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Local government is going through a period of change. What effect will the new, powerful leaders have on pension fu...
Local government is going through a period of change. What effect will the new, powerful leaders have on pension funds? Mike Ellsmore looks at the implications of modernisation.
The Local Government Act 2000 has introduced many sweeping changes to the way local government is managed. The starting point for the changes can be found in a pamphlet written by prime minister Tony Blair in 1998, Leading the Way - A new vision for local government.
Mr Blair concluded that 'to play its full part in modernising Britain, local government itself needs to modernise'. He gave three reasons why local government needs to change:
-Localities lack a clear sense of direction. With so many organisations playing a part in local issues, there is need for a clear vision and leadership
-The fragmentation of responsibilities between agencies adversely affects the services local people receive
-Too many public bodies are content to be mediocre.
So what does this message of modernisation involve and more specifically what impact will it have for council pension funds?
A key part of the government's approach is to develop new ways of working. This involves changes to the way councils are managed, and heralds a significant change to the way decisions are taken.
The key feature of these proposals is the separation of the executive - governing function - from the legislature - scrutiny function. Councils will have to adopt one of three forms of executive:
-A directly elected mayor with cabinet -similar to the way Ken Livingstone operates.
-A cabinet with a leader - similar to the way in which central government operates.
-A directly elected mayor and council manager - a mayor working with a 'super' chief executive.
Once appointed the executive becomes totally responsible for running the council. It must obtain full approval for major policies and the annual budget, and is accountable to the council for its actions. Effectively, it runs the council.
The precise manner in which the executive operates is a matter for local choice. In a radical departure from existing arrangements, individual councillors will, for the first time, be allowed to take executive decisions. Underpinning these changes is a strengthened scrutiny function - essential if power is to be concentrated in a small group of people.
The scrutiny function will be the responsibility of three groups. The first comes in the form of the council. At present the council is all powerful, in future it will have no option but to cede most of its power to the executive.
But it will remain responsible for a number of key functions including:
-Agreeing policy and budgets
-Making decisions on any executive matter which fall outside the agreed policies or budgets.
The second and most important check on the executive will be the creation of scrutiny committees. Every council must have at least one of these. They are similar to parliamentary select committees. They are cross party and canhold wide ranging reviews of council policy and executive action. No executive member can be on a scrutiny committee.
The third and final body is the standards committee. Every council must have a standards committee. Their purpose is to promote and maintain high standards of conduct by councillors and assist them to observe the new code of conduct each council has to draw up. The new arrangements need to be implemented in 2002, though many council will have made an early start.
Bexley LBC has adopted the cabinet with a leader model. The cabinet will have seven other councillors chosen by the council on the leader's recommendation.
Each cabinet member will have a portfolio, like government ministers, based on the council's key objectives with a portfolio added for corporate affairs.
Four review committees will keep an eye on the executive, scrutinising the cabinet's decisions and policies.
What does this mean for the management of the council's pension fund? Given the amounts of money involved is it dangerous to concentrate power in the hands of so few? There are a few areas the executive will not be allowed to make decisions on. Instead separate committees will be formed. At Bexley four committees have been established to look after these non-executive functions:
-Planning control - planning applications and development issues
-Public protection - licenses, registration and elections
Bexley's pensions committee replaces the existing investment panel with wider terms of reference:
-Approving the admittance of non-council organisations into the fund
-Monitoring of early retirements
-Approving discretionary decisions relating to the payment of pension
-Matters relating to the actuarial valuation of the fund
-Approving asset allocation
-Approving statement of investment principles - including corporate governance and socially responsible investment
-Monitoring fund performance
-Appointing of managers and advisers.
The thrust of the committee will still be the performance of the fund. With council pension funds worth£100bn and growing, it is inevitable a high level of councillor interest will be generated. The link between investment management performance, employers' contributions and the impact on council tax levels is well established in councillors' minds.
Two or three years of under performance quickly translates into increased contributions and pressure to make service reductions or impose higher taxes. Persuading the electorate to accept an increase in council tax to pay for staff pensions is not easy.
Fortunately, pension fund managers and the market have delivered. The last 20 years have been halcyon days for investment performance. UK equities have delivered an average annual return of 17.2% over the last 20 years, while UK gilts have delivered 13.3% - both in excess of local government earnings inflation.
Pension funds have therefore enjoyed some protection from theinexorable rise in the cost of pensions as life expectancy increases and employment law opens membership. But 2000 saw a rare negative return from UK equities at just under -6% and the volatility of the market has meant chasing the WM local authority average return is more difficult.
The range of returns around the median has increased. Unless a manager is prepared to be a 'closet indexer', the risk of underperformance is greater than ever before. It is interesting to note the number of funds achieving returns within 10% of the WM average has declined over the past four years. In 1997 64 funds returned 10% either side of the benchmark, in 1998 57, in 1999 and 2000 this had fallen to 37 and 35 funds respectively. Performing close to the average is becoming hazardous.
With only four years in office councillors serve a significantly shorter term than the long term liabilities of the fund. Periods of underperformance are therefore likely to attract the attention of councillors far quicker than perhaps they ought to. Though, I have to say Bexley councillors showed great patience in sticking with Phillips & Drew, a decision which in 2000 has paid off handsomely and is now beginning to filter through into good third year performance figures.
The new arrangements, with the emphasis on a small number of key councillors, may result in more powerful lobbying of the fund trustees. A leader or directly
elected mayor could prove to be an all-powerful and fearsome individual. Though the pension fund will be protected by its non-executive classification, there will always be a risk that a powerful councillor could bring political pressure to bear on fund management, particularly in the area of socially responsible investment and corporate governance.
Increases in employers' contribution rates due to prolonged periods of underperformance will quickly attract the interest of the cabinet members.
I suspect as a result of this fear among councillors many councils' pensions committees will have a number of cabinet members sitting on them.
Against the move to greater executive power, officers will continue to play a key role in the management of funds. Given the size of council pension funds directors of finance are unlikely to relinquish a hands on involvement in the appointment of managers and advisers. They are perhaps best placed to take a longer, more patient view of manager performance. A tendency to chop and change managers like a football club is unlikely to produce consistent long term performance.
While the move to greater executive power is a radical change, performance will continue to be all important in the management of pension funds.
It was Rocco Forte who, when asked what sells a hotel, said 'location, location, location'. One cannot help but conclude that when it comes to fund management it is 'performance, performance, performance'.
-Mike Ellsmore, assistant financial controller, Bexley LBC.
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