Summary
In the recent case of R (on the application of Palestine Solidarity Campaign Ltd and another) v Secretary of State for Housing, Communities and Local Government the Supreme Court ruled that ministerial guidance, given to administering authorities of Local Government Pension Scheme (LGPS) funds on how to discharge their investment powers, is unlawful.
The case was decided on established principles of public law, but by a split 3:2 decision. For three of the judges, the Public Service Pensions Act 2013 (the “2013 Act”) did not allow central government policy to be "imposed” on LGPS funds. For the remaining two judges, the public interest component of the 2013 Act was key, and, under certain circumstances, central government could legitimately seek to align LGPS fund investment with government policy.
Importantly, all five judges accepted that administering authorities owe “quasi-trustee” duties to LGPS members (at least in the area of investment) and that, as the law stands, the Secretary of State’s powers are limited by these overriding duties.
Background
Local Government Pension Scheme (LGPS)
The LGPS is a funded public sector scheme with almost £300 billion of assets. In England and Wales the LGPS comprises 89 separately administered pension funds. These funds, and the assets held under them, are administered and managed by “administering authorities” (predominantly local authorities), in accordance with regulations which govern the LGPS.
One of the key responsibilities of administering authorities is to invest the assets of their fund. Their duties include formulating an investment strategy in accordance with the Local Government Pension Scheme (Management and Investment of Funds) Regulations 2016 (the “Investment Regulations”) – regulations made under the 2013 Act. This investment strategy must include “a policy in relation to how social, environmental or corporate governance considerations [now commonly known as ESG factors] are taken into account in the selection, non-selection, retention and realisation of investments”.
In 2014, a report published on fiduciary duties of investment intermediaries by the Law Commission of England and Wales found that the duties of administering authorities in managing assets were similar to the fiduciary duties of trustees and that, in practice, administering authorities considered themselves to be “quasi-trustees” acting in the best interests of their members. In relation to ESG investment considerations, the Law Commission concluded that the same constraints on trustees should apply to administering authorities, namely: (1) there must be good reason to think that scheme members would share the ethical concern; and (2) the investment decision must not involve a risk of significant financial detriment to the fund.
The Secretary of State guidance
In November 2016, guidance issued by the Secretary of State for Housing, Communities and Local Government (the “Secretary of State”) on LGPS fund investment strategies took effect. The guidance was made under wide and seemingly unfettered powers granted to the Secretary of State by the 2013 Act and Investment Regulations. Although termed “guidance”, the Investment Regulations make clear that administrating authorities must follow any Secretary of State guidance when making their investment strategies - so it is in fact mandatory.
The guidance included a section on how administering authorities should formulate ESG policies. This section acknowledged the status of administering authorities as quasi-trustees for investment matters. It also included the following statement:
“…the Government has made clear that using pension policies to pursue boycotts, divestment and sanctions against foreign nations and UK defence industries are inappropriate, other than where formal legal sanctions, embargoes and restrictions have been put in place by the Government.”
and that administering authorities:
“Should not pursue [ESG] policies that are contrary to UK foreign policy or UK defence policy”
The legal challenge
Shortly after the guidance was issued a judicial review was brought by two claimants, one being Palestine Solidarity Campaign Ltd, a Palestinian rights and anti-racism organisation.
The claimants argued that the two passages above were unlawful as the Secretary of State did not have the power to impose the restrictions. On 22 June 2017, the High Court found that the two passages were unlawful. The government appealed this decision and it was subsequently overturned in the Court of Appeal. It was then heard by the Supreme Court, which gave the final judgment in the case on 29 April 2020.
The Supreme Court Judgment
By a majority decision of 3:2, the Supreme Court overturned the Court of Appeal decision and found that the two passages of the guidance were unlawful and must be removed.
In the leading judgment for the majority, Lord Wilson applied the principle from the Padfield case that a discretionary power granted in legislation can never be completely unfettered and must be exercised in accordance with the purpose or object of the legislation in question. Lord Wilson held that the purpose of the 2013 Act and the Investment Regulations was to assist administering authorities with formulating procedures and strategy for administering and managing the LGPS. However, the legislation did not give central government the power to direct exactly what administering authorities should or should not do. Therefore the guidance could stipulate how to approach investment decisions but not direct what investments should be made.
Lord Carnwath, in agreeing that the guidance was unlawful, held that any guidance must respect the primary responsibility of administering authorities as quasi-trustees of LGPS funds and, imposing central government policy choices on ESG investment policies properly formulated in accordance with those responsibilities, failed to do this.
The dissenting judges, also applying Padfield principles, decided that a key part of the policy purpose of the 2013 Act was “to ensure that the public interest is reflected in the arrangements for the management of [public sector] schemes”. Consequently, they held that, so long as administering authorities’ primary quasi-trustee duty to make investment decisions in the best financial interests of members was not compromised, the Secretary of State could lawfully restrict ESG policy in the way that the guidance sought to do, if this was considered to be in the public interest. In their view, the guidance did not direct LGPS funds to invest or disinvest in certain stocks; instead, it required that administering authorities refrained from making investment decisions for particular non-financial reasons. Therefore, the overriding duties to members were not compromised.
Our Comment
This case was decided on established principles of public law, albeit by a majority decision.
Although the court was split, importantly, all five judges agreed that administering authorities owe quasi-fiduciary duties to LGPS members (at least in the area of investment) and that, as the law stands, the Secretary of State’s powers are limited by these overriding duties.
The judgments also touched upon important questions, such as whether the assets held by LGPS funds could be considered “public money” and if administering authorities could properly be described as “part of the machinery of the state” (as was held by the Court of Appeal). These are potentially crucial issues – for example, if not part of the state, are local authorities still subject to public law principles when acting as administering authorities or should they be regarded as “quasi-trustees” in all their dealings, including with employers of the LGPS? Unfortunately, the court’s answers to these questions are not exactly clear, and the discussions are probably best seen as obiter dicta and therefore not legally binding.
The case also highlights a contradiction in central government’s current dealings with the LGPS. On the one hand, government accepts that administering authorities are quasi-trustees with duties to invest in the best financial interests of members, and says it wants to give more autonomy to LGPS funds. On the other, government also wants to influence LGPS investment strategies for what it sees as the wider public interest.
Following the Supreme Court’s decision it is not clear if central government LGPS policies, such as increased pooling of LGPS assets and encouraging LGPS investment in UK infrastructure projects, are legally sustainable. To pursue these policies primary legislation may now be needed, and the government has suggested it will seek to change the law. However, even with new legislation, the court’s decision makes clear that government influence would remain subject to the wider duties that LGPS funds owe to members, unless these duties are themselves overridden by new laws. We think it is unlikely that government would seek to override fiduciary duties, as removing basic member protections would be extremely politically sensitive.
How Burges Salmon can help
We have a specialist team of pension lawyers who advise on all legal matters relating to public sector pensions schemes, including the LGPS.
If you would like advice on any issue raised by this article or public sector pension schemes more generally, please get in touch with Michael Hayles, Ed Curtis or your usual Burges Salmon contact.
This article was written by Ed Curtis, a senior associate in our Pensions team.