“The UK local government pension investment regulations are a step in the right direction”
As we enter 2017, I would like to look back on what has been one of the most significant years for local government pensions in recent memory. In November 2015, the UK government issued a consultation on replacing the current regulations around the management and investment of pension funds. New legislation has now entered into force, and the Department for Communities and Local Government (DCLG) has published guidance on how to complete the new Investment Strategy Statement (ISS).
Until now, every occupational pension scheme has been legally required to prepare and maintain a Statement of Investment Principles (SIP). This is expected to cover the trustee’s plans for securing compliance with their statutory duties, their policies on investments, risks and returns, and how they will exercise their voting rights. While the SIP and ISS sound similar (and in a lot of ways, they are) there are two differences.
Many in local government pensions, including fellow members of the Local Authority Pension Fund Forum (LAPFF), have considered the 2009 Investment and Management Regulations to be over-prescriptive in the context of the needs of Local Government Pension Scheme (LGPS) funds. In effect, the role of the ISS is to provide a framework for a measured relaxation of these regulations. Since administering authorities are responsible for preparing and maintaining the ISS, the regulations implicitly and explicitly restate the importance of the administering authority as the repository of fiduciary responsibility for LGPS funds.
That might sound like nothing has changed, but in the context of deregulation it matters a lot. Most significantly, the guidance brings forward an expansion as to what and how environment, social and governance (ESG) considerations are to be managed. In short, this allows funds to consider factors that they believe will influence the financial performance of their investments.
Underpinning this is the argument that companies with strong ESG credentials have better long term performance: a company committed to environmental sustainability, that cares about its staff, and is well-run and well-managed should, in the long term, always profit over a company that does none of these. If you do not think this is the case, look at Sports Direct’s share price in recent months, or Volkswagen’s following the 2015 emissions scandal. ESG considerations matter to the bottom line, and I’m happy that the guidance accepts this fact.
Encouragingly, the guidance also makes a positive contribution to the debate around the exercise of rights (including voting rights) attaching to investments. This is something that the LAPFF has pursued, and successes in this area include bringing forward the separation of the role of chief executive and chairman at Marks & Spencer, and co-filing a resolution seeking an independent chair at News Corporation, which received over two-thirds of non-Murdoch shareholder votes.
This clear narrative of shareholder engagement and activism, both in theory and in practice, is being enthusiastically advocated by the DCLG in their requirement for every administering authority to lay out their policies on stewardship. This is a tightening up around stewardship, and a move which I welcome. I have long believed that divestment, and the cutting of investor rights and communications channels, is inferior to focused and vigorous engagement as a means of driving real changes in corporate responsibility.
No longer do we have the excuse that economics must take priority over ethics – although securing returns for our members must always form the basis of what we do. This move towards activism isn’t just happening at a fund level. Individual pension fund members are also taking an interest in how their money is being managed, a process which includes asking questions that funds without a clear policy on responsible stewardship may find awkward.
However, on the flip side, there are some concerns about the expansion of the powers of the secretary of state. This new legislation, which makes it clear that any instruction from Whitehall must be followed, up to and including forcing funds to change policies or investments if they are considered ‘inappropriate’, flies in the face of the deregulatory spirit of the rest of the guidance. It also goes far beyond the influence exerted by the Pensions Regulator over similar private sector schemes.
This is unfortunate as it appears that Conservative prejudices about spendthrift local government letting politics influence their investment choices have made their way into the statute book. However, while I agree that there is a greater scope for central intervention in theory, I remain relaxed about what this will mean in practice. Pension funds can often do better than the likes of the Foreign Office in both identifying investment opportunities abroad and realising when it is prudent to step back, and, in my experience, the people who are the quickest to accuse pension funds of playing politics are almost always unable to provide specific examples to support their argument.
As long as pension funds can show that any investment or policy decision was made on a fiduciary basis, even the most meddlesome secretary of state will hesitate at the prospect of having to carry the responsibility of a botched intervention – ultimately the meeting of the liabilities for the fund.
It is fair to say that the new guidance marks a departure from the 2009 regulations, not only in approach but in style and feel. For the most part, I consider this to be a positive development. It’s clear that in many cases, particularly around voting rights and the move to a Prudential framework, the DCLG has taken account of the feedback of individual pension funds and the wider trends in the pensions industry. Administering authorities will, in the overwhelming number of cases, continue to be supreme in the setting of policy on asset allocation, risk and diversification.
While the power of direction for the secretary of state remains a concern, I am confident that a compromise can be reached that addresses government’s concerns while maintaining the supremacy of individual authorities – and their accountability to local council taxpayers. This could include grounding any intervention on advice from the national Scheme Advisory Board, which is already in existence and suited to fulfil this purpose. There is still some way to go, but the dream of unlocking the power of pension funds to drive real change while securing returns for our members seems to be moving closer to reality.