Scottish local government pension funds looking to asset pool should carefully consider their options with a focus on their objectives
• Scotland is consulting on whether local government pension funds should set up pooling partnerships
• Pooling should cut costs and encourage infrastructure investment
• Advice from England and Wales is that robust governance is the key to success
As local government pension schemes in England and Wales start transferring investments into their newly created asset pools, the question is whether Scottish funds will eventually follow suit.
In June, the advisory board to Scotland’s Local Government Pension Scheme (SLGPS) proposed pooling its 11 local authority funds to boost economies of scale and cut costs.
A further rationale was to encourage greater investment by Scottish funds in the country’s infrastructure.
The consultation seeks views on four options:
• Retain the current structure with 11 funds;
• Promote co-operation in investing and administration between the funds;
• Pool investments between the funds;
• Merge the 11 funds into one or more new funds.
All the options involve varying degrees of trade-off between scaling up to reduce investment costs, and retaining governance locally: assessing this trade-off forms an important part of the consultation.
The deadline for responses is 7 December 2018. These will then be evaluated and presented to Scottish government ministers in 2019 for a decision.
So what should Scotland focus on to get things right?
David Walker, head of LGPS investment at Hymans Robertson, points out that the consultation is using four different factors – cost of investing, governance, operating risks and infrastructure – for stakeholders to assess in forming a judgment.
“However, it is important that the focus should be on how each of these can help the cost-effective delivery of the LGPS and benefits to members on a sustainable basis,” Walker says. “For example, a focus solely on costs – rather than the returns of LGPS assets, net of costs – could lead to solutions that aren’t aligned to the objectives of the LGPS. To get things right, the decisions should be based on evidence-based analysis of the options being considered under the consultation.”
He says: “The focus on infrastructure also needs to be carefully considered. Looking for a solution that removes potential barriers to invest in a range of asset classes is a positive step. However, investing in infrastructure needs to be driven by a strong supporting investment rationale.”
The eight England and Wales pools encompass a variety of structures, with five different models being used.
Some, such as Border to Coast, have set up companies authorised by the Financial Conduct Authority (FCA). In contrast, the Wales pool and Access (made up of funds in eastern England) – have both outsourced their pooling infrastructure to Link Asset Services.
Meanwhile, one pool – the London CIV – has already had problems, with criticism from several of its members, one of which – Kensington & Chelsea – has so far refused to pool any of its assets.
“Pension funds need to be sure there is a robust business case or case for change against clear deliverables/strategic outcomes – what, why, and how”
But can England and Wales give the Scots advice from experience?
“There is no one way to do this – the model has got to be right for the underlying funds,” says Fiona Miller, chief operating officer at Border to Coast. “It depends on factors such as the fund size, and also the investment mix.
“There is a real mix in Scotland from very small to very big funds,” she says. “For example, Strathclyde Pension Fund, the second-largest LGPS in the UK, will already have lower fees because of its size, so has different needs from very small ones. Because Border to Coast is not a regional pool, we had to have a very clear idea from day one about what we wanted to build.”
Hugh Grover, former CEO of London CIV, says: “Pension funds need to be sure there is a robust business case or case for change against clear deliverables/strategic outcomes – what, why, and how. What is also crucial is governance, and clear definitions of roles, responsibilities and accountabilities. This is where London CIV and the London boroughs have ultimately been challenged the most, in my opinion.”
He warns: “Resist getting drawn into fund manager fee savings as the prime driver, there are many other potential benefits but, sadly, fees are the easy target, as they are more immediately measurable.”
Learning from boards
A key part of governance is communication. Gerard Moore, independent chair of three LGPS local pension boards, says: “To my knowledge, there has been little evidence that, despite the guidance, the England and Wales pooling projects have proactively engaged with the local pension boards of the underlying pension funds, either individually or collaboratively. This has been a lost opportunity as, in many cases, pension boards have significant skills and experience in governance issues in order to perform their scrutiny role.
“As several different pooling models have been adopted, each pool has brought its own governance challenges and in some cases, even at this late stage, some fundamental principles still remain outstanding, or at best, unclear,” he says. “Even the standard of retrospective briefings to pension boards on pooling developments has varied enormously.”
Moore advises: “Pension boards exist to assist the administering authorities. Should Scotland move down the pooling route, their LGPS pension funds would benefit from adopting processes that enable pension boards, ideally as a group, to offer timely assurances, and as appropriate, challenges, when devising and implementing their governance proposals in order to help achieve robust, fit for purpose, arrangements.”
For pension fund pools considering the FCA authorisation route, Miller points out the inherent tension in governance in terms of welding together the two legal regimes.
“The pension funds are part of local government, so are subject to a raft of government law, particularly rules on public procurement and the Freedom of Information Act,” she says. “But as an FCA-regulated company, you may have a situation where you want to keep information confidential. So you have to design a governance structure that meets both sets of regulations.”
Susan Martin, chief executive at London Pensions Partnership (LPP), says: “Pooling is a good thing for employers, members and council tax payers to bring their funds together. But only if it’s done in the right way, with high standards of governance.”
Crucial to this, she says, is a framework that clearly shows all delegations from the pension fund board to the pooling subsidiary, and how the latter should execute and implement the strategic asset allocation from the pension fund board.
LPP has full delegation from the LGPS pension fund boards to manage 100% of its three clients’ assets – worth £16bn at end-June 2018 – from day one.
This includes a clear assessment of risk. “Risk is at the core of the business, and at LPP we look at risk in terms of liabilities and investing as a whole, not just how secure the assets are,” says Martin. “We are very cognisant that it is the employees’ money and we act as if it were ours. Furthermore, we have robust standards of transparent reporting, again treating this as if it was our own money.”
Martin says the FCA structure is important as it provides clients with the assurance that their assets are being managed to the highest standards.
“At the same time, LPP and our clients also benefit from the security that the environment we are operating in is one that is highly regulated, with comprehensive oversight and a robust governance framework,” she says.
Views from Scotland
Lothian Pension Fund (LPF) already collaborates with other LGPS in a number of areas, giving them the benefits of investing on a bigger scale and – for other funds – to benefit from the in-house team.
For example, over the past year, Lothian has collaborated with Falkirk Council Pension Fund on seven infrastructure investments. A staff secondment arrangement also shares internal staff costs with Falkirk.
Clare Scott, chief executive at LPF, says: “Scotland should focus on what is in the interests of the members and employers in the funds, putting aside conflicts of interest. Lothian’s collaboration with other funds under its FCA authorisation shows that it is possible to work together under the current fund structure.”
But she warns: “The governance of any new arrangement, whether pooling or merger, is the most critical aspect. The general lack of consistency of reporting – particularly in relation to transparency on investment costs – could hinder the debate. Costs are very important, but the focus should be on governance, sustainability and risk management.”
Miller agrees, saying: “It is about having a better long-term risk-adjusted return. If you make it just about cost and not performance, you will probably make material errors. So it is worth paying to get the governance and key operating structures right.”
In any case, she says, while pooling should bring about savings on fees, this needs to be considered against the outcome that the cost of transitioning the assets outweighs the future benefits.
Miller advises Scotland to resource pooling projects professionally upfront.
“Several of us at Border to Coast ended up working all hours,” she recalls. “So the Scottish funds need to assess and be ready to make the upfront investment in professional resources, including where necessary hiring industry specialists in asset management design. And they need to align getting the changes through all their councils’ governance structures and different reporting cycles.”
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