William Bourne channels his inner Mystic Meg to offer some predictions for the LGPS in 2022. He highlights the risk of policy errors, rising contributions, new investment regulations and more stringent requirements on climate change disclosures.
The LGPS ended 2021 in good health, at least on the surface. Markets are buoyant, the real ramifications of the McCloud judgement on age discrimination and GMP on funds are beginning to emerge out of the mist, and after six years at least some of the pools are approaching normal working. The S13 standardised LGPS valuation report was released just before Christmas, with a ‘best estimate’ funding level of 109% in March 2019. This compares with the 98% aggregate funding level on a local basis at the same date.
The most obvious threat to this rosy picture is on the asset side. It is clear that the world’s economies are slowing down following the post lockdown boost. At the same time, inflation has picked up to 30-year highs in the US and the UK. It is presenting central banks with a dilemma. Should they tighten policy to keep inflation under control, or focus on sustaining economic growth? In the short-term, the Omicron variant surge and renewed lockdowns are placing extra pressure on policy making.
Potential for falls in asset values
In these circumstances, policy error looms largest in my crystal ball for 2022. If the authorities get it wrong, there is plenty of scope for a fall in asset values. Inflation above about 3% has historically been bad for equities, particularly when combined with low growth. Equally, a fall back into economic recession leads to the spectre of deflation, with few policy tools available after 13 years of easy money.
Of course, the big event of 2022 will be the triennial valuation at 31 March. It may surprise employers, given the healthy funding level, that contributions are more likely to rise than to fall. This is primarily down to the impact of higher inflation assumptions on future service benefits. As the Section 13 report points out, significantly higher contributions could cause problems even for tax-raising employers.
2022 is also the year when we expect long-awaited updated investment regulations from the Department for Levelling Up, Housing and Communities (DLUHC). The current regulations mainly date back to 2016, and the amendments are expected to include new wording in three important areas: pooling, climate change and social aspects of investment.
Uneven pension pool progress
Six years on from the establishment of the first pools, progress in pooling the assets of the 88 England and Wales funds has been uneven. Amounts committed to pools vary from 98% at the Local Pensions Partnership downwards. The biggest barrier has been the tension between the Section 101 committees’ overriding fiduciary duty to look after the interests of members, and the regulatory pressure to allocate to pools that lack a track record or resources compared to private sector rivals.
I would like the new regulations to encourage LGPS funds to invest across pools, whether through cross-pool ventures such as the London Fund and the GLIL infrastructure fund, or directly with pools other than their own. As partner funds mostly have stakes in their own pools, I do not expect a rush, but the freedom to do so is a good way to avoid unnecessary duplication and ensure best practice wins out.
Following the introduction of climate change disclosure legislation in October 2021, it is almost certain that the new investment regulations will include more stringent disclosure requirements. The science of climate change metrics is evolving rapidly, and, to avoid unintended consequences, the guidance around these rules will need to be not too prescriptive.
The race to net zero
2021 has seen a considerable shift among investors over how to mitigate the financial risks to funds from climate change. There seems to be a growing coalescence around a net zero target, whether 2050 or sooner, and a much greater understanding that fossil fuels will be needed to get there. In 2022, I expect investors to focus on identifying carbon capture strategies to offset those industries (eg building) and countries (eg India) that are not going to achieve net zero by that date.
Investors, including the LGPS, are increasingly skewing their investments to companies that will be part of that transition (eg in the context of fossil fuels) and away from those that won’t (eg coal). I therefore expect the debate in 2022 to move away from blanket exclusion policies and towards more targeted disinvestment from companies that are not aligned. Any disclosure metrics will need to capture this.
The other great surge in 2021 has been towards ‘impact’ investing, ie looking for investments that provide some social benefit in addition to financial returns. Much has already happened over the past few years with environment, social and governance (ESG) issues, and I expect more managers explicitly to look for social as well as financial targets in 2022. The cynical will call it ‘impact washing’ (on the same lines as greenwashing), but in my view it reflects another step in the evolution of market capitalism away from pure financial returns and towards broader social objectives.
Combining codes of practice
Finally, there are two other projects that may well see the light of day in 2022 after long gestation periods. One is a proposal from the Pensions Regulator (TPR) to combine ten codes of practice, including the LGPS’s Code 14, into a single code. TPR is taking time to consider the substantial feedback from its consultation in 2021, but we can expect to see the results this year. If there is a single code, the most important impact for the LGPS is likely to be that the asset side of its balance sheet will find itself within TPR’s scope. It may be difficult to square this with the various other investment regulations the LGPS is subject to.
Secondly, the recommendations in the Good Governance project run by the LGPS Scheme Advisory Board are long overdue for implementation. Could 2022 be the year?
All this will add further burdens on the limited resources at LGPS funds, in addition to the stresses on the administration side caused by McCloud etc. So, my final prediction for 2022 is that LGPS funds will find themselves competing in a limited pool for trained and knowledgeable staff. I would like to think that pay rates for key pension officers may rise as a result.
William Bourne is principal of Linchpin Advisory Ltd and has roles with five LGPS funds.
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