Tuesday, October 11, 2016

UNISON Briefing: LGPS Asset Pooling - How Will It Work?

Introduction

The government has demanded that every Local Government Pension Scheme (LGPS) fund in England and Wales must join an asset pool. This briefing explains the key issues on the vehicle the government requires all the investment pools use:Authorised Contractual Schemes(ACSs).

We have tried to minimise the use of investment jargon in this briefing. Where it has proven necessary they are highlighted in bold,with a list of explanations at the back of this report.

Summary of the key issues

  • Every LGPS fund in England must create an asset pool which must be an ACS
  • Eight pools have been submitted to government for approval
  • Only one mentions trade union scheme member representation.
  • UNISON and other LGPS unions have demanded four seats on each pool
  • If the government approves a pool it is due to be operational by 2018
  • A lot of LGPS members’ savings will be put into ACSs in the years ahead, possibly more than half of the £230bn total.
  • ACSs do not give local authority pensionfunds direct ownership of the assets they use members’ contributions to fund future members’ pensions.
  • Without direct ownership it is harder for members and unions to influence the way companies treat their workers, such as in the recent Sports Direct campaign.
  • However, most of the alternatives to ACSs – currently in use and likely to be used in the near future – suffer from the same weakness. They earn a return but don’t give members the rights that should come with making investments worth billions of pounds.
  • Whether things improve depends on whether the new Pools manage members’ savings themselves with in-house teams, with a public sector ethos, rather than expensive city firms who just want to make money (often for themselves).
  • How the eight Pools are run and how they deal with the local authority pension funds which they serve will be the test.

1.Background

In the 2015 summer budget the Chancellor of the Exchequer announced that Local Government Pension Scheme (LGPS) funds would be asked to bring forward proposals for pooling LGPS investment assets. In the autumn statement the Chancellor expounded on the proposals and announced the creation of asset pools.

The government has demanded that all the investment pools useACSs

An ACS is an investment vehicle, based in the UK, which allows lots of pension funds to invest alongside each other - while keeping a clear record of who owns what assets an ACS purchases on the behalf of its partner investors.

There are eight proposed pools, see below. All of their bids can be found on the LGPS Scheme Advisory Board web site.

Name of Pool / Funds / Assets
(£bn)
London CIV / Established for the 33 LGPS funds administered by London's 32 boroughs and the City of London Corporation, / 25
Northern Pool / West Yorkshire, Greater Manchester and Merseyside / 35
Central / Cheshire, Leicestershire, Shropshire, Staffordshire,West Midlands, Derbyshire, Nottinghamshire, Worcestershire and the West Midlands Integrated Transport Authority / 34
Brunel / Avon, Cornwall, Devon, Dorset, Gloucester, Somerset and Wiltshire, Oxfordshire, Buckinghamshire and the Environment Agency Pension Fund. / 23
ACCESS / Northamptonshire, Cambridgeshire, East Sussex,Essex, Norfolk, Isle
of Wight, Hampshire, Kent, Hertfordshire, West Sussex and Suffolk. / 34
Wales / Carmarthenshire, Cardiff, Flintshire, Gwynedd, Powys, Rhondda Cynon Taff, Swansea, and Torfaen. / 13
Border to Coast / Cumbria, East Riding, Surrey, Warwickshire, Lincolnshire, North Yorkshire, South Yorkshire, South Yorkshire Passenger Transport Pension Fund, Tyne & Wear, Durham, Bedfordshire, Northumberland and Teesside. / 36
LPP / Lancashire, Berkshire and the London Pension Fund Authority / 13

2.Proposed pooling criteria and process

The Government invited authorities to develop proposals for pooling assets that meet published criteria. Draft proposals were submitted by the end of February 2016 and final proposals were submitted in July 2016. They are now with the government for analysis and the proposals will be accepted or rejected. They are due to be operational by 2018.

It is for authorities to suggest how their pooling arrangements will be constituted and how they will operate. In developing proposals, they were asked take into account four criteria, in conjunction with supporting guidance. These were:

  1. Asset pool(s) that achieve the benefits of scale

The 90 administering authorities in England and Wales should collaborate to establish, and invest through asset pools, each with at least £25bn of Scheme assets.

B. Strong governance and decision making

The proposed governance structure for the pools should:

i. At the local level, provide authorities with assurance that their investments are being managed appropriately by the pool, in line with their stated investment strategy and in the long-term interests of their members

ii. At the pool level, ensure that risk is adequately assessed and managed, investment implementation decisions are made with a long-term view, and a culture of continuous improvement is adopted.

C. Reduced costs and excellent value for money:

In addition to the fees paid for investment, there are further hidden costs that are difficult to ascertain and so are rarely reported in most pension fund accounts. To identify savings, authorities are expected to take the lead in this area and report the costs they incur more transparently. Proposals should explain how the pool(s) will deliver substantial savings in investment fees, both in the short term and over the next 15 years, while at least maintaining overall investment performance.

D. An improved capacity to invest in infrastructure

Only a very small proportion of Local Government Pension Scheme assets are currently invested in infrastructure; pooling of assets may facilitate greater investment in this area. Proposals should explain how infrastructure will feature in authorities’ investment strategies and how the pooling arrangements can improve the capacity and capability to invest in this asset class.”

3.What is UNISON’s position on pooling?

UNISON supports the pooling process but with the qualification that there should trade union nominated scheme member representatives appointed to the pool governance structures.

UNISON supports proposed cost reductions and income improvements. However the law requires pensionfunds to invest in the best interests of scheme members, therefore infrastructure investing should be in the interest of scheme membersnot the governments. The requirement for a full cost analysis of all of the LGPS funds is an endorsement of UNISON’s consistent demands over the last five years for cost transparency.

Our demand for investments to be in the ‘best interests’ of scheme members and not the government is required in law. The LGPS Scheme Advisory Board, the Law Commission and UNISON have requested that the government apply the Investment Regulations applicable to all other pension funds in the UK and the European Union. Our legal opinion suggests that the government is in breach of the EU Directive 41/2003 Institutions for Occupational Retirement Provision (IORP). In UNISON’s view the UK government is denying the scheme members of the LGPS their statutory right to have their pension funds invested in their best interests.

What is an ACS?

An investment vehicle and fund manager, based in the UK, that allowsLGPS pension funds or other organisations with money to invest alongside each other - while keeping a clear record of who owns what.
The regime was introduced in theCollective Investment in Transferable Securities (Contractual Scheme) Regulations 2013, and the Financial Conduct Authority (FCA) rules for the authorisation of ACSs and regulates them.
ACSs are effective for a number of reasons:-
  • The principle behind an ACS is to bring the UK into line with other EU countries by creating a regime that puts investors in the same position (or better)with regard to income and capital gains taxes, as if they had invested directly in the underlying fund assets.
  • ACS can easily create new compartments to put money into different kinds of investment assets. Some other vehicles have lots of clients but can only invest in one kind of investment.
  • ACSs are good at keeping each client’s contributions separate.
  • If one compartment suffers a disaster, for example, it loses all its money, then the other compartments will be safe. There is no liability from one compartment for another.

What is bad about ACS?

  • Pools will incur costs because they are new. So although government wants more efficient funds, the changes will cost more to begin with.
  • The proposals for the eight Pools recognise this. The London Pool for example expects to keep 25% of its savings exactly where they are because it is cheaper than moving to an ACS.
  • It is estimated that new changes will eventually save between £190 and £300m a year across the UK. That would make members’ pensions more affordable. But note these are an educated guess.
  • An ACSwill not give pension funds’ direct control over the companies in which they invest (these tend to be very big companies like Vodafone, Sainsbury’s, Apple and McDonalds). This is already the case for most current LGPS investments, so it will be the same as before.
  • The Northern Pool (Greater Manchester, Merseyside, West Yorkshire) does not want an ACS. These three funds believe that they could just club together and push down providers without an ACS.

Why is the ACS the preferred model for LGPS pooling?

  • One reason is because the government wants the ACS to be a commercial success. This vehicle is a recent invention, so there are not that many in existence. Local authority pools will be good news for ACSs as a business.
  • ACSs were created to help the City of London compete with other financial centres such as Luxembourg.This might sound a poor reason, but the other but the investment vehicles currently used for members savings are pretty similar. Some will continue to be used alongside ACSs.The difference between these vehicles does not matter anywhere near as much as who controls the assets and how much they pay for the service.
(Nor does this reporttackle the bigger question of why or how local government workers’ should help the City of London.)
  • The second reason for promoting ACSs is that the government thinks they are a good way for pension funds to work together without fully merging. In other words, they want pension funds to try harder. The government has not forced funds to use ACSs, but by encouraging them to do so, one challenge was to see if they could find an alternative.

What have the LGPS administering authorities done so far?

  • Most of the eight LGPS Pools have followed the government’s preferred model and said they will use an ACS for all or most of their investments. The London Pool (32 London boroughs plus the Corporation of London)and LPP (Lancashire, the London Pension Fund Authority and Berkshire) have already got their ACS up and running.
  • The Northern Pool (Merseyside, Greater Manchester and West Yorkshire) submitted aproposal that does not use an ACS.

What is the ACS structure?

  • The ACS has to be managed by an organisation approved by the financial regulator (the FCA). This organisation has to be legally separate from any local authority (in terms of location it can be in the same building).In the diagram below, this organisation is called the Operator. The Operator sits above the ACS. The Operator looks afterthe savingsthat the participating pension fundsgive to the ACS to invest (so the Operator is the people; the ACS is a set of documents –very valuable documents in the case of local government pension funds, worth billions of pounds).UNISON uses the term ‘Pool’ to cover the Operator and the ACS.
  • The Pool will put the money into numerous compartments within the ACS, labelled here sub-funds. The following diagram gives some examples of what kinds of assets those sub-funds can buy.

Figure 1

How is this different to current investments of members’ savings?

  • The current system is simpler: local government pension funds give members’savings to commercial companies (Schroders, Jupiter, Aberdeen, BlackRock– companies that offer ISAs) to invest on their behalf.
  • If it is a big chunk of money – e.g. more than £100m – then the commercial company might offer the fund a special, dedicated account, which isn’t shared with another organisation and has dedicated staff at the commercial company looking after it. The jargon for this special service is a ‘segregated account’ – the more you pay, the better service you get.
  • For less than £100m, the money is likely to go into an account with other investors, including other pension funds. These are known as pooled funds.

What is the difference between sub funds in figure 1 and pooled funds?

  • This depends as sub funds in an ACS are flexible. They might be pooled funds, in which case there is no difference, but the sub funds can be run as a kind of segregated account, with a special agreement between the Pool and whoever runs the sub fund.
  • As with any other segregated account, what really matters is the amount of money involved. The more you have, the more likely you are to get a segregated account.
  • What is most important is the nature of pooled versus segregated.It is not just about ‘quality of service’. If savings are segregated then the administering local authority knows exactly what it owns. So a segregated account might have shares in companies like Sainsbury’s or Vodafone. That means the authority owns a part of Sainsbury’s or Vodafone and the share are pieces of paper to prove that ownership.
  • If you invest in a pooled fund, then you would not own shares directly. Instead you would buy units in the fund. The fund would then go and buy shares in companies like Sainsbury’s or Vodafone in proportion to the units.

Why bother with units if you could have a bespoke, segregated service?

  • The financial services sector has pushed unitisation, not pension funds or other savers. Units make it easier for the asset manager to run its business. For unions, who want to have more control over where members’ savings go, units are a barrier.
  • If you own the shares direct you have the right to give your views to the management of a company on how they are running it. If you hold units then you should earn the same kind of return as the shares but you have to rely on the asset manager – a middleman – to speak on your behalf.
  • Asset managers work in the City and don’t belong to a union. They might have different views to their customers and as there may be lots of clients in a pooled fund, the clients might not all agree on what they want to say. So holding units makes it harder to influence companies.

Will the new Pools help the LGPS?

  • Possibly. They are going to handle huge pots of savings – over £30bn in some cases - which means that they will have more clout in dealing with the City and big companies like Sainsbury’s and Vodafone.
  • A lot of the staff working in the Pools will transfer over from local authorities rather than from commercial providers, so will be from the public sector. And as the local authorities will own the Pools that should safeguard the public sector ethos.
  • On the other hand, the government wants Pools to do a better job than current administering authorities. Channelling assets will mean bigger saving pots and more clout, but there may be a temptation for staffin the Operator to pay themselves more and become as greedy as some of those in the City.
  • Although many employees in the Pools will transfer from local authorities, as they expand they are likely to take on staff from the City.
  • ACSs areflexible, so it is not yet clear how ifthe problem of owning units rather than shares (weaker rights for workers’ capital)will persist. Current evidence from the ACSs is that a lot of pooling will take place.

Why not find a way to pool and keep stronger control over the pension funds’ assets?

  • This is what the Northern Pool has tried to do. The three funds in it, Merseyside, Greater Manchester and West Yorkshire want to work more closely together as a Pool, merging investment functions, but don’t want to set up an ACS. These three already have large segregated accounts and think that setting up an ACS would weaken their control over assets in the segregated accounts.
  • Not all those segregated accounts are managed by commercial firms. Merseyside, Greater Manchester and West Yorkshire have in-house teams doing considerable amounts of investing. This Pool argues that they are already doing what central government is asking.
  • In-house teams are cheaper than using City firms and, because they are in-house, are always on hand to adjust the investments in line with the wishes of the administering authority.

Why not do more in-house management of local authority workers’ savings and forget ACSs?

  • Using an ACS does not prevent more savings being managed in-house. Nor do they stop segregated accounts. Forming the new Pools can be seen as a step towards more in-house management. Several submissions from the Pools to government say they intend to manage more savings in-house.
  • If the money is managed in-house at the Operator, then the local authorities ought to have enough control as they will be the only clients in the sub funds. Within a Pool there will be many sub funds so different funds can access different sub funds. In that sense ACS flexibility is good.

What is the ownership structure of the ACS?

  • LGPS funds are the only clients of the Pool (so the Welsh Pool has eight clients). They are also the only owners. Each fund holds one share in the Pool. Most Pools are proposing to govern themselves based on a majority. So it could be that one or a minority of owners don’t have their wishes met if all the funds aren’t unanimously agreed on a decision.
  • LPP is an interesting case because Lancashire County Council and London Pension Fund Authority already own an ACS. Berkshire County Council is in the process of joining the Pool but it is not clear that Berkshire will become a shareholder.

How else will the funds exert control?

  • Figure 1 shows an Oversight Entity, sitting above the Operator. The Oversight Entity will be formed from the chair of each pensions committee of the relevant local authority. These committees are made up of local Councillors from councils in the region of the administering local authority, e.g. Merseyside.For the Oversight Entity, there will probably be an independent chair as well.
  • The Oversight Entity’s role is to make sure that the Operator does a fair job on behalf of the owners – the local authorities.
  • Some Pools also have set up Investment Committees to officially recognise the role of local authority finance executives. The chief financial officer, treasurer and similar staff will be on hand to advise each of their own pension funds and pension committees. That is the same as now. But the London Pool has also set up a formal committee for the executives of each Borough to discuss issues with their Pool.
  • There is little reference to Local Pension Boards (LPBs) in the proposals on Pooling. Presumably the LPBs keep their monitoring role by asking the senior financial officers of the administering authority – and the pensions committee – what they have been up to. There is not a direct relationship for the Local Pension Boards and the Pools.
  • There is also little mention of union representation on any Oversight Committee of the Pools. The Northern Pool’s submission to government mentions the possibility of union representation but there is no detail.
  • UNISON and the other lead LGPS unions have demanded four seats on each of the Oversight boards. We have asked the LGPS Scheme Advisory Board to issue advice on this.

What is the proposedACS operating structure?