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PUBLIC TREASURER FEATURE - BALANCING THE BOOKS

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The existing pension fund regulations are, on balance, pretty good. But there is always room for improvement. Pete...
The existing pension fund regulations are, on balance, pretty good. But there is always room for improvement. Peter Scales makes some suggestions.
In mid-December last year, the DETR issued a consultation paper seeking views on the operation of the Local Government Pension Scheme (Management and Investment of Funds) Regulations 1998. Responses are due back by 9 March and many of the organisations consulted will be entering their submissions now.
In essence, the regulations do exactly what they say on the tin, with the slight qualification that they apply only to the pension funds involved in
administering the LGPS. The regulations work pretty well in practice and the scheme is well funded. But the definition of funded is important as this has a bearing on the purpose of the regulations.
Under the scheme, contributors pay a fixed proportion (6%) of their salary and in return, as pensioners, receive legally defined benefits. The employers pay a varying rate of contribution based on actuarial valuation every three years with the expectation that the rate will be as constant as possible.
The money not required to pay pensions immediately is invested until needed, and this is where the regulations kick in. Thus we expose two important variables - what the employer pays and investment returns.
The pension funds business is long term and, as the saying goes, investments can go down as well as up. But charging taxpayers is a much shorter term business, with the immediacy of annual increases in the council tax or other charges.
Getting it right is a matter of balance and one, where public money is involved, subject to regulation. These are fundamental principles underlying the prudent operation of pension funds.
The consultation addresses two pillars of modern governance:
-The degree of regulation imposed
-The representation and participation of stakeholders.
At one end of the spectrum we have the councillors who are charged specifically with the responsibility of managing the pension funds. In this respect, they act like trustees of public money, or like the trustees of private sector pension funds. At the other end, we have a vast array of diverse interests, concerns and views which may or may not have a bearing on prudent investment management.
These extremes may conflict, but there is no doubt they exist and the management process must achieve a degree of balance between them.
The first pillar addressed in the consultation paper is the degree of regulation and the broad policy objectives underpinning their current form. Reference is made to well-worn phrases such as 'prudent management', 'reasonable returns', 'proper stewardship' and 'continued solvency'. The regulations do not define these terms - nor should they - but provide the framework to achieve these objectives.
Do they operate satisfactorily? Are there any major deficiencies? Are they effective and efficient? Are the prudential limits on certain investments too constraining? How does UK practice sit alongside Europe's? What changes are needed? These are all valid questions and each party must form their own judgement in response. But I'm writing the article so I can say what I think.
The regulations work well, but any set of trustees must operate to certain standards, and these should not be part of a hidden process, accountable only by outcomes.
One deficiency I perceive in the operation of these regulations is the lack of a common set of guidelines on best practice which would provide a prudential benchmark against which each fund could judge its own operation. These should not be a matter for regulation in themselves, but each fund would be required to sign up to their adoption and publish their approach in the statement of investment principles.
As regards the investment limits, some relaxation or more flexible operation would be in order. The best idea so far is to change these from regulatory maximum limits to benchmarks of general acceptability. Each fund would be free to determine their application in practice and publish the constraints in their statement - flexibility, balanced with accountability, without regulation.
Another element of the regulations covers the appointment of investment management professionals. In the consultation paper, questions are asked as to whether these managers should be required to account for their actions, and whether one or more managers is appropriate.
These are matters best left to prudential management rather than increased regulation, but influenced by best practice guidance and by taking proper advice as the regulations require.
The second of the two pillars of modern governance - representation and participation - forms the major thrust of the consultation. This promises to be a contentious issue, though it should be an argument of principles rather than substance.
The extent to which individuals or representatives can properly influence investment decisions must be constrained by the extent to which those decisions can affect their interests - no power without responsibility. Of course, scheme members have views, but their benefits are protected. If undue weight is given to such influence, then prudential management becomes and confused.
The proposals to regulate for the setting up of advisory pension forums imply a secondary executive decision process which will do just that. Again, it is a matter of balance and it would be much better to concentrate on improving the many examples of existing good practice. It would be foolish to suggest all is perfect. Those funds that already have various means to inform and communicate can admit to the need for continuous improvement - those who do not should pull their socks up. Formal guidance on best practice is the key, not regulation.
The London Pensions Fund Authority is an example of an operational structure which can deal with the issue of representation and participation. It has an appointed board representative of skills and interests, and accountable for its decisions without the muddied waters of secondary advisory bodies.
On the issue of proper advice, it is worth praising the role of the chief financial officer. The input of the officer with statutory duties and responsibilities is the ace up the sleeve of LGPS investment management and too often overlooked. These officers not only provide professional advice but also ensure balance in the prudential management of pension funds.
We need to strengthen that framework and not dilute its effectiveness by imposing the confusion of influential interests by regulation.
-Peter Scales, chief executive, London Pensions Fund Authority.
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