New public procurement bill comes into force October 2024
Public sector procurement is coming under new legislation. The Public Sector Procurement Bill passed Parliament last autumn and comes into force in October 2024. Apart from putting in place legislation to replace the previous EU directive, one objective is to make things simpler. There is an important change in the wording for the financial services exemption in particular. The new rules will make procurement for Local Government Pension Scheme (LGPS) simpler. This article focuses on how they could also potentially allow a new and superior model of governance for the pools which have been set up to implement their investment strategies.
Public procurement requires that all contracts beyond a stated value (today around £215,000 for public authorities other than central government) and not covered by an exemption are subject to public tendering. The objective is to deliver value for money to the public sector while being fair to all potential suppliers, large and small.
From a private sector perspective the process has significant flaws. It works to a fixed and slow timescale; the requests for interest or procurement (RFIs and RFPs) tend to be lengthy and burdensome to complete, often with only a small chance of winning, so that many tenderers will add a % to their proposed fee in order to compensate for the time spent on unsuccessful applications; the publicly visible scoring system can easily be gamed by tenderers; and most importantly, as some-one with experience of both systems pointed out to me, there is no scope to negotiate with the winning tenderer at the very point most private procurement will be doing just that.
The exemption for financial services is clarified and expanded
While much of the old EU legislation is carried over to the new Bill, there is one important change for the financial services industry. Under the previous rules there was an exemption for “financial services, with the exception of insurance services”,[1] but no clear definition of financial services was given. Within the LGPS, while there is some variation in how this has been interpreted, the general practice has been that investment products, such as collective investment schemes, are considered exempt, while the procurement of ancillary services such as managers to run segregated portfolios or investment consultants are not and are therefore subject to public procurement rules.
Under the new law, there is an exemption not just for financial products, but also for portfolio management and investment advice. The exemption is for[2] “contracts for the provision or carrying out of an investment service or activity, or of an ancillary service, in relation to a financial instrument by an investment firm or a qualifying credit institution.” Investment services are defined by reference to FISMA 2001[3] and explicitly include both portfolio management and investment advice.
We are not lawyers at Linchpin, but that exemption seems clearly to include the procurement of managers and advisers, including the pools. From an LGPS perspective procurement of investment managers is largely moving to pools, but administering authorities will still need to procure a range of other services. They may well choose to continue to use public procurement in order to try and demonstrate they are obtaining value for money. However, there is no longer the obligation to do so.
LGPS pools historically used the Teckal exemption to avoid public procurement
A more important implication of the new Bill is about the governance of the pools. Most of them, though not all, were created as Authorised Corporate Schemes (ACS). As they do not directly invest in regulated instruments, under the old rules they were subject to the OJEU procurement process. In order to avoid having to go through this, the partner funds setting them up in most cases chose to use a different exemption under the 2015 Public Contracts Regulations, derived from EU law.
The Teckal exemption, as it is called, provides that contracts can be directly awarded by contracting authorities so long as certain conditions are satisfied. The public body must control the service provider in question as if it was that public body's own department; more than 80% of its activities must be for the public body concerned; and there must be no meaningful private sector participation. The last two were relatively easy to satisfy, but the first meant that the partner funds had to demonstrate they controlled their pool. In the case of most pools partner funds have chosen (probably on legal advice) to demonstrate their control by constitutionally reserving a range of powers to themselves.
Using the new exemption could improve pool governance
The new Bill comes into place in October 2024 will still contain exemptions for vertically and horizontally controlled entities (i.e., similar to Teckal). But LGPS funds will have the alternative of avoiding public procurement by using the new financial services exemption. The pools are providing portfolio management services and investment advice and are therefore covered.
Using this exemption would allow partner funds to move to a different model of pool governance and one which is closer to good international practice. In particular the removal of the requirement to ‘control’ means that many of the powers reserved to the partner funds, which have historically acted as constraints, can be removed. I have also long argued that a pooling model where an independent board governing the pool executive and answerable solely to the partner funds would be superior to the current one.
I am not suggesting that all funds would necessarily embrace this immediately, nor would it immediately provide a solution to all the tensions inherent in pooling. But the model of independent Boards is accepted among similar funds around the world. The owners set the strategic objective and appoint the Board, which in turn is responsible for appointing the senior executives and providing the governance framework to fulfil the set strategy. For example, instead of the partner funds all having to approve the pool budget, it would be up to the Board to do that. The owners’ remedy if the Board goes too far away from their wishes is to change the Board.
Accountability works the other way, with executives being responsible to the Board, and the Board to the shareholders, the partner funds. Making this model work will require agreement among the owners on the pool’s objectives (i.e., mission clarity) and also the confidence (I’d call it trust if that weren’t so emotive a word) to set pools free from many of their current constraints. In return the funds would have clearer levers of governance to ensure their strategic objectives are indeed achieved, and to make changes if the pool is going off track.
In my view the likelihood of pooling succeeding would be considerably enhanced if funds were to use this new exemption when it comes into force rather than Teckal.
[1] Defence and Security Public Contracts Regulations 2011 7 (1) (j).
[2] Public Procurement Bill 2023 Schedule 2 paragraph 16.
[3] The Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 Schedule 2 Part 3.