MiFID II: LGPS retail label could stymie alternative investments

The markets in financial instruments directive – known as MiFID II – aims to improve the functioning of financial markets in light of the 2008-2011 crisis and to strengthen investor protection. It is currently being transposed to national law in European Union member states and has the potential to make serious waves for the Local Government Pension Scheme.

MiFID II will reclassify European local authorities as retail investors; because LGPS funds are not legally segregated from their administering authorities the scheme could also be drawn under the retail umbrella.  

The shift from professional to retail investor status could puncture chancellor George Osborne’s plans for asset pooling across the scheme due to the investment restrictions that come with a retail label – most notably around complex structures including infrastructure and private equity.  

Local authorities would have the ability to request an ‘opt-up’ to professional status if they meet certain qualifying criteria, including asset size and investment expertise, but industry figures are currently uncertain of the scale.

Reclassification

Jeff Houston, head of pensions at the Local Government Association, warned delegates at the Local Government Pension Investment Forum this week that a retail status would inhibit schemes’ investment activity.

“If you don’t opt-up to professional status some of your managers won’t deal with you, and those managers who will deal with you will sell you a very much restricted range of assets at a much higher price,” he said.  

Toby Simon, chair of the pension committee at Enfield Council pension scheme, said a change in status would present significant issues for his fund’s “large number of complicated strategies”.

“Even if you opt-up, annexe 2 [of the directive] says you have to be given warnings. The status of an opt-up professional [investor] is not the same as a true professional,” he said.

Bob Holloway, head of workforce pay and pensions at the Department for Communities and Local Government, urged the Financial Conduct Authority to intervene.

“The LGPS, because it is part of a local authority, will be the only occupational pension scheme that starts off life as a retail client,” he said. “We need the FCA to come forward with evidence.”

If MiFID II ends up causing an issue there, then that’s not going to be helpful for anyone

Richard Batchelor, Eversheds

Opt-up regime

Under the existing opt-up regime, retail clients can elect to be treated as professional investors provided certain qualitative and quantitative criteria are met.

This includes ensuring the investor agrees to waive the protections otherwise afforded to retail clients and has the necessary expertise, experience and knowledge to make investment decisions and understand the risks involved.

MiFID II member states have the discretion to adopt specific alternative or additional criteria for the assessment of the expertise and knowledge of local authorities requesting to be treated as opt-up professional clients, but there is no mention of whether the directive extends to local government pension funds.

The FCA addressed the reclassification of local authorities under MiFID in a discussion paper back in March, but panellists at the conference called for specific guidance from the UK markets watchdog on the potential impact of reclassification for the scheme at large.

Houston said: “One of the things we are talking to the FCA about – and we will be seeing the FCA [this] week – is… that process of opting up to professional status for local government – because it’s different, they need to recognise those differences,” said Houston.

Constructive solution

Richard Batchelor, partner at law firm Eversheds, said any reclassification would have “significant implications” for the LGPS and present additional hurdles for entry into asset classes desired for pooling of scheme assets.

“If you’re classified as a retail investor it’s quite difficult for FCA-regulated firms to market those products to [you],” he said.

“As far as LGPS is concerned, that would include infrastructure funds, private equity, hedge funds and real estate.”

However, Batchelor said the direction of travel was not “set in stone” and the threat of severe implications for both the FCA and the government would ensure constructive work towards a “sensible solution”.

“If MiFID II ends up causing an issue there, then that’s not going to be helpful for anyone,” he said.