The UK is in the middle of a revolution in the way a significant portion of its pension funds are managed, and the knock-on effects for responsible investment will be huge. However, as Jimmy Cliff once famously sang, there are ‘more questions than answers’. And they are big, complex, profound questions on issues such as manager selection, costs, transparency and responsible investment, many of which will be presented and discussed at RI’s ESG in Manager Selection event on October 12 in London: Link (Excuse the promotion, but we do try to make our events as topical and business critical as possible!)
Previously, 89 local government pension funds ran the retirement money for local government civil servants via autonomous pension funds known collectively as the Local Government Pension Scheme (LGPS). This money was run by hundreds of fund managers and mandates.
The system is now being rationalised. The 89 funds will remain intact and take decisions on behalf of their fund members on asset allocation, but the money will be put into 8 giant pools (made up of like-minded funds) that will hire the investment managers to run those assets, or run some of the money in-house, depending on the asset class.
The pools are effectively self-owned asset managers and they are expected to have formulated their Investment Strategy Statements by April 1st 2017.
The underlying pension funds will take a pro rata portion of the mandate given to each manager/s hired for the various asset classes. The hundreds of managers and mandates will become a whole lot less!
The rationale for the project has primarily been the cost of running multiple funds underpinned by the taxpayer (more of which later), although one could question whether the expensive means will justify the end?
Others argue that the Treasury’s goal was to earmark a portion of the asset pools for UK infrastructure (government ministers have alluded to the funds as ‘wealth’ funds, which, of course, as member’s pension funds, theydefinitely are not). That said, a portion of assets in government-backed, steady returning infrastructure assets (particularly green) would be no bad thing if done with the usual full fiduciary caveat. So far two of the pools have received registration with the Financial Conduct Authority (FCA) regulator. There are already plans for the pools to invest in infrastructure but existing illiquid assets will probably remain outside the pools for the time being. Some of the pools may develop services for third parties, pitting them as competition to fund managers. The impact of these changes is already being felt deeply across the UK funds industry. Over the summer, the pools have been developing and fine tuning their business plans, including governance structures and costs benefits, which must be submitted to government by November/December. The country’s investment regulations look likely also to change to allow the funds more latitude within prudent principles to manage such large asset pools. The draft regulatory framework for how the pools will work is expected shortly, and we’ll cover that as it becomes apparent.
The fees ‘revolution in a revolution’..
Sitting above the pools is the advisory body that oversees the pools, the National Scheme Advisory Board, which is made up 50% of employer representatives and 50% trades union representatives, and is appointed by The Department for Communities and Local Government. The Board chair is Cllr Roger Phillips, former chair of the Local Government Pension Committee. The vice chair is Jon Richards, National Secretary for Pensions, Education and Children’s Services and Health and Safety at UNISON, the UK’s main public services union with over 1.25 million members, over half a million of whom are in the LGPS. The union has been a key driver in some of the main LGPS reforms. The Board has taken a firm line on the controversial issue of investment management costs and charges, and will require managers to fill out a publicly available fees template
The template, initially for listed assets (in both pooled and segregated funds), but later for unlisted assets, was drafted and tested by the West Midlands Pension Fund working with Dr Chris Sier, a financial services professional
and Professor of Practice at Newcastle University Business School (who has worked extensively with Dutch pension schemes on their well-respected fees transparency system), and the Investment Association. Sier has specialised on fees and charges for some ten years. It’s hugely important work: far too many pension schemes currently don’t know what they are really paying in fees and charges, and have little idea of market rates or whether they are getting value for money for the investment strategy they have chosen. The FCA is already carrying out a review on competition in asset management, which will issue an initial report at the end of the year
The UK Pensions Regulator (TPR) says trustees must act as “demanding consumers” on fees. At the EU-level, MIFID II and the planned (and now postponed) PRIIPS. (packaged retail and insurance- based investment products) regulation also aim to weigh in on fee transparency. Similar initiatives are happening worldwide. (More of which in another article soon).
The Board says the templates will “concentrate on those areas which should already be available but may not have been supplied by asset managers either proactively or in a format easily useable by LGPS funds.”
The Board is also developing a voluntary Code of Transparency for LGPS asset managers, and a consultation meeting was held on 21 September 2016 with representative fund accountants, whose minutes can be found here
The Code is expected to launch this Autumn and fund managers who sign up will be listed on the Board website and able to use the Code logo on their marketing literature.
That’s a revolution within a revolution if asset managers are obliged to be as fully transparent as possible on fees, or look for business elsewhere. The knock-on impact to the rest of the market should be significant.
Is the revolution good or bad for RI?
A side effect of the fees shift will likely be major fee discounting by large funds houses, and an increase in the already major move to passive management. That’s a whole other debate, and not for this piece. But, forresponsible investors, it does bring up the subject of ESG product cost, and how (whether) it will be borne by local government pension funds that have traditionally been amongst the most RI friendly. Active ESG managers that charge above market rates could find it hard to get a look in on mandates unless their products are seriously competitive, or highly specialist. Some of the 8 pools will maintain a clear ESG profile, others less so. The £23bn Brunel pool whose founding funds include The Environment Agency Pension Fund, and the Local Government Funds of Avon, Buckinghamshire, Cornwall, Devon, Dorset, Gloucestershire, Oxfordshire, Somerset and Wiltshire, is partisan. Some of its members are already leading a cross-pool initiative to promote ESG consistency. And across the pools there will be tenders for ESG services, particularly corporate engagement and share voting, such as the recent joint procurement tender RI recently reported for £4-£10m in voting and engagement services, ESG research and stewardship-related project services.
RI has also reported what the UK government, within its recent LGPS ‘Preparing and Maintaining an Investment Strategy Statement’ report, has said the LGPS should do (and not do) in terms of RI; notably calling on all the pools to sign up to the Stewardship Code. However, the pool structures do raise questions about how share voting gets done. Fund managers are reluctant – and some contractually unable – to divide the votes in a pool. This has already been a hurdle for the AMNT Red Lines ESG voting initiative. It’s a question that has yet to find an answer as far as I can see. Another governance question is what will happen to the Local Authority Pension Fund Forum (LAPFF), which represents 64 funds with combined assets of over £115bn, on ESG engagement and voting. How will that work with the new structures? It’s not yet clear, but it could be a bigger opportunity to carry out more governance for large asset volumes. LAPFF has welcomed the LGPS investment strategy report.
In addition, UKSIF has published a handy update on the LGPS reforms from an RI perspective: Link
All this comes as new UK Prime Minister Theresa May is set to make responsible capitalism a theme of the Conservative Party conference this week, with plans to put workers on company boards and to create more transparency over top pay.
There may still be more questions than answers, but they are bang on topic! And RI will be looking at these issues in more detail in coming articles.
RI’s ESG in Manager Selection event takes place on October 12 in London: Link