Fresh government guidance asks LGPS funds to have ESG policies but this could be at odds with their requirement to act in line with UK foreign and defence policies. Stephanie Baxter asks whether it is cause for concern.
At a glance
- Government guidance requiring funds to have ESG policies welcomed
- This could be challenged due to the ban on funds pursuing policies contrary to the UK’s foreign or defence policy
- Others feel the conflict will not restrict the fund from making legitimate fiduciary decisions
Ever since former chancellor George Osborne announced the pooling agenda for the Local Government Pension Scheme (LGPS), there has been much speculation over central government meddling.
Those concerns have been raised again in light of guidance on producing the new investment strategy statement from April 2017, which replaces the statement of investment principles.
The guidance, issued in September, came as the government moves closer to publishing the final LGPS investment regulations, which will assist pooling but contain controversial elements. Crucially, the secretary of state for communities and local government has powers to intervene if an administering authority fails to act in accordance with the guidance.
The guidance requiring funds to have a policy on social, environmental and governance (ESG) factors has been welcomed. Funds are expected to explain the extent to which non-financial factors have been taken into account and explain their approach to social investments.
However, this guidance could be challenged as it may be in conflict with the government's rule that funds should not pursue policies that are contrary to the UK's foreign and defence policy.
This came on the back of the 2015 Conservative conference, where concerns were raised over certain local authorities refusing to make investments, particularly in relation to Israel.
Building on comments by the then-Cabinet Office minister Matthew Hancock in February, the guidance states: "Using pension policies to pursue boycotts, divestment and sanctions against foreign nations and UK defence industries are inappropriate, other than where formal legal sanctions, embargoes and restrictions have been put in place by the government."
There are concerns the government is trying to use the LGPS as an arm of the UK foreign office.
John Gray, a member-nominated trustee on the Tower Hamlets Pension Fund, welcomes the guidance for setting out a clear requirement for funds to have an ESG policy. However, he strongly disagrees with forcing them to invest in line with UK policy, and thinks it's going to be a "dog's dinner".
Nabarro head of pensions North John Hanratty is also concerned there will be overlap between ESG investing and UK foreign or defence policy.
He explains: "For example, say you have an ethical policy against investing in arms manufacturers or distributors, which is a perfectly legitimate aim for pension funds to follow as it's financially sensible. If you choose not to invest in arms distributors in Israel or Saudi Arabia, the government could come along and say that's contrary to its political interests and use its intervention power to enforce the investment.
"There is so much overlap that you could do it inadvertently, and then the secretary of state could use his intervention power to take on the investment portfolio."
It could create problems for funds with a policy to ban tobacco investment or have already started divesting from fossil fuels. "Are they going to say you can't boycott the biggest tobacco producers in the world just because it's contrary to UK foreign policy because the government supports America? It just doesn't hang together in this document," says Hanratty.
There could be tensions where funds want to take non-financial considerations into account, which they can if there is good reason to think members would support the decision.
Gray says there could be issues where members say they do not want to invest in a certain country, but such a policy goes against foreign or defence policy.
"I thought if there are conflicts between taxpayers and beneficiaries, which there may well be, the scheme has to be run in the interests of beneficiaries."
It could even create longer-term issues where funds choose to engage with companies rather than divest.
"There's no point having engagement if at the end of the day you can't have divestment as a last resort; otherwise engagement does not work as companies will just spin you along," says Gray. "There has to be an ultimate sanction of divestment to make engagement work."
Surely the government does not wish this to prevent funds from doing ESG and divesting from tobacco or fossil fuels? The difficulty is not knowing how the SoS will exercise his power and how far he will go.
Allenbridge independent adviser Karen Shackleton, who advises several LGPS funds, says although the situation is unclear, she is less concerned.
"The devil's in the detail in terms of what they categorise as these boycotts. I can understand where the government is coming from – it doesn't want pension funds to be very clearly going against government policy. But quite how it will implement that, I don't know.
"I would be very surprised that the secretary of state would intervene unless there were very severe concerns about where a local authority was investing. My guess is it would only come after dialogue with the authority."
Greater Manchester Pension Fund chairman Kieran Quinn does not believe it will restrict any fund from making a legitimate fiduciary decision.
"The need to comply with British foreign office dicta will continue to be a cause of concern but in truth it's how they apply it that will be more of an issue.
Using funds to pursue boycotts against foreign nationals is "inappropriate" and has always been the case as "pension funds should not be used for that level of politics", he says.
"There'll always be a council somewhere that will say 'don't invest in country A, country B'. The guidance says if there's evidence of that, then clearly the government will start the process to look into that."
Overall Quinn is quite pleased with the outcome of the guidance as the early draft seemed much more prescriptive.
"My concern was around them not allowing us to do the job we're good at. The LGPS has a very strong record of not making decisions based solely on politically motivated divestment campaigns or issues. There's no evidence of that, but every now and again there's an MP or councillor who makes a statement around an issue, and then the assumptions are that investments have been made on the back of that."
He gives the example of how the LGPS reacted to the problems with South Africa's regime during apartheid.
"Most funds withdrew from the South African regime, not directly because of apartheid, but because that government and country was failing. Therefore investment was hugely risky and the funds didn't want to end up with egg on their face if the country fell apart. These were legitimate fiduciary decisions taken with appropriate governance."
The government is right to prevent the potential use of pension funds to pursue politically-motivated boycotts against foreign nationals. However, the ban must not hinder funds from taking their own legitimate fiduciary decisions, including ESG investments, at the local level.
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