Local Government Pension Scheme funds’ plans to pool their assets have hit delays due to uncertainty over whether certain assets can legally be held in collective structures.
Most LGPS funds plan to set up their pools as authorised contractual schemes. An ACS is a tax-transparent investment vehicle regulated by the Financial Conduct Authority. However, there are concerns that ACS cannot hold units in life funds: investment funds run by insurers.
Investors buy units in a life fund by purchasing an insurance policy. The premiums the investor pays are invested in a fund comprising different assets. Legally, the owner of this contract (the insured party) must also be the beneficiary. In the case of institutional investors such as pension funds, the insured party is the trustee body or, in LGPS funds, the pension committee members. LGPS funds often invest in passive equities, a large proportion of their portfolios, in this way.
However, there is a concern that where an ACS structure is used, the insured party would be the ACS itself, not the trustees of the pension fund.
The only pool to have launched so far is the London Collective Investment Vehicle, which uses an ACS structure. In a summer update to its 33 London borough fund members, the London CIV said it will delay the launch of its passive equity sub-funds because of the problem.
The update, included in a report for Harrow LBC’s 6 September pension committee meeting, said: “Every effort has been made over the last six months to work with providers through a complex range of issues associated with converting life funds into structures that can be held in our ACS.
“However, some of the issues, in particular the issue of value for money, are likely to take longer to resolve than we had hoped.
“As a consequence, boroughs which were looking to transition their passive assets [into the CIV] in the relatively near future should be aware this will not be happening for the moment.”
Borough funds currently hold their life funds outside of the London CIV, but they have negotiated a significant fee reduction from their life fund managers already by bargaining as a group.
The government recognised the problem in a statement to pension funds this summer and said they could keep their life fund investments outside of their pools for the time being.
However, the government said it does not expect the LGPS to take up any new life fund business after the pools launch in April 2018 without a clear financial case for doing so.
Legal & General Investment Management is one of the top three providers to the LGPS of passive equity products to the LGPS.
James Sparshott, head of local authorities at LGIM, said that having taken legal advice, the firm believes it is possible to hold life funds in an ACS.
“Our understanding is that it is possible for life funds to be held within an ACS via the issue of a unit-linked insurance policy to the ACS,” said Mr Sparshott.
“The structure of an ACS does not prevent the participants from having an insurable interest in such an insurance policy. This is because the ACS has no legal personality and the participants would all hold the assets managed under the ACS, including the insurance policy, as beneficial owners as tenants in common.”
However, Mr Sparshott said LGIM had in 2015 launched a new product, structured as an ACS itself, as an alternative for its pooled LGPS clients. This new product could be held in a pool, and would allow pension funds to continue to do business with LGIM if they transfer their passive equity holdings into it.
However, an investor factsheet from LGIM said the cost of using the new products will be higher initially.
“If life funds and the ACS were both ‘at scale’ (i.e. of the order of many tens of billions), then on-fund costs could be similar. However, initially, when the ACS is small, we estimate that on-fund costs could be up to three to four times higher in the ACS,” the document said.
The ACS would be more expensive initially because, with fewer investors paying in, the costs of administration, transfers, custody services, legal and accounting fees would be shared among fewer customers, LGIM said. LGIM’s own fees would be the same for either a life fund or the ACS product, according to the factsheet.
Jeff Houston, head of pensions at the Local Government Association, said Brexit has added a further complication.
“Post-Brexit the future is uncertain, because ACS may end up being a UK-only tax transparent fund, rather than a Europe-wide tax transparent fund,” said Mr Houston.
“Because of that uncertainty, providers are holding fire on moving life funds into ACS.
“It’s something that we all need to sit down and thrash out.”