Recently published guidance for the UK’s local government pension schemes (LGPS) has revived concerns about the potential power of the government to direct investment.  

Last Friday, 16 September, the Department for Communities and Local Government (DCLG) released guidance that gave the LGPS and associated industry a first glimpse of what will be required under new, keenly anticipated investment regulations.

The regulations would move away from a schedule of limitations on pension funds’ investments to a more relaxed framework under which a LGPS would have more freedom to decide its own investment strategy.

This is to be set out in an investment strategy statement (ISS), which will replace the statement of investment principles.

The regulations, a draft of which was published for consultation late last year, are keenly awaited by the LGPS, not least because of their efforts to comply with government deadlines in relation to the requirement for them to pool assets.

Jeff Houston, board secretary for the Local Government Pension Scheme Advisory Board, told IPE the release of guidance before the associated regulations themselves had been published was an unusual step, and that it came amid “a frustration, both within the board and across all the funds, that these investment regulations are taking so long to come out”.

Although it is unusual for guidance to come before the regulations, “if getting this guidance out first helps us to get the regulation quicker, then fine”, said Houston.

He added: “Now that the guidance has been cleared, we hope we will see the regulations very shortly.”

The DCLG did not respond to a request for comment.

David Walker, head of local government pension scheme investments at Hymans Robertson, told IPE the guidance was “quite consistent” with the contents of the draft regulation and “what looks likely to be in the new regulations when they come out”.

He registered some concern about the timescale for the new investment strategy statements, pointing out that the guidance gave a deadline of 1 April 2017, whereas the draft regulations had referred to a deadline of six months after their coming into force.

“With the new regulations still to emerge, and if 1 April is still going to be fixed as the date, it potentially means the funds have quite a short window to respond to this to get the documentation in place,” he said.

However, he acknowledged that the release of the guidance allowed the funds to “potentially start mapping out what their investment strategy statements might look like”.

In line with the draft regulations, the guidance refers to powers of intervention in investment matters that the secretary of state will have in certain circumstances. 

Power of direction concerns

These were met with some surprise and consternation when the draft regulations were published, and and the UK Sustainable Investment and Finance Association (UKSIF) was critical of them in its response to the government guidance.

Chief executive Simon Howard said the association was “very concerned with the power of direction, whereby the secretary of state can direct a fund to make changes to its investment strategy, force it to invest in specific assets and transfer the investment functions of the administering authority to the secretary of state or a nominated person”.

He added: “Once again, we call on the secretary of state to clarify that this power will only ever be used where an authority has breached its fiduciary duty.”

The UK’s Pensions and Lifetime Savings Association (PLSA) previously raised similar concerns, calling for fiduciary duty to be made explicit in the LGPS investment regulations.

UKSIF also expressed concerns with a requirement that local government pension funds’ policies must be in line with UK foreign policy, with Howard saying this could impact their ability to invest.

Houston, at the LGPS Advisory Board, said the provision was one over which individual funds would “probably be scratching their heads” as they read and tried to digest the guidance, and that there would probably be a desire for more clarification, including about how, if at all, it might “kick back into our fiduciary duty to get the best returns”.

Houston said he expected there to be “a nervousness” around the power of direction for the secretary of state, even though local authorities are used to situations where the government has powers of intervention – in social services or education, for example.

The LGPS Advisory Board as a whole has not yet been able to review the guidance, but Houston said he expected it would want to be certain the powers of intervention were a “last resort”, and that the secretary of state would have to follow a “robust process”, with individual authorities able to make their case.

UKSIF was positive, however, about the requirement for LGPS to have a policy on environmental, social and governance (ESG) factors and stewardship, as well as the new provision that the pension funds must explain their approach to social investment and the extent to which non-financial factors are considered in their investment process.