RI Comment: How about an Ethical Council for new UK ‘wealth funds’?

Huge new capital pools need ESG embedded at the outset

As the dust settles on Sweden’s failed attempt to consolidate its six AP buffer funds, the UK is creating precisely the name number of ‘wealth funds’ out of the local authority pension schemes.

Earlier this month the Swedish government cancelled its reforms of the AP Fund system amid widespread resistance – not least from the funds themselves. In a separate development, the UK government announced it wanted local authority funds to pool assets in a bid to help them focus on infrastructure investments and lower costs.

The nub of the plan is for the 89 local government pension schemes to create six “British Wealth Funds” with a combined £193bn (€274bn) – meaning each fund would have at least £25bn of scheme assets each. Whether the UK Treasury looked at the AP funds as a template is unclear but at a stroke it could revolutionise not only the UK’s pension landscape, but also the voting, engagement and stewardship picture too – if things are handled correctly at this early stage.

Right away there will be huge new capital pools that could potentially be a focal point for shareholder influence, although doesn’t appear to be one of the government’s key aims. But ESG issues need to be firmly plugged into the new funds’ DNA at the outset or it will be an uphill struggle to insert them at a later date.

It would create an opportunity for pension fund investors to speak with a more coherent voice, and if this benefits beneficiaries, that’s all to the good. It could take its cue from the Local Authority Pension Fund Forum (LAPFF).

Luckily, part of the criteria that the proposed funds will be measured against as they put proposals together is to demonstrate how ethical, social and corporate governance policies will be handled by the pool; and how authorities will act as responsible, long-term investors through the pool, including how the pool will determine and enact stewardship responsibilities.

The Treasury says schemes will want to consider the findings of the Kay Review when developing their responsible investment and stewardship proposals. It also cites the Financial Reporting Council’s UK Stewardship Code as good guidance.

The document also states that the Law Commission has recently clarified that as part of fiduciary duty schemes may take purely non-financial considerations into account. So far so good, but how serious the authorities are about all this is open to question, given they want to avoid “boycotts, divestments and sanctions” and the whole initiative is being driven by cost savings and achieving scale. But the opportunity is there and the responsible investment sector should take it.Local government pension schemes are already forming partnerships. The London Pensions Fund Authority has developed a £10bn asset and liability management partnership with Lancashire County and a £500m infrastructure investment joint venture with Greater Manchester. And just this week eight English local authority funds have agreed to pool £35bn in the largest asset pool so far. So the momentum is clearly there.

The whole plan is being pushed through at what, in pension industry terms, is breakneck speed. With LGPS authorities having to submit their initial proposals by February 19 next year, it means they will have a mere 54 working days to rustle something up from the date of the official announcement – and that includes the holiday break. Completed submissions, however, are expected by July 15.
What had traditionally appeared to be an almost impossible task is now happening in an instant. And that’s not even mentioning the misgivings some have about calling them ‘wealth funds’ in the first place, which implies that they are somehow part of the government apparatus.

This cannot be the case because each fund has its own distinct liability profile and beneficiaries, not to mention consultant and asset management relationships. How this will play out is, at this stage, not clear. It’s almost as if the government, in forming these ‘wealth funds’ is belatedly making up for not forming a sovereign fund with the North Sea oil bonanza.

So, our modest proposal – as the funds work out the way forward – is for consideration to be given to the setting up of a UK version of the Swedish AP funds’ Ethical Council.

The Ethical Council (which only operates on behalf of four of the AP funds) has been a lynchpin of responsible investment since its formation in 2007. Its stated aim is “to make a difference”. The AP funds do this by acting as long-term, committed and responsible owners who exert influence on companies the world over to improve their efforts in relation to environmental and social issues.

Surely putting a similar structure in place in the UK would be worth aiming for?
A UK version could have a transformative effect and create a new locus of voting, engagement and stewardship. It could dovetail very nicely with the Investor Forum, one of Professor Kay’s key recommendations, and really put shareholders in the driving seat of UK plc.