Archived decisions

Agenda Item: 5

HAMPSHIRE COUNTY COUNCIL

Decision Report :

EXECUTIVE SUMMARY

1) Summary of Decision Area:

1.1. To approve a response to the Government's consultation on revised regulations on the management and investment of Local Government Pension Scheme funds.

2) Issues Covered in Report:

2.1. This report briefly summarises the draft regulations and highlights some issues concerning separate bank accounts for pension funds, borrowing by the County Council of Pension Fund cash balances and governance matters, on which a response should be made to the Government.

3) Recommendation:

3.1. That the draft response to the Government's consultation, attached as Appendix 1 to the main report, be approved.

MAIN REPORT

1) Purpose of the Report:

1.1. This report briefly summarises the draft regulations and highlights some issues on which a response should be made to the Government.

2) Contextual Information:

2.1. The investment of the Pension Fund is governed by the Local Government Pension Scheme (Management and Investment of Funds) Regulations 1998 which have been subject to a number of amendments over the last ten years. The Government issued for consultation on 6 February 2009 a draft set of regulations to consolidate these amendments and to introduce a number of new proposals. The consultation period ends on 3 April 2009 and the Government intends that the new regulations will come into effect later this year.

2.2. The Pensions Panel of the Chartered Institute of Public Finance and Accountancy (CIPFA) published a report on possible changes to the investment regulations in November 2008 following a survey of administering authorities. The Government has reflected some but not all of CIPFA's recommendations in its consultation proposals.

3) The Government's proposals:

3.1. The significant changes in the Government's draft regulations will:

· require administering authorities such as the County Council to maintain a separate bank account for the Pension Fund

· provide a limited power for administering authorities to borrow for the Pension Fund

· restrict employer-related investments

· revoke existing powers for administering authorities to use Pension Fund money.

3.2. The consultation also seeks views on how permitted investments by pension funds are best defined and whether that can be achieved by adopting the requirements for private sector funds on trustees' fiduciary duty.

3.3. These issues are briefly examined in the following sections.

4) Separate bank account for the Pension Fund

4.1. The County Council operates a single bank account with NatWest for all its activities, including the Pension Fund. Separate accounts are kept for the Pension Fund in the County Council's accounting system. Interest is credited to the Pension Fund at the seven day market rate. On occasions, deposits are made with external counterparties specifically for the Pension Fund and the Fund is credited with the actual interest earned on those deposits. Overall, the Fund's cashflow is managed so that it does not become overdrawn in compliance with the current regulatory requirement that the Pension Fund does not borrow.

4.2. The Government believes that separate bank accounts would improve the transparency between the accounts of pension funds and their administering authorities. It is said to be the Audit Commission's longstanding best practice to have separate bank accounts. CIPFA's report supports separate bank accounts although it was not a matter included in their survey of administering authorities.

4.3. In Hampshire's case, there is already clear transparency between the accounts of the Pension Fund and the County Council which would not be improved by separate bank accounts. In terms of transparency, it could be viewed as tokenism and seems rooted in a world of jam jar accounting, not modern electronic accounting systems. It would, however, add to costs in respect of bank charges, administrative time and audit fees.

4.4. The Government asks for views on what would be a suitable and practical lead-in time for implementing separate bank accounts. If the change has to be made, it would be sensible to allow a significant transition period to adjust accounting systems and renegotiate contracts. It would be helpful if the deadline for implementing the new arrangements was set as 1 April 2011.

5) Power to borrow

5.1. The Government proposes to introduce a limited power for local government pension funds to borrow for temporary periods. There is currently no such explicit power. The power will be limited to temporary loans or overdrafts in order to pay benefits or meet investment commitments arising from a reorganisation of investments. The borrowing and interest will have to be repaid from contributions or investments within 30 days.

5.2. This is a sensible clarification of the regulations and will cover incidents when unexpected changes in the timing of outgoings and income temporarily leave the Fund overdrawn. However, the micro-management imposition of detailed limitations in the proposed regulations would seem to be inconsistent with a "prudential" approach to the management of the Pension Fund.

6) Restrictions on employer-related investments

6.1. The draft regulations clarify that employer-related loans and employer-related investments at an undervalue are not allowed. An undervalue would be if the employer gives a consideration for the investment that is less than the value of the investment. Other employer-related investments are limited to 5% of the Fund.

6.2. This restriction has particular relevance for the misuse of private sector pension funds by sponsoring companies. It would prevent the use of the Pension Fund for investments associated with the Hampshire local authorities or other employers.

7) Revocation of the administering authority's power to use Pension Fund money

7.1. The proposed regulations remove the existing power for administering authorities, such as the County Council, to use the Pension Fund's cash balance. A transitional period is proposed to allow such arrangements to be unwound over six months.

7.2. This has been a convenient way for the Pension Fund to invest its temporary cash balance. The interest payable to the Pension Fund by the County Council is calculated at the seven day market rate. Coupled with the proposal to require separate bank accounts, this proposal will add to the Pension Fund's administrative costs.

7.3. Government believes that "some commentators" see allowing administering authorities to use pension fund money as "out of step", presumably with private sector practice. The Government also comments that there is no obvious reason why administering authorities should have this power and other participating employers do not.

7.4. The other employers may be more concerned about efficient management of the Pension Fund. If the Government feels that this practice should be restricted, it could limit the amount of pension fund money that administrative authorities may use to, say, 5% of the total value of the Pension Fund. This would allow efficient management of cash balances to continue. The limit of up to 5% could be included in the Funding Strategy Statement which would give the other employers an opportunity to agree it.

8) Governance

8.1. The Government is seeking views on whether the definition of permitted investments should be changed from the existing detailed definitions to a more conceptual approach to which explicit or implicit links can be drawn to the duty of care owed by those responsible for investment decisions.

8.2. CIPFA have proposed that a wider definition should be adopted:

· the assets of the pension fund must be invested in such a way as to ensure the security, quality, liquidity and profitability of the portfolio as a whole and, in doing so, take appropriate market, risk and investment advice. In the event of a potential conflict of stakeholder interests, investments must be made in the sole financial interests of the fund.

8.3. As a general approach to Local Government Pension Scheme matters, the Government has sought to adopt relevant aspects of the regime for private sector pension funds. It has put forward, alongside the CIPFA suggestion, the following alternative based on the regulations that apply to private sector schemes:

· trustees must exercise their powers of investment, and any fund manager to whom any discretion has been delegated must exercise that discretion, in a manner calculated to ensure the security, quality, liquidity and profitability of the portfolio as a whole.

8.4. CIPFA's proposal is clearer and whilst it does not specifically associate trustees with the definition, that would be implicit in terms of their fiduciary duty. The final sentence of the CIPFA proposal that investments must be made in the sole financial interests of the fund is an important clarification.

8.5. CIPFA also proposed replacing the detailed limits on investments in the existing regulations (eg, no more than 10% of the pension fund may be invested in any single holding) with a series of principles that pension funds would be required to operate within, similar to those applied to private sector schemes, as follows:

· The assets of the fund must consist predominantly of investments admitted to trading on regulated markets.

· Investment in assets which are not admitted to trading on such markets must in any event be kept to a prudent level.

· The assets of the scheme must be properly diversified in such a way as to avoid excessive reliance on any particular asset, issuer or group of undertakings and so as to avoid accumulations of risk in the portfolio as a whole. Investments in assets issued by the same issuer or by issuers belonging to the same group must not expose the scheme to excessive risk concentration.

· Investment in derivative instruments may be made only in so far as they:

(a) contribute to a reduction of risks; or

(b) facilitate efficient portfolio management (including the reduction of cost or the generation of additional capital or income with an acceptable level of risk), and any such investment must be made and managed so as to avoid excessive risk exposure to a single counterparty and to other derivative operations.

8.6. This would require pension funds to invest in a prudent and proper manner. It would bring the philosophy of pension fund investment management into line with the successful prudential capital regime operated by local authorities since 2004. The Government has not referred to CIPFA's proposal in its consultation paper but this approach would be a sensible way forward.

8.7. The Government has also not responded to a proposal by CIPFA that the definition of a permitted investment manager should be extended to include persons authorised by an overseas regulator recognised by the FSA (not just those in the European Union as at present). This would widen the range of investment management firms that could be appointed by pension funds to include those registered outside the UK and the EU.

9) Conclusions

9.1. A draft response to the Government dealing with the issues raised in this report is attached for the Panel's consideration and approval as Appendix 1.

10) Recommendation:

10.1. Please see the recommendation in the Executive Summary.

i:\. . . .\ian\docs\penpanel 030309 regs cons.doc 25 February 2009

CORPORATE OR LEGAL INFORMATION:

IMPACT ASSESSMENTS:

1. Equalities Impact Assessment:

a) Equality objectives are not considered to be adversely affected by the proposals of this report.

2. Impact on Crime and Disorder:

a) The proposals in this report are not considered to have any direct impact on the prevention of crime.

3. Climate Change:

a) How does what is being proposed impact on our carbon footprint / energy consumption?

· No specific changes.

b) How does what is being proposed consider the need to adapt to climate change, and be resilient to its longer term impacts?

· No specific impact.

Appendix 1

Draft response to the Government's consultation on changes to the Local Government Pension Scheme (Management and Investment of Funds) (Consolidation) Regulations 2009

Thank you for inviting comments on the proposals for changes to the Management and Investment Regulations.

Separate bank accounts

The case for separate bank accounts for pension funds appears to be based on improved transparency. That seems to be an outdated perception of the financial world and ignores the reality of electronic accounting systems. The Hampshire Pension Fund is transparently and clearly separate within the County Council's accounts within its accounting systems. Transparency will not be improved by separate "jam jar" style bank accounts. It will just add to the costs of the Pension Fund, in terms of bank charges, administration and audit fees.

If this requirement is implemented, a suitable transition period will be necessary to change systems and renegotiate contracts. It would be sensible to require the new arrangements to be implemented by 1 April 2011.

Revocation of the administering authority's power to use Pension Fund money

This is also an unnecessary fettering of the administrative authority's ability to manage the Pension Fund efficiently.

As an alternative, the amount of pension fund money that administrative authorities may use could be limited to, say, 5% of the total value of the pension fund. This would allow efficient management of cash balances. That limit could be included in the Funding Strategy Statement which would give the other employers an opportunity to agree it.

Temporary borrowing power

This is a sensible proposal but it questionable whether there is a need for the regulation to be so prescriptive particularly if a more prudential approach can be taken to the regulation of investments.

Governance

CIPFA's proposal for a revised definition on "investments" is preferred to the alternative derived from the regulations for private sector schemes.

It should be coupled with a move to a prudential approach to the regulation of pension funds as suggested by CIPFA in the report of its Pensions Panel Investment Regulations Working Party in November 2008. This would see the detailed investment limits in current regulations replaced by a series of principles under which funds would be required to operate, as set out in the Working Party's recommendations. This would be consistent with the successful use of the prudential regime for capital finance since 2004.

CIPFA also suggested that the definition of investment manager should be extended to include managers authorised by an overseas regulator as defined in the Financial Services and Markets Act 2000. This suggestion is supported.

End