The Government is proposing to force pension funds to invest 5% into Private Equity (or 10% for the LGPS). There are lots of arguments against this, not least the fact that this proposal is committing investment error 1.01 by assuming past performance will continue in the future.
In this article, however, I look at whether this proposal contravenes pension fund law and in particular The Occupational Pension Schemes (Investment) Regulations (2005) (“OPS(I)R 2005”), which covers occupational pension schemes.
Pension trustees’ discretion must not be constrained.
The first question is whether these proposals ‘fetter’ pension trustees’ discretion. OPS(I)R 2005 section 4 (3) stipulates that "the powers of investment, or the discretion, must be exercised in a manner calculated to ensure the security, quality, liquidity and profitability of the portfolio as a whole.” What this meant in practice was then outlined in the Kay review (2012) and in more detail by the Law Commission (2014).
The Kay review examined the fiduciary duty of investment intermediaries as part of its review into the functioning of equity markets. Professor Kay wrote: Asset holders and asset managers ought to match their advice to the risk preferences and time horizons of ultimate beneficiaries….. they should not use their position to advance political goals or other objectives not directly related to the welfare of their beneficiaries. Their duties are to all their beneficiaries but not to savers at large…….”
The Government then asked the Law Commission to examine this question of fiduciary duty further in the Law Commission’s Report on the Fiduciary Duties of Investment Intermediaries published in 2014. This is not law, but was broadly accepted by the Government, (albeit with some spin which does not appear in the Report), in its response. Section 6.12 of the Report states that:
Most importantly, trustees must not “fetter their discretion.” They must genuinely consider how to achieve a pension for their members and must not simply apply a pre-existing moral or political judgement.
The Government’s proposals today on levelling up are clearly part of the political agenda, and to me seem prima facie to contravene this principle set out by the Law Commission. It is simply not possible to argue that levelling up is not, in Professor Kay’s wording, a political goal not directly related to the welfare of their beneficiaries.
None of my argument so far is intended to suggest that pension fund trustees who wish to invest in investment policies which may have broader objectives than purely financial should not be free to do so, so long as it is consistent with fiduciary duty. The point I make is that the Government should not place any requirement to do so on them.
Assets should be predominantly invested in traded markets.
The second question is whether the proposals contravene the legal requirement to invest predominantly in traded instruments. Sections 5 and 6 of OPS(I)R 2005 state that:
(5) The assets of the scheme must consist predominantly of investments admitted to trading on regulated markets. (6) Investment in assets which are not admitted to trading on such markets must in any event be kept to a prudent level.
Lawyers can wrangle over the precise meaning of the words ‘predominantly’ and ‘prudent’ in this context, but the evidence of the LDI crisis in 2022, when many private sector DB schemes ran into liquidity problems, is that in practice they contravened this regulation. The Government’s proposals today are encouraging DC schemes in the same direction.
What about the LGPS?
The LGPS is governed by different legislation. Indeed the Law Commission report (section 2.10) clearly states that: 'public service schemes are generally unaffected by occupational pension scheme legislation'. That would suggest that OPS(I)R 2005 does not apply to the LGPS.
On the other hand the legal opinion obtained by the Scheme Advisory Board from Nigel Giffin KC in 2014 on the fiduciary duty of the administering authority under the LGPS, concluded (paragraph 6) that while the LGPS is not a trust-based scheme, the administering authority does owe fiduciary duty to both employers and members. His words were “Although not strictly speaking a trust fund, an LGPS fund is closely analogous to one.” He further concluded (paragraph 23) that “the administering authority’s power of investment must be exercised for investment purposes, and not for any wider purposes.” While this does not, unlike the Law Commission report, overtly use the word ‘political,’ it must surely bear the same meaning.
So, with my informed layman’s hat on, I conclude that LGPS administering authorities, in the course of their duties, are equally bound by the need not to fetter their discretion. And it seems to me that the Government, in setting minimum weightings for infrastructure (5%), levelling up (5%) and private equity (10%) is seeking to do just that.
If it is considered that OPS(I)R 2005 does apply to the LGPS, and despite the Law Commission’s comment on public sector schemes, I have seen lawyers argue to this effect, then sections 5 and 6 must apply too. Many funds now have weightings in unlisted assets which approach or are above 30%. I am not sure that that meets with the requirement in section 5 to be invested predominantly in regulated markets.
I am not a lawyer, and I shall await with great interest legal arguments to tell me where I am wrong. But if not, then DLUHC will be opening itself to legal challenge if it pursues these proposals.