Local government pension schemes will enjoy greater flexibility with their investment arrangements, guidance on forthcoming regulation indicates, but concerns remain about the scope for government intervention.
The guidance, released late last week, outlines a number of areas to be covered in the investment strategy statement of LGPS schemes.
It also gives further detail on the secretary of state’s ‘power of direction’, which will allow intervention in pension scheme investments where they are “failing to act in accordance with [the] guidance”.
It would seem entirely possible that current or future secretaries of state might choose to add to the guidance
Dave Lyons, Aon Hewitt
Regulations will be introduced later this year, while LGPS administering authorities will be required to publish an investment strategy statement by April 2017.
For the most part, experts welcomed the guidance.
David Walker, head of LGPS investing at consultancy Hymans Robertson, said the guidance allows “greater freedoms in terms of some of the restrictions being removed”, referring to previous limitations on the amount that could be invested with individual managers, arrangements and limited partnerships.
Dave Lyons, head of public sector investment consulting at Aon Hewitt, said it was fairly similar to existing guidelines, “except for the power of direction and the greater emphasis on pooling”.
However, he added that the requirement to follow the guidance could lead to tampering with it in future.
“New guidance could be added more easily than an amendment,” he said. “It would seem entirely possible that current or future secretaries of state might choose to add to the guidance or evolve it, and it might not necessarily follow the same rigorous scrutiny as changes to the regulation might involve.”
Investment strategy statements must outline the scheme’s approach to the following areas:
Diversification: Schemes have a requirement to invest in a variety of assets.
Suitability: The scheme’s process for assessing an investment opportunity. The guidance adds: “There is a clear expectation that the assessment should be broadly consistent across all administering authorities.”
Approach to risk: The key risks facing the scheme and countermeasures to mitigate them.
Approach to pooling: Details of the proportion of assets to be invested through the pool, the structure and governance arrangements, and the ways the scheme can hold the pool to account.
Environmental, social and governance factors: How the scheme will incorporate ESG factors when making investment decisions. However, the guidance says: “The government has made clear that using pension policies to pursue boycotts, divestment and sanctions against foreign nations and UK defence industries are inappropriate, other than where formal legal sanctions, embargoes and restrictions have been put in place by government.” The guidance permits impact investments in which “some part of the financial impact may be forgone in order to generate the social impact”. It adds: “These investments will also be compatible with the prudent approach providing administering authorities have good reason to think scheme members share the concern for social impact, and there is no risk of significant financial detriment to the fund.”
Exercise of rights: The approach to stewardship, including monitoring and engaging with companies in which the scheme is an investor.
Despite the guidance saying schemes could forego some financial return for a social impact, Simon Chisholm, investment director at social impact investment manager Resonance, said both schemes and market forces were leading to increasingly financially attractive impact investments.
“[Impact investment] is reaching a scale that is sensible for investors to consider,” he said. “We always have to tick the box in terms of investment profile.”
Some schemes also look at where the impact will be generated geographically, aiming to benefit their local areas, Chisholm said. He gave the example of a fund that invests to secure accommodation for homeless people, saying many scheme decisions on whether to invest in it “have been contingent on whether the fund will begin to move to invest in a particular region”.
Power of direction
The guidance says that as the regulation around scheme investments is being relaxed, “it is important therefore that the regulations include a safeguard to ensure that this less prescriptive approach is used appropriately”. This is the reason cited for giving the secretary of state power of direction.
LGPS calls for details of government intervention
LGPS experts have called on the government to give more details regarding controversial plans to introduce intervention powers for the secretary of state over investment decisions.
The power will allow the secretary of state to require authorities to make changes to investment strategies within a timescale; to require them to invest assets as specified; to transfer investment functions to the secretary or someone nominated by the secretary; and to require them to comply with instructions from whomever the functions have been transferred to.
However, the secretary of state must consult the authority and all relevant evidence before reaching a decision.
Hymans Robertson's Walker said: “It doesn’t seem automatic that the secretary of state will step right in… funds will get the opportunity to provide evidence.”
