The role of non-financial factors became the headline issue in the government’s attempt to ban political boycotts from LGPS investment decisions. Nick Stones explores the implications of the recent Supreme Court hearing on the Palestinian Solidarity Campaign case.
Arthur Scargill means different things to different people. Many will recall his leadership of the National Union of Mineworkers (NUM) and the long strike of 1984-85. What might be more interesting is to consider whether Mr Scargill and a Conservative government have something in common?
Both, albeit thirty years apart, wanted non-financial factors to be taken into account when deciding how to invest pension scheme monies. Indeed, it might be argued that the NUM and its former leader began the modern debate over the extent a trustee can take into account non-financial issues when deciding how to invest monies entrusted to them.
Perhaps, not unreasonably, the leader of the NUM was not happy that some of the mineworkers’ pension fund was investing in industries that were in direct competition with the coal industry.
Boycotts
Thirty years later the debate moved on and the government did want pension scheme investors to be able to consider non-financial matters. However, it did not like the idea of this being taken to allow boycotts or divestments against foreign nations and the UK defence industry.
This brings us to the more recent example of the Supreme Court ruling on the Palestinian Solidarity Campaign and whether LPGS funds can make investment decisions that run counter to government policy.
In Arpril, the government, like the NUM, lost at the courts. The ruling says the government overstepped its powers in that whilst it is able to tell funds how to approach the matter of investment decisions, it should not direct funds as to what investments they can make.
It is important to understand that this is a technical ruling on the scope of government power under primary legislation to make secondary legislation. A lawyer’s thrill but not a fundamental re-write of the law.
Machinery of the state
But there is some interesting commentary on wider matters impacting on LGPS that are of note. The Supreme Court has commented on the separation of the administering authority from its pensions role and its governmental role. An administering authority is not part of the machinery of the state and pension fund money is not “public money”.
There is therefore an affirmation of the concept of the administering authority, being a quasi trustee looking after “other peoples money”: Whilst the government can issue guidance, as empowered by the primary legislation, it is not able to substitute the administering authorities’ own policies for those of the state.
It is difficult now to argue against the administering authority being a quasi trustee and, as such, the transposition of trust law principles as another layer of legal oversight for LGPS alongside the statutory framework.
The government wanted non-financial considerations to be taken into account, just not those that interfered with foreign or defence policy. The ability to do so remains in place, but this is not a charter to start boycotts.
The starting point is always what powers and requirements are set out in the relevant legislation. The 2016 Investment Regulations should be the starting point of any exploration and contain the first commandment: to seek proper advice.
Non-financial factors are factors that might influence investment decisions that are motivated by other (non-financial) concerns, such as improving members’ quality of life or showing disapproval of certain industries.
The example from the Law Commission was tobacco. Not investing in tobacco because the risk of litigation may impact on return is a financial factor. Not investing in tobacco because it is a reputational risk, or because it kills people, are non-financial factors.
Tobacco
Subject to the trust deed / LGPS regulations, the investor of pension scheme money must act in the best interests of the members, which is normally their best financial interests. This is usually the main takeaway point from the 1985 NUM case. The primacy of the need to invest for investment purposes and not alterior purposes remains today, albeit the scope and sophistication of the debate around non-financial factors and the role they can play has developed.
Within the LGPS context the administering authority is the sole decision maker. It should, within prudence, seek the maximisation of investment returns. However, it can take non-financial factors into account provided those factors do not present a material detriment to the fund.
But in this context the non-financial factors should still be linked with the underlying purpose of investment. That means using the investment power set out in legislation to achieve the investment function: a diverse range of suitable investments capturing the correct balance between risk and return based on the circumstances and needs of the fund and in accordance with the principles of a prudent investor.
Consensus building
But whilst the administering authority can take non-financial factors into account it must do so carefully and for the right reasons. There is a need for consensus building among the different constituents of the LGPS, the main two being the members and the scheme employers. It is not a case of one party imposing their will on the others.
The administering authority should consider the guidance set out by the Law Commission in 2014 which identifies two tests for the use of non-financial factors (no material detriment and a shared concern amongst the stakeholders) the language of which has found it way into the 2016 Investment Regulations.
The regulations are well known and require a published policy on the use of non-financial factors that permeates not just into future investments but also the retention and realisation of existing investments.
This is where we come back to the recent case. Administering authorities’ investment strategy statements must be prepared and maintained in accordance with the statutory guidance—an absolute to be followed rather than a form of guidance.
The aspects of the guidance dealing with how an administering authority deals with ESG remains as before—the way the authority must conduct its policy formation, the primacy of the investment function and the need to demonstrate a common interest / level of support.
Where the government overstepped the mark was when it impinged on the investment decision function of the authority for reasons outside of any investment function.
Nick Stones is a partner at Pinsent Masons.
