The UK government has foreshadowed keenly awaited investment regulations for local government pension schemes (LGPS), with guidance published today giving insight into aspects such as asset allocation, environmental, social and governance (ESG) considerations, and the power of the government to intervene.
The investment regulations will be introduced later this year, under which local authorities will have to publish investment strategy statements (Regulation 7) by 1 April 2017.
This is distinct from the Statement of Investment Principles (SIP), which is more of an overarching statement of intent.
The statements are key to granting LGPS more investment freedoms as part of a shift to a prudential framework with less central prescription, one of the main aims of the upcoming investment regulations.
The guidance spells out what the investment strategy statement must include, namely, in the government’s words:
a) A requirement to invest money in a wide variety of investments;
b) The authority’s assessment of the suitability of particular investments and types of investments;
c) The authority’s approach to risk, including the ways in which risks are to be measured and managed;
d) The authority’s approach to pooling investments, including the use of collective investment vehicles and shared services;
e) The authority’s policy on how social, environmental or corporate governance considerations are taken into account in the selection, non-selection, retention or realisation of investments; and
f) The authority’s policy on the exercise of rights (including voting rights) attaching to investments.
According to the guidance, the statement must also set out the maximum percentage of the total value of all investments of pension fund money that will be invested in particular investments or classes of investment.
Guidance is also provided about the component parts of regulation 7 – for example, telling local authorities that they “must take proper advice” and assess the suitability of investments.
The guidance goes into some detail on how ESG considerations should be taken into account, noting that “the law is generally clear” that schemes should consider ESG or any other factors where they are financially material.
It adds a reference to the relevance of such factors depending on the time horizon of a scheme’s liabilities.
The guidance also tells local authorities that 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 the government”.
“Social investments” by LGPS, meanwhile, appear to have the government’s blessing, with the guidance noting that such investments – which deliver a social impact as well as a financial return – will also be compatible with the prudent investment approach as long as 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”.
The guidance also explains how the government’s power of intervention to direct investments will be regulated.
It states that the relevant regulation, regulation 8, “will include a number of safeguards, including full consultation with the relevant authority, to ensure that the proposed power is used appropriately, proportionately and only where justified by the evidence”.
Assuming these criteria have been met, the secretary of state – currently Sajid Javid, the business secretary before new prime minister Theresa May reshuffled the Cabinet – can use “the power of Direction” in the following ways:
a) To require an administering authority to make changes to its investment strategy in a given timescale;
b) To require an administering authority to invest assets as specified in the Direction;
c) To transfer the investment functions of an administering authority to the Secretary of State or a person nominated by the Secretary of State; and
d) To require an administering authority to comply with any instructions from either the Secretary of State or the appointed person in circumstances when the investment function has been transferred.
The regulations provide for the Department for Communities and Local Government (DCLG) to intervene if the secretary of state is “satisfied that an administering authority is failing to act in accordance with this guidance”.
Whether the definition of ‘failure’ has been further defined remains unclear.