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EU rule change could scotch infrastructure plans

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Local Government Pension Scheme bodies have warned an update to an EU directive would stall the drive to invest council pension funds in infrastructure.

The Markets in Financial Instruments Directives are EU rules that regulate companies providing investment management services. An update to the directives, known as MiFID II, is due to take effect from 3 January 2018.

Part of the directives dictate the categories to which the different investors belong. As a result of the revision, the Financial Conduct Authority is proposing to reclassify different types of investors within its own Conduct of Business Sourcebook (COBS).

MiFID categorises investors in recognition of the different levels of experience and knowledge they have, and requires investment management firms to treat them according to these categories. Those categorised as ‘retail clients’ are considered to be less sophisticated than those in the ‘professional clients’ category, and therefore investment managers are prohibited from selling them certain complex investment products.

As a result of the latest revision of MiFID categories, the Financial Conduct Authority is proposing to reclassify local authorities and their pension funds as retail clients by default. Its consultation on changes to COBS closed on 3 January.

Bodies representing LGPS funds have warned the reclassification is unnecessary, will increase the administrative burden on funds, and even prevent them investing more in infrastructure as instructed by the government.

The LGPS Advisory Board said in its consultation response that “the reclassification of local authorities as retail investors is unnecessary” and that it would “have serious consequences for the effective implementation of pension fund investment strategies”.

The FCA proposed to allow councils and their pension funds to ‘opt up’ to become professional clients, by asking their investment managers to treat them as such.

It is investment managers’ responsibility to demonstrate their clients are sophisticated enough to buy complex investments. Under these proposals, investment managers would have to apply a new, rigorous test to determine whether clients are professional or retail. With the added costs this would bring, there is no guarantee that investment managers would continue to do business with council pension funds, or continue on the same terms.

The board also called for clarity on how the FCA would view the complex investments already sold to LGPS funds prior to 3 January 2018.

The Local Government Association also said LGPS funds should be regarded as professional clients.

It said in its consultation response that there “should be no uniform classification at EU level stating that all local authorities are automatically categorised as ‘retail’ investors”.

It added: “To properly account for the diversity of local authorities across the EU, and in line with subsidiarity, it must be up to each member state and its local authorities to decide whether they are sufficiently experienced to be able to assess and manage financial risk, taking into account the national regimes in place to ensure prudential borrowing and investments.”

The Pensions and Lifetime Savings Association, of which many LGPS funds are members, warned that infrastructure would count as a complex investment and therefore out of the reach of retail investors, causing problems for LGPS funds reclassified as such.

“LGPS respondents to the PLSA’s most recent annual survey reported that 1.1% of their assets are invested in infrastructure. Across the whole LGPS this would equate to around £2.7bn of infrastructure investment at risk,” the PLSA said in a statement.

“As a retail investor, there is no guarantee that asset managers would be willing to do business with LGPS funds, or would not impose significant cost for doing so,” it added.

PLSA director of external affairs Graham Vidler added: “The FCA needs to consider that LGPS have significant levels of investment expertise, a robust track record of effective risk management in investments, and considerable experience across a wide range of asset classes, including infrastructure.

“We urge the FCA to distinguish between the investment activity of local authorities and local authority pension funds, so the latter may retain its professional client status to continue its effective investment strategies.”

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