On 14 November, Chancellor Rachel Reeves delivered her much-anticipated Mansion House speech and launched a package of proposals and consultations for reform of pensions and investments. As summarised in our earlier article, from the pensions perspective, the proposed changes centre around a clear policy objective to drive consolidation of schemes – the rationale is that larger funds are more willing, and more able, to invest in a wider range of productive assets, and this is backed by the initial findings from phase one of the Government’s pensions review (the Interim Report on which was published as part of the Mansion House speech package). Consolidation will therefore, so the logic goes, lead to increased investment in UK productive finance and infrastructure, and will thus drive economic growth, the central pillar of the new Government’s fiscal policy.
For the LGPS, this translates to a proposal that all of the assets of all 86 individual funds participating in the scheme will be transferred into pools, which will be authorised and regulated by the FCA. The structure of pools will be standardised through a universal set of standards, including the pool taking on all aspects of investment implementation for the strategy set by the fund. Measures will be put in place to improve governance at both pool and fund level.
The Government is now seeking views from stakeholders on its proposals via its consultation “Local Government Pension Scheme: Fit for the Future”, which runs until 16 January 2025, In this article we consider some of the key measures being proposed and share our thoughts on some of the legal and practical challenges. The consultation groups the proposals into 3 themes which we will examine in turn:
- Pooling
- Local investment
- Governance
Having considered the proposals we then consider what is missing from the current plans and look ahead to what comes next.
Pooling
Pooling of LGPS assets was an ambition first announced by the then Chancellor George Osborne, as part of his 2015 Mansion House speech, which proposed an eventual aim to create six asset pools. This led to the formation of eight asset pools by the 86 Administering Authorities within the LGPS, into which a growing number of fund assets have been transferred over the years.
This transfer process was sought to be accelerated by the then Chancellor Jeremy Hunt in 2023. In July 2023 he launched his own Mansion House package of measures, which for the LGPS included setting a suggested deadline for all LGPS funds to transfer their listed assets (as a minimum) into local government pension pools by March 2025. Since the July 2024 General election, the new Government has confirmed that this deadline still stands and, prior to the Mansion House speech, had already indicated that it would consider legislating to mandate pooling if enough progress was not made. By the end of March 2024 £178 billion of LGPS assets were invested through pools, with a further £107 billion managed by pools but sitting outside of pooled investment vehicles. This accounts for 72% of LGPS assets in total.
It is against this background that Chancellor Rachel Reeves has set out her own vision for LGPS pooling to go further and faster. The current consultation proposes the following:
- Administering Authorities will be required to transfer all remaining assets to their pool;
- They will also be required to fully delegate the implementation of their investment strategy to the pool, and to take their principal advice on their investment strategy from the pool; and
- The pools will be required to be investment management companies, authorised and regulated by the Financial Conduct Authority (FCA).
A. Transfer of remaining assets to pools
In terms of the requirement to move all assets into pools, it is noted that there is currently significant variation in the degree to which Administering Authorities have embraced pooling – the percentage of assets invested by funds in pooled vehicles varied from 6% to 95% as at March 2024. The consultation document makes very clear the Government’s view that “in order to deliver the full benefits of scale AAs would need to transfer 100% of their invested assets to their pool with no new investments being made outside their pool, including local assets”.
Until now, whilst the statutory guidance has indicated all assets should be pooled this has been on a “comply or explain” basis and the focus has been on consolidating listed assets within the pools. The Government has recognised that transferring other assets can lead to incurring unnecessary costs in the short term (such as for termination of long-term contracts). Under the new measures, it is proposed that such legacy assets will all be managed by the pools, but with ownership retained by the relevant fund. In this way, says the Government, efficiencies will be gained through, for example, staff with the appropriate expertise only being required at the pool level, rather than at individual fund level.
However, it is recognised that it will take time for pools to build the necessary investment management capacity in house for illiquid assets – in the immediate future there are likely to be increased costs, though the Government suggests these will be offset (at least in part) by reduced costs for Administering Authorities. However, it is easy to envisage circumstance where delegating management of an illiquid investment such as a block of flats or an agricultural land holding may result in significant additional costs in the short term. A pool without the relevant in house capability will continue to delegate management of the investment in the same way as the fund has previously but with the pool sitting in between, adding an additional layer of bureaucracy and, inevitably, cost. Funds will need to conduct due diligence on the illiquid assets they hold and assess whether or not the pool has, or can source, the necessary capability to manage them.
B. Investment strategy and advice
The mandate for LGPS funds to transfer the management of all of their assets to the pools (and in the case of listed assets, to transfer them into pooled investment vehicles), in place of the previous “comply or explain” approach to pooling, marks a fundamental shift in the way LGPS assets are invested. Hand in hand with this comes the proposed approach for investment strategy, whereby administering authorities are now required to fully delegate implementation to the pool and also to take their principal investment advice from the pool.
The proposal is that the Administering Authority will set the investment strategy at a fund level, to include parameters such as level of risk, return, funding level, stability of contributions, ESG factors, local investments etc and “if the administering authority wishes to do so, a high-level strategic asset allocation”. That strategy is then fully delegated to the pool to implement – an analogy is drawn in the consultation paper with the fiduciary manager approach often adopted in the private sector by trust-based schemes. The Administering Authority will then be required to take advice on their investment strategy from the pool.
We note there is some inherent tension here between the pool on the one hand acting as the investment manager for the fund, and, on the other, acting as its principal investment adviser. Does the dual role of the pool in this regard give rise to concerns regarding potential conflicts and lack of scrutiny / oversight? How will the pool’s conflict of interest be managed when giving the Administering Authority investment advice? Unlike the fiduciary manager in the private sector, with which an analogy is drawn in the consultation paper, in the LGPS there will be a limited number of alternative pools to which a fund would be able to move if not satisfied with the approach or performance of their existing pool.
This is addressed in passing in the consultation paper, which comments that: “the requirement for AAs to have an independent adviser or committee member would equip them to challenge the pool’s advice in the majority of circumstances, however it is recognised that in exceptional circumstances AAs may wish to seek additional advice from external investment advisers to help them test the advice given to them by the pool.” We can see it being the case that this “exceptional circumstances” provision for Administering Authorities to seek external investment advice to test advice from the pool becomes more widely used by funds than perhaps the Government anticipates.
C. FCA authorisation
Currently the eight existing pools have varying structures – including standalone FCA-authorised investment management companies, outsourced models, and joint committee oversight. Some have made less progress than others in receiving assets from the participating funds, while others have created numerous sub-funds, reducing the potential benefits of scale.
As set out above, the Government is proposing to harmonise arrangements by setting out minimum standards for pooling which will include a requirement for all pools to be authorised and regulated by the FCA by 31 March 2026.
This would ensure that the funds are managed by firms that adhere to strict standards of compliance. Five pools within the LGPS are already using FCA authorised investment companies but three are not yet. This means that the three pools with other models in place will need to consider either seeking FCA authorisation or merging with one of the pools which is already FCA-authorised. The ambitious timescales may mean that it is challenging to achieve FCA authorisation by the March 2026 deadline (a process that can typically take at least 18-24 months).
Pools will be required to develop their own in-house investment management capabilities – the Government’s aim is to replace the reliance on external fund managers, and manage their investments themselves. It is recognised that this will be a substantial change for all eight of the pools, and it will take time (and cost money) to build up the necessary in-house capabilities, particularly in respect of local investments and for providing advice on investment strategy to funds.
The aim is “for all pools to develop further as powerful global and local investors, delivering strong performance, value for money, and resilience over the long term”. However, it is worth noting that the sheer range of assets held by funds within a pool will mean there will always be circumstances in which external advice is required. Anecdotally we understand that the Maple 8 funds in Canada, which the Chancellor has looked to for guidance in developing this new model (more on this below), themselves use external fund managers.
One could make the case for the Government’s ambition for pools to manage their own investments, having some overlap with its ambitions for the use of LGPS assets to advance the productive finance agenda. It seems inevitable that the concentration of assets in a small number of pools will attract greater political attention – will it also lead to increased politicisation of decision making and does taking investment management in house increase this risk? Again, we can look to experience in Canada where there is a recent cautionary tale from Alberta, reported by Bloomberg UK, where the entire board of the Alberta Investment Management Corporation (Aimco) was recently replaced following intervention by the state’s Finance minister.
Local Investment
The LGPS already invests approximately 30% of its assets in the UK. The Government has indicated that it feels that the LGPS should be investing a greater proportion of assets in local communities to “unlock growth”. The consultation sets out that the Government believes that pooling will allow a greater proportion of funds to be invested locally, as Administering Authorities have to consider factors, like conflicts of interest and potential reputational issues, when deciding whether to invest locally. A pool may also be in a better position to carry out due diligence and assess potential investment opportunities. The Government believes that pools will be better able than Administering Authorities to align their investments with local growth plans and economic priorities.
In terms of the proposals within the consultation, the Government suggests that Administering Authorities should collaborate with pools and combined authorities and introduce their own objectives for local investment in their Investment Strategy Statements, including setting targets for local investment. The consultation also proposes that Administering Authorities take local growth plans and economic priorities into account when deciding their investment strategies. Pools would be carrying out the due diligence for local investment opportunities and managing the investments, but this would still require Administering Authorities to have the capacity to deal with other matters in relation to local investment. Understandably, there is a difficult balance to be struck in allowing the Administering Authorities some discretion to influence local investment, while reducing the overall burden on them.
Supplemental to this, the consultation proposes that funds will produce a section within their annual report to cover the extent and impact of their local investments to increase transparency. All of these changes would be set out in new regulations.
The suggestion of targets for the level of local investment has led to concern from some quarters regarding the interaction with their fiduciary duty to act in the best interests of members, as the priority should always be making the right investments on behalf of members. Investment opportunities, local or otherwise, should be assessed with rigour. Additionally, the consultation is unclear what meets the definition of “local” investment, merely stating that the aim will be to allow members to see locally important investments delivered. The absence of a clear definition may make this a challenging aim to fulfil, particularly where the pool makes the investment decisions – an Administering Authority can identify and put forward local investment opportunities as part of their investment strategy but it will be the pool that ultimately chooses when and where investments are made. If ten funds participating in the pool put forward ten local investment opportunities, will those funds whose opportunities are not taken forward by the pool, be fulfilling their “local investment” target allocation if e.g. a fund in the south west makes a “local investment” via the pool by purchasing an airport in the north east? Should there be a geographic element to the “local investment target” and if so how could and should a pool balance the competing local investment targets of participating funds?
Governance of funds and pools
In terms of the proposals to alter the governance of funds and pools, the consultation poses a series of new measures. Several of the requirements relate to Administering Authorities, and it is welcome to see that the majority are adopted from the Scheme Advisory Board’s 2021 good governance recommendations. This includes the creation of a new role – the “senior LGPS officer” who will have overall delegated responsibility for the management and administration of the fund, who would act as the voice of Administering Authority – and a new requirement for funds to undertake a biennial independent governance review (and then produce an improvement plan if any improvements are required).
In addition to this, the proposals suggest that Administering Authorities should be required to:
- prepare and publish an administration strategy (currently authorities can but are not required to);
- prepare and publish a governance strategy that includes a conflicts of interest policy; and
- improve the accessibility of annual reports under the proposals.
As well as this, the consultation proposes a new requirement for a required level of knowledge and skills of those involved in the management of LGPS funds, whereby committee members, the senior officer and officers would need to have certain skillsets and an appropriate level of knowledge for their roles. More stringent training strategies would also need to be set by Administering Authorities to ensure consistency across different portions of the LGPS.
At pool level, the consultation suggests that pool company boards should include one or two “shareholder representatives” and should consider how they can improve their transparency and reporting. This means of course that not every participating fund would be represented on the pool company’s board.
A key governance consideration not considered in the consultation is member representation and some concerns have already been voiced as to how member interests would be represented within a pool structure. Members do not have the same level of representation at pool level as they do at local pension board level (as required by the Public Service Pensions Act 2013 and the Local Government Pension Scheme Regulations 2013). It may become difficult for members to feel that their concerns have been heard and a route for members to feed concerns back to the pool may be helpful, as may including a geographic element within the local investment allocation target. The local investment allocation would then be reported in the fund’s annual report, which may help members feel that their fund still represents and supports local interests, even where investment management now happens at a pool level.
Missing measures
Most notably absent from the Mansion House speech and its accompanying pensions package were measures addressing ESG concerns. In the context of the Labour party manifesto ESG commitments, it was anticipated that we might see content addressing the role sustainable investments should play for both the LGPS and pension schemes more broadly. With the Government pushing for decarbonisation, and the LGPS with its estimated £500bn of assets by 2030 being the largest liquid asset the Government has to deploy, is there a missed opportunity here to advance the ESG agenda? After all, there is a place for local investment targets for Administering Authorities in the measures, a similar target for ESG investments could feasibly have been included.
Given the keen focus on generating economic growth, ahead of the Mansion House speech it had been anticipated that any measures announced may well include prescribing minimum levels of UK investment for pension schemes, including LGPS funds. In the end this wasn’t included – for the time being at least, the Government has stopped short of mandating minimum levels of UK investment. However, the phase one review continues, with the final report expected in Spring 2025. The Interim Report indicates that the review will use its “next stage” to “consider whether further interventions may be needed by the Government to ensure that these reforms […] are benefitting UK growth”. And of course, as set out above, the proposals do include a requirement for Administering Authorities to set targets for their pool’s investment in their local economy – the Mansion House press release highlights that if each Administering Authority were to set a 5% target, that would mean £20bn of investment in local communities. An attractive proposition for a cash strapped Government no doubt – might we see mandation further down the line if the local investment targets fail to generate sufficient revenue for community and infrastructure projects?
What next?
As set out above, there is much for the LGPS to tackle in the consultation, and quickly, and we look forward to the publication of industry responses in the early weeks of the New Year.
Whilst there is no proposal on the table to reduce the existing number of LGPS pools, there are some who have questioned why – if bigger is better, why is eight the magic number here? And will the requirement for pools to be FCA authorised by March 2026 – an ambitious timescale for a process that can easily take two years – lead to one or more of the three pools that are currently not so authorised seeking to merge with another in any event? We note that in relation to the expectation that pools “develop capabilities to deliver the implementation of investment strategies through in-house investment management”, the consultation paper specifically says the following (emphasis added):
“The government believes that this step change in the investment framework of the LGPS creates an opportunity for increasing effective scale and encourages all pools to carefully consider all options in that light. These may include establishing a new pool company, merging with another pool, or becoming a client of another pool company for some or all services required. Depending on the approach chosen, there will be set up and ongoing costs. But as has been demonstrated by existing asset pools using a pooling company model, these costs should be recouped through savings in reduced investment management fees. Pools will need to consider which route is most viable and efficient over the expected timescale (discussed below).
The government encourages pool mergers and sharing of services where this provides a more efficient route to the required standard. As part of their proposal, each pool will be expected to demonstrate why a merger with another pool, or use of existing capability in an established pool company, would not be a more cost effective or otherwise more preferable approach to achieving compliance with the reform proposals. For the avoidance of doubt, Government is not seeking to use this process to move to a single pool for all AAs.”
And what of consolidation of the funds themselves? Again, not a measure tabled in November’s package (despite rumours swirling in the lead up) but with the launch of the English Devolution White Paper on 16 December 2024, significant structural change in local government is on the cards. Will the reorganisation result in fund mergers as well? We will have to wait and see, but whatever the outcome, it is clear that there is plenty of change on the horizon for the LGPS in 2025 and beyond.
This article was written by Michael Hayles, Louise Pettit and Charlotte Colvin