19 th February 2016 LGPS Reform Department for Communities and Local Government 2/SE Quarter, Fry Building 2 Marsham Street London SW1P 4DF Submitted via email to: lgpsreform@communities.gsi.gov.uk RE: Local Government Pension Scheme: Revoking and replacing the Local Government Pension Scheme (Management and Investment of Funds) Regulations 2009 Dear Sirs, BlackRock, Inc. ( BlackRock ) [1] is pleased to have the opportunity to respond to the Department for Communitive and Local Government s consultation on Local Government Pension Scheme (LGPS): Revoking and replacing the Local Government Pension Scheme (Management and Investment of Funds) Regulations 2009. As a fiduciary for our clients, BlackRock supports a regulatory regime that increases transparency, protects investors, and facilitates responsible growth of capital markets while preserving consumer choice and assessing benefits versus implementation costs. CIPFA Investment Regulations Summit On Monday 11 th January, BlackRock played host to the Chartered Institute of Public Finance and Accountancy (CIPFA) Investment Regulations Summit, whereby Local Authority clients with whom we work met to discuss the proposed regulation changes in the industry as a result of the requirement for funds to pool their assets more broadly as well as the specific issues raised in the consultation. 75 conference attendees representing 36 Local Government Pension Schemes were present. In our response, we have incorporated some of the thinking that came out of this event to refine our own internal thinking. We have attached a two page summary of the event as an annex to our response. Areas of key focus BlackRock welcomes the consultation and is supportive of the need to reform given the importance of the Local Government Pension Schemes (LGPS) in providing retirement income for local government employees across the UK in a sustainable and cost effective manner. We welcome the proposed deregulation of investment powers and the move to a prudent person standard of management. We believe this will ensure that the LGPS are able to develop investment strategies that reflect those open to their private sector counterparts. The success of these changes will depend the ability of LGPS investment committees to bring together individuals with the right level of competence and experience to assess the risk and liability profiles of the reliant schemes and reflect these in the new statements of investment strategy. [1] BlackRock is one of the world s leading asset management firms. We manage assets on behalf of institutional and individual clients worldwide, across equity, fixed income, liquidity, real estate, alternatives, and multi-asset strategies. Our client base includes pension plans, endowments, foundations, charities, official institutions, insurers and other financial institutions, as well as individuals around the world. 1
Making sure that the right skill set is in place will take time and is likely to be particularly challenging at a time when the LGPS are already reviewing their governance procedures and controls to achieve pooling of assets. We would welcome any further discussion on any of the points that we have raised. Yours faithfully, Christopher Head Director BlackRock Head of UK Local Authorities christopher.head@blackrock.com Martin Parkes Director BlackRock Public Policy, EMEA martin.parkes@blackrock.com 2
Responses to questions Q1. 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? Q2. Are there any specific issues that should be reinstated? Please explain why. The current 2009 guidelines are quite prescriptive and it is unclear the extent to which they are binding on investment by LGPS. The proposed regulations will improve diversification of funds and allow more flexible responses to changing economic circumstances. Thus we believe that the proposed deregulation does achieve its intended policy aim, which we support, and we have not identified any requirements that would need to be reinstated. Q3. Is six months the appropriate period for the transitional arrangements to remain in place? We agree with the need for an appropriate transitional arrangement before the publication of investment strategy statements. Although the work entailed will be significant we believe that six months is a realistic and reasonable time period. Nevertheless, the process of moving assets between managers and structures has inherent risks and costs. Careful consideration as to how risks are managed and how costs are minimised is critical to the success of any project. These costs and the crystallization of the risks taken have the ability to eclipse the potential savings gained from the initial decision to implement change. The engagement of experts within appropriate experience of transition management is vital to identify the risks, quantify the costs and put in place strategies to mitigate them. Q4. Should the regulation be explicit that derivatives should only be used as a risk management tool? Are there any other circumstances in which the use of derivatives would be appropriate? The requirement to take into consideration a prudent person approach when producing a scheme s investment strategy which takes into account the need for suitably balanced and diverse investments that meet liabilities in a reasonable way should already address any concerns that unreasonably risky strategies using derivatives might be employed. Thus there should be no need to introduce a specific prohibition on the use of derivatives save for the purpose of risk management. Were such a prohibition introduced it would reduce the scope of schemes to invest flexibly. Conceivably it would also place a new onus on schemes to be able to demonstrate that where it makes use of derivatives that it is entirely for the purpose of risk management. A particular concern raised by local authority representatives at our event was the need to use derivatives as a cost effective tool for efficient portfolio management in line with private sector schemes. As such we do not support a narrow definition of the appropriateness of derivative use it is more important that the LGPS understand the benefit of the uses of specific derivatives instruments and satisfy themselves that the risks are being properly controlled. 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? 7. Does the proposed approach allow the Secretary of State sufficient flexibility to ensure that he is able to introduce a proportionate intervention? 3
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? We agree that the main goal of any powers should be that interventions short of taking direct control should be desirable wherever possible and that direct control powers should only be exercised as a last resort. Regulation 8(4)(d) already provides the Secretary of State the power to make use of any evidence deemed relevant that the scheme has been complying with applicable regulations and guidance. However consideration might be given as to whether an appropriate experts group might be convened comprising of, for example, actuarial experts, consultants, and investment specialists. In addition to being able to report back and provide independent recommendations to the Secretary of State, such a group could also serve to provide guidance to help bring a scheme back into line short of a formal direction from the Secretary of State. Assessment of whether or not investment strategies are appropriate given a scheme s liabilities should also be embedded explicitly into any decision regarding intervention. A number of metrics that might be used to assess a scheme s performance, such as investment returns taken in isolation and without reference to the scheme s liability profile, might be misleading in this context and it is important that this is recognised in any assessment process. It is also unclear from the regulations whether the Secretary of State may intervene with regard to wider policy considerations rather than for specific breaches of the principles as set out in the regulations themselves. This could be sensitive with regard to the government s stated objective of increasing the level of LGPS investment into infrastructure. Other comments Governance While the consolidation of ninety schemes into six pools can bring significant cost savings, nonetheless it represents a huge logistical task that will require individuals with appropriate qualifications and expertise to be put in place. Consideration needs to be given as to the support required to ensure that appropriate governance structures can be built. In particular there will be a need to manage and balance the needs of very diverse liability requirements across the different schemes. This will be all the more challenging given the less prescriptive approach to investment strategies that is being taken. The government might therefore wish to supplement this deregulatory approach with nonlegislative initiatives to help support schemes looking to build new governance structures. This might include the development of industry best practice and encouraging schemes to share resources and expertise. Outstanding uncertainty over investment policy We note the aspiration to increase levels of investment in infrastructure projects by LGPS. We wholeheartedly support this goal. Long term asset classes such as infrastructure often compliment the liabilities of pension funds and we welcome the government s initiative to give greater flexibility to improve the capacity for LGPS to make such investments. However the primary consideration for LGPS deciding whether or not to make investments into infrastructure must be whether or not there is a good pipeline of competitively priced projects that do indeed meet the scheme s liabilities. Any decision to intervene over levels of infrastructure investment must bear this in mind over and above any goal to meet pre-determined infrastructure investment targets. Please also see our recent ViewPoint on how to encourage greater investment into infrastructure assets available here- https://www.blackrock.com/corporate/en-gb/literature/whitepaper/viewpoint-infrastructureinvestment-november-2015.pdf 4
We also note the requirement on schemes not contravening government foreign policies. In the absence of any clear white / black list of overseas jurisdictions, these foreign policies may not be straightforward to ascertain in practice. LGPS would benefit from clear and explicit directions that can easily be implemented into investment restrictions. It is also important that it is clear and explicit that this requirement does not force LGPS to continue to hold a particular asset where there are legitimate investment or fiscal reasons to divest or where there are other pertinent concerns for example concerns about governance standards in an investee company. We appreciate the opportunity to address and comment on the issues raised through the course of your work and will continue to work with your department on any specific issues which may assist in area of reform. 5