Hymans Robertson’s David Walker discusses likely changes to the Local Government Pension Scheme following the chancellor’s review of the UK financial services industry, including pooling and investments in illiquid assets.
Late last year, chancellor Jeremy Hunt announced plans for a wide-reaching review of the UK financial services sector in his Edinburgh Reforms. The stated aim of the reforms is to drive growth and competitiveness, but a key question for Local Government Pension Scheme (LGPS) stakeholders is how the reforms might impact the running of pension funds and the long-term sustainability of the scheme.
Of the areas listed in the reforms, a couple stand out as having the most direct impact on the LGPS: asset pooling; and investing in illiquid assets such as venture and growth capital.
Future of asset pooling
In his announcement on 9 December, Hunt confirmed the intention to “consult, in early 2023 on issuing new guidance on Local Government Pension Scheme asset pooling”. While this consultation has long been expected, this was a rare public commitment on timing.
Pooling reforms formally kicked off in 2015, when the government published criteria and guidance on asset pooling in the LGPS. The guidance focused on four key areas: benefits of scale; strong governance and decision-making; reduced costs and excellent value for money; and more capacity to invest in infrastructure.
The government published an informal consultation on asset pooling in the first quarter of 2019. While this focused on the same key areas as the original guidance, it included more specific proposals around the regulatory structures of pools, requirements to review investment arrangements, decision-making and governance, in particular around strategic and tactical allocations.
The consultation also focused on requirements to transition assets into pools, where assets could be invested outside pools and also ambitions for investment in infrastructure (albeit stopping short of setting specific targets). The informal consultation received wide-ranging responses and views that reflected the different structures and approaches that had been taken to pooling.
It is not yet clear where the focus will be from the government for this latest formal consultation on pooling. A huge amount of progress has been made across all the pools in England and Wales to develop investment solutions that meet the needs of partner funds, but there is plenty of work still to do.
A key question will be whether the government is happy with the direction and pace of pooling to date. Could we see increased pressure to pool more assets at a quicker rate? Whatever the focus, it will be important that all funds and pools respond to reflect their needs and ensure any regulation and guidance on pooling helps to achieve better outcomes for the LGPS.
A key question will be whether the government is happy with the direction and pace of pooling to date. Could we see increased pressure to pool more assets at a quicker rate?
Are illiquid assets on the cards for LGPS funds?
The prospect of investing in venture and growth capital was also mentioned in the Edinburgh reforms. This appears to be another example of the government looking to use LGPS investment to bolster the UK economy, as it did with infrastructure in the initial pooling plans. It is also consistent with the levelling-up agenda. Introduced by Boris Johnson’s government, the agenda has been criticised for not yielding results, and LGPS investment is being eyed as a lever for change.
It’s unclear if a consultation on the LGPS investing in venture and growth capital will be part of the pooling consultation or part of broader consultations expected this year, including levelling up. Although such illiquid asset classes bring the prospect of higher returns, they also bring risks. Our view is that they could have a place in a diversified strategy, but their use would need to contribute to a fund’s goals and meet its financial requirements on risk and return before considering any wider benefit to the UK economy.
[Venture and growth capital] could have a place in a diversified strategy, but their use would need to contribute to a fund’s goals and meet its financial requirements on risk and return before considering any wider benefit to the UK economy.
Financing the transition to net zero
A third area outlined in the reforms is on the government’s Green Finance Strategy. Most LGPS funds will already have responsible investment and climate risk high on their agendas, with legislation scheduled to come into force this year requiring funds to report against the Taskforce for Climate-Related Financial Disclosures (TCFD). As part of these climate risk considerations, many funds have committed to varying forms of net-zero ambitions.
To achieve net zero, it will be vital for companies to transition their businesses. Consequently, having a financial system and regulatory framework that reflects the government’s own net-zero target will help this process. We hope this will also provide opportunities for investors, such as the LGPS, to invest in the transition and achieve positive change as well as financial returns.
Although there is limited detail available to date, it is encouraging the see the delivery of net zero being included as an area of focus for the reforms.
David Walker is Hymans Robertson’s chief investment officer.
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