Department for Communities and Local Government Fry Building 2 Marsham Street London SW1P 4DF.

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1 Department for Communities and Local Government Fry Building 2 Marsham Street London SW1P 4DF LGPSReform@Communities.gsi.gov.uk Local Government Pension Scheme: Investment Reform Criteria and Guidance & Revoking and Replacing the LGPS (Management and Investment of Funds) Regulations 2009 This is the initial response of the Cheshire Pension Fund to the Government s publication of 25 November 2015 which set out criteria and guidance on how administering authorities can deliver against the Government s expectations of pooling LGPS assets. The Cheshire Pension Fund is actively collaborating with 8 other LGPS Funds under the banner LGPS Central. The participating Funds are committed to the success of this collaboration and believe that by creating a multi asset pool of c 35bn, it can meet the Government s criteria for pooling LGPS assets. Attached to this submission is: a) A Joint submission from LGPS Central to government in response to the DCLG issue of Local Government Pension Scheme: Investment Reform Criteria and Guidance b) A Joint statement of Commitment agreed by the participating Funds of LGPS Central Whilst the Cheshire Pension Fund fully endorses the Joint Submission, it also welcomes the opportunity to submit its individual response to DCLG below and also its response to the consultation to revoke and replace the LGPS (Management and Investment of Funds) Regulations The LGPS Central group looks forward to discussing its response and proposals in the near future. Yours faithfully, Mark Wynn Director of Finance Cheshire West and Chester Council

2 This is the Cheshire Pension Fund s initial proposal to DCLG on Investment Reform to be read in conjunction with an Initial Joint proposal from LGPS Central (dated 5 February 2016). The specific criteria set out in the DCLG consultation are repeated in the table below, together with the Fund s response. Criteria: Asset pool(s) that achieve the benefits of scale Commitment to Pooling Cheshire Pension Fund (CPF) is fully committed to the pooling of LGPS assets and is collaborating with 8 other LGPS Funds in submitting a proposal to DCLG for the creation of LGPS Central. CPF and five other of the participating Funds in LGPS Central have already collaborated on a joint procurement exercise, realising significant savings on passive investment fees. This demonstrates the ability to work together and achieve agreement through open and constructive discussion. This approach forms a firm basis for the creation of LGPS Central Anticipated size of the pool once fully operational Assets proposed to be held outside the pool and the rationale for doing so. LGPS Central will comprise assets in excess of 35 billion at 31 March It will include the assets of: Cheshire Pension Fund Derbyshire County Council Pension Fund Leicestershire County Council Pension Fund Nottinghamshire County Council Pension Fund Shropshire County Pension Fund Staffordshire Pension Fund West Midlands Pension Fund West Midlands ITA Pension Fund Worcestershire County Council Pension Fund Our expectation is that over time all CPF assets will be managed within the Pool. However, the DCLG publication recognises that transitional arrangements may be required for some illiquid assets with significant costs of transition or potential loss of value from forced sale and it is anticipated that these will initially be kept outside the pool until market opportunities for transfer or sale arise. Based on CPFs current investment strategy, as at 31 March 2015 transitional arrangements may be required for the Fund s UK Direct Property Holdings, Private Equity Funds, Hedge Funds and other closed end fund investments For clarification all new investments into these assets classes will be made through the pool. Type of pool including the legal structure if relevant. Further details will be provided in the July 2016 response from LGPS Central. The Group is in the process of procuring an options paper which will set out the legal implications of these structures

3 How the pool will operate, the work to be carried out internally and services to be hired from outside. Timetable for establishing the pool and moving assets into the pool. Transparent reporting of progress against the pools timetable. LGPS Central has developed a Statement of Commitment (attachment) which incorporates several principles of like-mindedness to show how individual Funds will co-operate and work together in a collaborative manner. It is envisaged that investment management will be provided both internally and externally. Further details will be provided in the July 2016 response from LGPS Central. The detailed implementation plan will be developed by LGPS Central in time for the 15 July 2016 submission. It is anticipated that regular reports will be made to bodies existing under each participating Funds current governance structure (e.g. Pensions Committee, Pensions Board) as well as any LGPS Central governance structure implemented. Criteria: Strong governance and decision making Governance structure for the pool, including the accountability between the pool and elected councillors, and the way in which external scrutiny will be used. Mechanisms by which the authority can hold the pool to account and secure assurance that their investment strategy is being implemented effectively and their investments are being well managed. Decision making procedures at all stages of investment, and the rationale underpinning this. Shared objectives for the pool and any policies that are to be agreed between participants. Resources allocated to the running of the pool, including the governance budget, the number of staff needed and the skills and expertise required. The way in which environmental, social and corporate governance (ESG) policies will be handled by the The detail of the Governance Structure for the Central LGPS Pool will be developed in time for the 15 July 2016 submission. Irrespective of structure, an overriding principle is that each participating Fund will have one vote. The mechanisms by which the administering authority can hold LGPS Central to account will be developed in time for the 15 July 2016 submission. The decision making procedures at all stages of investment will be developed in time for the July 2016 submission. Strategic Asset Allocation decisions will remain with each administering authority and LGPS Central will need to operate flexibly to ensure that each authority s individual asset allocation can be delivered. LGPS Central has developed a Statement of Commitment (Appendix A). As LGPS Central gains clarity around its governance structure, further policies will be developed as considered appropriate and will follow in the 15 July 2016 submission. The detailed implementation plan, including the resources required will be developed by LGPS Central for the 15 July LGPS Central is fully committed to ESG matters and has recognised such in its Statement of Commitment (Appendix A). An ESG Policy will be jointly developed by participating Funds in LGPS Central in time for the 15 July 2016 submission.

4 pool. How the authorities will act as responsible, long term investors through the pool, including how the pool will determine and enact stewardship responsibilities. Public reporting of the net performance of each asset class by the pool, to encourage the sharing of data and best practice. Extent of using benchmarking by the authority to assess their own governance and performance and that of the pool, for example by undertaking the Scheme Advisory Board s key performance indicator assessment. LGPS Central has recognised in its Statement of Commitment (Appendix A) that Responsible investment can enhance long term investment performance. The July 2016 submission will include details of how participating authorities will act as responsible, long term investors through LGPS Central, and how the pool will determine and enact stewardship responsibilities. The legal structure of LGPS Central will determine its public reporting requirements. However, as a participating Fund, CPF fully expects to report our own asset class performance, in line with current best practice, in our Annual Report and Accounts. The sharing of data and best practice will be encouraged. CPF will continue its current best practice of benchmarking the administering authority against other LGPS Funds through: CIPFA benchmarking; CEM benchmarking; Hymans Robertson like for like comparison; and participation in SAB KPI analysis. Benchmarking arrangements for LGPS Central will be determined once more detail about its structure and investments are known. Criteria: Reduced costs and excellent value for money Transparent assessment of investment costs and fees as at 31 March Transparent assessment of current investment costs and fees, prepared on the same basis as 2013 for comparison. Detailed estimate of savings over the next 15 years. Detailed estimate of implementation costs and when they will arise, including transition costs as assets are migrated into the pool and an explanation of how these costs will be met. Proposal for reporting transparently against forecast transition costs and savings. Reporting of fees and net performance. CPF has prepared a fully transparent assessment of investment costs and fees based on CIPFA guidance. LGPS Central is also analysing all participating Funds costs and fees, as at 31 March 2013, on this basis. Full details will be provided in the 15 July 2016 submission. LGPS Central is analysing all participating Funds costs and fees reported since 31 March 2013 in accordance with CIPFA best practice. Full details will be provided in the 15 July 2016 submission. The detailed estimate of savings for CPF as a participating Fund in LGPS Central will be developed by LGPS Central for the 15 July 2016 submission The detailed estimate of implementation costs, including transition costs, when they will arise and how they will be met will be developed by LGPS Central for the 15 July 2016 submission. LGPS Central has agreed in principle that all costs will be shared fairly between participants. The detailed proposal for reporting transparently against forecast transition costs and savings, together with the reporting of fees and net performance, will be developed by LGPS Central for the 15 July 2016 submission

5 Criteria: An improved capacity to invest in infrastructure Proportion of participating Fund currently allocated to infrastructure, both directly and through funds, or fund of funds. Development or acquisition of the capacity and capability to assess infrastructure projects, and reduce costs by managing any subsequent investments directly through the pool, rather than existing fund, or fund of funds arrangements. Proportion of participating Fund intended to be invested in infrastructure, ambition in this area going forward and derivation of that amount. CPF currently has a 7% Strategic Asset Allocation to UK Property including Industrial Estates, Retail Parks, Offices etc. Whilst CPF currently has no other explicit separate allocation to Infrastructure it is not adverse to investment in infrastructure, should the right opportunity arise that meets the Fund s strategic investment objective, at a fair value and with an appropriate risk/return profile. CPF will work with colleagues in LGPS Central to develop their understanding, capacity and capability to assess and access investments in UK Infrastructure. CPF believe that one of the secondary benefits of pooling LGPS assets is also to pool investment expertise and resource and build out knowledge and capacity in all asset classes including infrastructure. CPF will continue to assess Infrastructure opportunities as they become available based on the Fund s strategic investment objectives, pricing and the risk/return profile of investment opportunities. A strategic allocation to Infrastructure would also be reliant upon a suitable pipeline of investment opportunities for the Fund and the pool.

6 This is the Cheshire Pension Fund s response to the Consultation on LGPS: Revoking and replacing the LGPS (Management and Investment of Funds) Regulations The specific questions that the consultation asks are repeated in the table below, together with the Fund s response. Question 1 Does the proposed deregulation achieve the intended policy aim of removing any unnecessary regulation while still ensuring that authorities investments are made prudently and having taken advice? 2 Are there any specific issues that should be reinstated? Please explain why. 3 Is six months the appropriate period for the transitional arrangements to remain in place? 4 Should the regulation be explicit that derivatives should only be used as a risk management tool? 5 Are there any other sources of evidence that the Secretary of State might draw on to establish whether an intervention is required? 6 Does the intervention allow authorities sufficient scope and time to present evidence in favour of their existing arrangements when either determining an intervention in the first place, or reviewing whether one should remain in place? Cheshire Pension Fund Response Yes. The proposed deregulation provides the Fund with additional flexibility. The Investment Strategy Statement will be a crucial document that will set the prudential framework and quantify risks for each Fund. No. Regardless of the wording of the regulations we would continue to operate within a framework of good governance including regular monitoring of investments (quarterly). Yes providing that the 6 months transitional period commences from the date guidance is issued. The Investment Strategy Statement will form the foundation of the Fund s risk management strategy and it will therefore be critical that sufficient time is allowed develop this document based on appropriate advice. No, the regulation should not restrict the use of derivatives solely for risk management purposes because it can be difficult to differentiate between their use for risk management and return. We believe that these restrictions exist for historic reasons and are more applicable to a Council s treasury management function than to a pension fund. We believe that a Fund s policy on derivatives should be made explicit in the Investment Strategy Statement. No, providing that Secretary of State intervention is proportionate (i.e. follows a clear process with escalation in stages), transparent and evidenced based. There should also be a clear process for the Administering Authority to challenge the intervention. We cannot comment on this as a timescale has not been provided.

7 7 Does the proposed approach allow the Secretary of State sufficient flexibility to ensure that he is able to introduce a proportionate intervention? 8 Do the proposals meet the objectives of the policy, which are to allow the Secretary of State to make a proportionate intervention in the investment function of an administering authority if it has not had regard to best practice, guidance or regulation? The proposed regulations appear allow flexibility for intervention. The proposed regulations however do not appear to set out a prescribed framework and it is therefore difficult to comment on how a proportionate approach would work in practice. We suggest it would be helpful for the stages of and process for intervention be more clearly prescribed in the regulations. The proposals clearly allow the Secretary of State to intervene. We would however note that best practice is difficult to define and ultimately will be a subjective judgement.

8 Joint submission to government in response to the DCLG issue of Local Government Pension Scheme: Investment Reform Criteria and Guidance 5 February 2016 In the July Budget 2015, the government announced its intention to work with Local Government Pension Scheme (LGPS) administering authorities to ensure that they pool investments to significantly reduce costs while maintaining overall investment performance. In November 2015, the government published Local Government Pension Scheme: Investment Reform Criteria and Guidance which asked for submissions from funds on their proposals to meet the four specified criteria. Initial submissions should include a commitment to pooling and a description of progress towards formalising arrangements with other authorities. This is a joint submission on behalf of LGPS Central, a collaboration of nine LGPS Funds, all based in the Midlands, who are working together to create an investment pool of around 35 billion. The following funds have committed to be involved in the creation of LGPS Central: - Cheshire Pension Fund - Derbyshire County Council Pension Fund - Leicestershire County Council Pension Fund - Nottinghamshire County Council Pension Fund - Shropshire County Pension Fund - Staffordshire Pension Fund - West Midlands Pension Fund - West Midlands ITA Pension Fund - Worcestershire County Council Pension Fund Six of the funds involved have already collaborated on a joint procurement exercise, realising significant savings on passive investment fees. This demonstrates the ability to work together and achieve agreement through open and constructive discussion. This approach forms a firm basis for the creation of LGPS Central. Officers of the participating funds have been meeting regularly since November 2015 and are continuing to meet on a fortnightly basis to ensure the tight timescales for establishment of the pool are met. An event was held in January 2016 for the Chairs, Vice-Chairs and chief finance officers of each participating fund to meet and talk through progress to date and how it is envisaged that the pool will meet the criteria set by government.

9 A. Asset pool(s) that achieve the benefits of scale The collaboration will see the creation of a multi asset investment pool of around 35 billion in size, meeting the scale sought by the Government in its investment pooling criteria. It is expected that all investment will be made through the pool over time although the transition period for illiquid assets will extend beyond Participating funds will consider if they propose to hold assets outside the pool where this can demonstrate clear value for money. Any assets that are held outside of the pool will be kept under review. The pool will aim to deliver cost savings and to build on the individual participating funds strong investment knowledge and performance by providing scale, increased resilience and knowledge sharing. The new investment pool will offer access to both internal and external investment expertise. B. Strong governance and decision making The pool will ensure robust governance and decision making arrangements with equal say in the oversight of the new entity to each participating Fund. Preliminary investigations have been made into the process and possible structures for the pool and discussions are being held with the other emerging pools on procuring joint external advice. At this stage, no decision has been made over the structure but options being considered include: A joint committee FCA regulated operating company overseeing pooled vehicles including authorised contractual schemes (ACS), unit trusts and limited partnerships The final structure will ensure a clear link between the pool and the governance structures in each participating fund. Decisions over investment strategy and strategic asset allocation will remain with individual funds. A Statement of Commitment has been agreed to outline the key characteristics and investment beliefs of the pool, and this is attached below. A detailed work plan is being formulated to determine the structure of the pool, the internal and external resources required and the timescales for establishing the pool and moving assets. C. Reduced costs and excellent value for money The pool has already begun to collate data on costs incurred by participating funds for years ending 31 March 2013 and 31 March This is being collected on a consistent basis and will be analysed to inform the detailed submissions required in July. The pool is expected to generate savings over the long term but implementation and transition costs are likely to be significant. The size of the pool will enable significant savings to be made on external management fees. A number of participating funds have internal investment expertise which is recognised to be relatively low cost and it will be difficult for these funds to achieve cost savings. However, additional savings will be realised through stronger procurement of supporting services and the building and sharing of expertise across funds, particularly in alternative asset classes.

10 The pool intends to work collaboratively with the Local Government Pension Scheme more widely and with the other emerging pools. Procurement will be undertaken where possible through the LGPS National Frameworks, other approved frameworks or jointly with other LGPS pools. D. An improved capacity to invest in infrastructure Consideration will be given to participating funds current asset allocation and the best ways to access all asset classes including infrastructure. It is recognised that infrastructure has a role to play for many LGPS funds given their long term liabilities and the nature of returns from infrastructure. Analysis of participating funds current allocations to infrastructure shows that LGPS Central already has a higher than average allocation to the asset class and that this has increased substantially since Funds also invest in infrastructure assets (in areas such as energy, utilities, logistics and housing) through their allocations to property, bonds and listed equities. Participating funds within LGPS Central have different funding levels and deficit recovery profiles and so have differing risk appetites and return requirements from infrastructure. It is expected that an LGPS infrastructure platform will be set up that will allow all LGPS funds to access the asset class in a manner that is low-cost and also allows individual funds to match their required risk/return profiles. LGPS Central will ensure that appropriate cost-effective ways of accessing infrastructure are available, which may include building on internal expertise.

11 STATEMENT OF COMMITMENT LGPS Central is investigating the opportunities for investment collaboration between like-minded Local Government Pension Scheme funds against the background of the government s proposals for pooling LGPS investments. The Group has a regional identity but collaboration with other LGPS pools will be welcomed. One fund, one vote, will be an overriding principle of any resulting pooling arrangement. Recognising that Funds have different funding levels and deficit recovery profiles; the pool s structure will aim to meet the Funds needs in this respect. Characteristics Assets will be managed by both internal and external investment managers The split between internal and external management will vary over time The internal investment resource and resilience will be developed where appropriate Knowledge and expertise will be shared Participants will be open to challenge and change Participants will listen and be constructive Strong governance, based on openness and transparency, within the pool will be paramount Costs will be actively managed and transparent, and will be shared fairly between participants Responsible investment will be an integral part of the investment process Collaboration with other LGPS pools will be encouraged Investment Beliefs A long term approach to investment will deliver better returns The long term nature of LGPS liabilities allows for a long term investment horizon Asset allocation is the most important factor in driving long term investment returns Liabilities influence the asset structure; funds exist to meet their obligations Risk premiums exist for certain investments and this can help to recover funding deficits Markets can be inefficient; therefore there is a place for both active and passive management Diversification across investments with low correlation improves the risk/return profile Secure and growing income streams underpin the ability to meet future liabilities Responsible investment can enhance long term investment performance Measurement of Success Successful delivery of the pool against the government s published criteria 5 February 2016