Securities services providers have a ring-side view of the pooling process for the UK local government pension sector. Brian Bollen polls the opinions
Good news of almost any kind is to be welcomed, even seized upon, at a time of such pronounced geopolitical and macroeconomic uncertainty – especially if it relates to the delivery on schedule of a project conceived and initiated by the notoriously accident-prone UK government. If the consensus among several of the world’s leading global custodians on the progress being made with preparations for the launch of local government pension fund consolidation in the UK is correct, then good news is indeed to be found.
Some might go so far as to say that confidence abounds that the 89 local authority pension funds across England and Wales will be ready for the brave new world that awaits them from April next year. By then, if all goes according to plan, they will have successfully consolidated themselves into just eight schemes, or super funds, to the timetable set out by the government.
“The amount of work involved is absolutely gargantuan,” says Mark Austin of the institutional investor group, EMEA, at Northern Trust, assessing the scale of the exercise. “This will be a momentous change for the LGPS [Local Government Pension Scheme].” The total recorded value of assets involved stood at £220bn (€255bn) at 31 March 2016. Austin adds: “Moving from what is a standard single-sponsor pension environment to a regulated multi-sponsor fund structure is a significant leap.”
But there is no sign that the funds involved are underestimating the task and the challenges it represents. The funds have, by all accounts, done a vast amount of work already in terms of changing their individual and collective mindset ahead of time. “The LGPS pools have been working on their designs for pooling over the past 15 months and have recently had, or are close to getting them approved by government,” Austin says.
Benjie Fraser, global pensions executive at JP Morgan adds: “Most are advanced in the process and are forming groups to support the new solutions they will require.”
“Progress to date has gone as well as might be expected and the local authorities have come up the learning curve admirably fast,” says Paul Traynor, international head of pensions and insurance segments at BNY Mellon. “But there is a lot of work still to be done.” He expects to see requests for proposal from the new pool operators as soon as the tendering process for custodians gets under way. An inevitable outcome of that process will be a significant reduction in the number of intertwined relationships between asset owners, asset managers, custodians and other professionals, he says.
Public sector pension funds face huge challenges, but they have risen to the task, says Andy Todd, head of UK pensions and banks, asset owners solutions at State Street. “For the best part of a year, we have been hosting training and education seminars focused on asset pooling. LGPS are in generally in good health and they are proactively facing up to the challenges and changes they have to administer, responding well to central government calls for asset consolidation. They are investing significant resources into making sure they understand what is required of them, establishing clear and robust strategies for new ways of operating and becoming more efficient and transparent than before,” he says.
But not everyone is so bullish. “Things are going to be tight to get legal structures set up by next April, especially as local authority spending has been curtailed so much that the resources are not easily available,” says Jeff Houston, head of pensions at the Local Government Association and a veteran of the local authority pension scene, having worked in it in one capacity or another since 1980. “But when councillor Roger Phillips [The chair of the scheme advisory board] and I recently met Marcus Jones, the local government minister, he was clear that he expects the timetable to be adhered to.”
“The challenge of creating investment platforms capable of managing the large sums of money, pooling the money and creating governance and administrative processes capable of competently overseeing and managing the new funds is unprecedented in the UK asset owner community”
Two LGPS are already over the line. London CIV (Collective Investment Vehicle) and Local Pension Partnerships have their operators set up, are Financial Conduct Authority-authorised, have their custodians in place and are starting to build sub-funds, Houston notes.
The consolidation process is exceptionally complex, says Gavin Ralston, head of official institutions at Schroders. “The challenge of creating investment platforms capable of managing the large sums of money, pooling the money and creating governance and administrative processes capable of competently overseeing and managing the new funds is unprecedented in the UK asset owner community,” he says. “The LGPS are going from a pension environment to a regulated fund environment and new skill sets will need to be acquired, whether learned or hired, to cover new functions like operator duties and having clients.
“The consolidation process will inevitably lead to the UK pension environment more closely resembling that of the Australian pension market.”
It helps that the sector is good at collaborating and sharing thoughts, views and experiences, explains Austin. It further helps that April is only the start of the phased transitioning of existing pension assets into the planned eight new pools. “That relieves some of the pressure,” he concedes. It might be worth noting here that only the assets are being pooled; the liabilities, and decisions on investment strategy and asset allocation, will remain with the original funds.
The consolidation drive is seen by many as an excellent opportunity to set new standards of governance, performance and costs in the LGPS sector. Greater scale will allow the funds to adopt a longer-term investment mindset, have the confidence to take more contrarian positions and also develop the expertise to invest in more specialised asset classes such as infrastructure and private assets. “The bigger you are the more investment opportunities there are, including infrastructure,” says Fraser at JP Morgan.
Traynor of BNY Mellon sounds a note of caution, however. Refering the fiduciary duty of the funds to maximise investment returns for their ultimate investors, current and future pensioners, he points out that while the concept is good, its translation into practice could be fraught with difficulty and disappointment. “The larger funds might well invest more in infrastructure, yes, but not necessarily in local infrastructure,” he suggests. “Depending on the risk-reward arithmetic, they might decide to invest in financing foreign infrastructure.”
One key issue that remains unresolved is the likely tax treatment of any paper gains made in the transition process. The industry clearly assumes that levying stamp duty or other tax that crystallises through a process mandated by central government would be wrong. Equity and justice sit comfortably on the pension-fund side of the argument. But when did equity and justice ever matter to a hard-up UK Treasury presented with potentially easy opportunities to raise revenue?
It is worth pondering whether there are lessons the UK can learn from elsewhere in more recent times. Some industry insiders point to the Australian market as being arguably the closest in terms of the structure that the UK is looking to achieve, with a small number of state-level institutions each managing similar amounts of money: about £25bn. The pension markets of Nordic countries and Chile also have similarities, say others.
What, then, happens next, once this once-in-a-lifetime consolidation of assets has taken place and been absorbed into future everyday routine? There is at least one tantalising prospect if the exercise is as successful as many expect it to be. Once the concept has been tested and proved in practice with public sector defined benefit funds, there is one logical development: eventual replication in the corporate sector.
Coming to specialist publications some time soon: pension fund consolidation 2.0?