By Punit Satsangi
The £179 billion UK Local Government Pension Scheme (LGPS) market is highly saturated. The government wants to streamline this market with 89 schemes into eight pools running at least £25 billion each by April 2018. Pools are currently presenting administrative and operational proposals to the government, with many opting to create an Authorised Contractual Scheme (ACS) structure.
An ACS is a relatively recent UK fund structure that complies with EU UCITS directives and the Alternative Investment Fund Managers Directive (AIFMD), and is overseen by the Financial Conduct Authority (FCA). One of its biggest benefits is tax transparency, which subjects members to lower withholding taxes. This is a welcome change as costs elsewhere, such as those incurred by regulation, have eaten into profits. Since tax transparent structures are operationally complex, LGPS schemes must partner with experienced service providers to ensure success.
One challenge to pooling is the designation of local authorities as retail investors under the Markets in Financial Instruments Directive II (MiFID II). Retail status impedes the LGPS’s flexibility to invest in certain asset classes and managers.
In addition, AIFMD and UCITS may not apply post Brexit. As such, the government will have to consider comparable regulations to govern the ACS. Some argue that LGPS reform – while a step in the right direction – does not address the fundamental structural challenges (i.e. deficits) that face the sector; and that LGPS market problems can be resolved only if there is a transition from a defined benefit (DB) to defined contribution (DC) setup.
LGPS pooling makes sense. Scalability allows LGPSs to deploy greater resources and reduce operational duplication. The cost savings,through streamlined investment mandates and service provider agreements, are significant. A small pension fund will struggle to obtain fee discounts from third-party asset managers while a much larger pooled structure may have more success. With greater resources, LGPSs can hire more skilled talent, which will help boost the portfolio manager selection process, and increase exposure to alternatives.
The UK government encourages greater investment in infrastructure as a means to support economic growth following Brexit. LGPS could be a useful source of capital for infrastructure spending.
Some institutional investors are dispensing with external managers in favour of creating an in-house asset management business, provided it adds value. This is another opportunity for LGPS once pooling goes live.
Transitioning to a pooled operating model can be complicated. Schemes must work with experienced service providers such as fund administrators who have the resources and expertise to guide them through the process.
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