to bring forward proposals for half a dozen “asset pools”.
In between we had seen ideas for five or ten funds, a single alternatives asset pool, a move to passive vehicles for all listed assets, different pools for each broad asset type, liability driven pools and sectoral pools.
A signpost to the government’s thinking had been included in the summer budget 2015 Red Book:
The government will work with Local Government Pension Scheme administering authorities to ensure that they pool investments to significantly reduce costs, while maintaining overall investment performance. The government will invite local authorities to come forward with their own proposals to meet common criteria for delivering savings. A consultation to be published later this year will set out those detailed criteria as well as backstop legislation which will ensure that those administering authorities that do not come forward with sufficiently ambitious proposals are required to pool investments.
This was followed by the Spending Review 2015 which included:
The government will today publish guidance for pooling Local Government Pension Scheme Fund assets into up to six British Wealth Funds, containing at least £25 billion of Scheme assets each. The government is now inviting administering authorities to come forward with their proposals for new pooled structures in line with the guidance to significantly reduce costs while maintaining overall investment performance, with the wider ambition of matching the infrastructure investment levels of the top global pension funds.
The language of “British Wealth Funds” was at best unfortunate and the focus on infrastructure still resonates through the debate today.
The November principles encompassed the following objectives:
- Attain scale – with £25 billion set as a target size for pools
- Make savings – no target was set but the word “substantial” gave an insight into the expectations
- Include good governance – but no clues (as yet) as to what that meant
- Do more infrastructure – expressed as an objective to develop the capacity and capability to increase investment but without a target (as yet)
Since then we have seen a certain amount of “principle creep”. The governance expectation was further refined to include an FCA-regulated structure at the heart of the pool (we will come back to the FCA later), and the infrastructure ambition was linked to the concept of a national infrastructure platform mooted by government (as well as some within the scheme).
Pools start to emerge
In February 2016 submissions were received by government for eight nascent pools. These groupings were a mixture of natural allies, geographical neighbours and/or the strategically like-minded.
It has to be said that at the outset for many involved, the move to create the pools was done with a lack of conviction in its benefits. Potential estimates of savings remained just estimates, while the costs of set up were becoming all too clear and the risk of losing control over day-to-day decision-making was very real. For others, the risks were worth the real reductions in fees, already being seen across those asset managers who were keen to be the providers to pools, together with the ability to directly access alternative investment opportunities.
The eight pools proposed in February varied in size from around £10 billion to the mid £30 billions.
It was at the time of the February submissions that the idea of an FCA-approved structure first raised its head. In its November publication, the government had not clearly defined a “pool”, the intention being that authorities would explore the possibilities and submit proposals accordingly. Although two of the pools (London CIV and LPP) were already well on the way to building pools using the authorised Collective Investment Scheme (CIS) model; this model (for example an Authorised Contractual Scheme or ACS) had been mooted by government but not explicitly set as the target for all.
So what is a pool?
It is worth taking a moment to recognise the nature of the LGPS and the reason why organising into recognised CIS pools was not seen as the natural course of action.
Despite appearances the LGPS has a lot more in common with its “pay as you go” public sector cousins than is appreciated. As with those schemes the benefits are secured in statute. No matter what happens in the wider economy, while legislation remains unchanged, the benefits will be underwritten by central or local taxpayers. Yes the LGPS is funded but it’s “funds” are not subject to trust law, neither are they pension funds for the purposes of financial regulation.
In his opinion of October 2016, Nigel Giffin QC stated: ”There is no doubt that the assets in the fund are legally owned by the administering authority and no one else,” stating also that the administering authority “…is not a trustee, even though in some respects it may resemble one.” He concluded with: “In managing an LGPS fund, the administering authority is not carrying on a regulated activity, and does not require FSMA authorisation.”
For these reasons the LGPS and the FCA had yet to meet. So when LGPS funds were asked to work together to pool assets, the natural legislative toolkit to turn to was that contained in various Local Government Acts – not the Financial Services and Marketing Act (FSMA).
This lack of clarity in what was intended by government, together with an unfamiliarity of FSMA and FCA rules, has been a significant cause of confusion, duplication of effort and delay. The result being proposals that contain some interesting variations on the theme of a regulated CIS.
The state of play
In July of last year the eight pools submitted detailed proposals to government. Culminating in meetings between each pool and the minister the next six months were about clarification rather than progress. So where are things now?
The April 2018 deadline for the creation of legal structures will be met by two of the pools as they are already in place. For the rest the word “challenging” takes us into a whole new definition of understatement.
Authorities in each pool are grappling with the tasks of building or procuring the FCA-regulated structures that will sit at the centre of their pools, and are considering the range and type of sub-fund structures to be offered in order to meet the strategic investment requirements of all.
They are also attempting to design governance structures that will ensure the pools work for their LGPS funds, and can report their actions comprehensively and transparently. This latter task cannot be underestimated as it is a vital junction between the politically-accountable authorities and the legally separate, FCA-regulated pools.
An officer group is working hard to develop options for the decision-makers in each administering authority to deal with a variety of cross-pool issues such as responsible investment, infrastructure platforms, and latterly MiFID II.
Investment managers are busy restructuring their structures, offers and vehicles for the day when their clients will be the pools rather than the administering authorities, while trying to maintain “business as usual” in the run up to 2018.
Keeping us up at night?
Hitting April 2018 is obviously the main target, but in many ways the real challenge only starts then. The transition of assets into pools will require careful planning, the creation of suitable receiving vehicles, significant time, and no doubt some luck. It will also require government co-operation in minimising the loss of value due to tax implications in the process of moving the ownership of assets.
Government also needs to engage sensibly with regard to asset types that are difficult if not impossible to pool such as life funds and property. Existing time-limited exemptions in these areas may need to be extended while solutions are developed.
At the time of writing, MiFID II still poses a multitude of risks to value and timing. Let’s hope we see a sensible opt-up process, although even then there will be challenges.
Sensibly in my view, the infrastructure platform question is being pushed to one side while pools are built. Options are being explored, but it would be a surprise if we don’t see infrastructure investment eventually be implemented at the pool and cross-pool level, with the latter meaning multiple solutions for different types of project.
Finally, although we are four years into a journey that sees another milestone along the way next April, this significant project is not being undertaken in isolation. The day job still needs to be done and is not getting any easier, while resources are being strained almost to breaking point. So far LGPS administering authorities have proved over and again their resilience, ability, and expertise in meeting the challenges thrown at them by government. The question is: can that situation be expected to continue in the light of increasing employer numbers, GMP reconciliation, exit payment reform, Brewster, cost management etc. etc. etc. etc…?