Now that the LGPS funds have finalised their initial plans for pooling assets, the next step is to decide what structures the pools will use. Two experts discuss the options.
Two structural options
PwC director Mark Packham
Two pooling structures feature in the initial proposals recently made by the investment pools. Both structures collectivise decision-making on appointing and removing investment managers, and both allow the participating Local Government Pension Scheme (LGPS) funds to retain high level asset allocation choice, so pension committees can focus on addressing deficits and stabilising contribution requirements.
First, the Authorised Collective Scheme (ACS). This is the UK's brand of choice for collective investment vehicles. ACSs are regulated by the Financial Conduct Authority, as are their operators.
The key to an ACS is tax transparency. While some countries apply different withholding tax rates on payments to an ACS, compared to a payment direct to a pension fund, in the vast majority of territories the pension funds, rather than the ACS, are seen as the beneficial owner. This means the funds can still access the favourable withholding tax rates they are entitled to in many of the double tax treaties the UK has negotiated with foreign territories.
Transfers of assets into ACSs give rise to costs of transition to be managed. While no UK stamp duty should be applied to the transfer of UK securities into an ACS, a number of non-UK territories are likely to apply a transfer tax. In addition there are transactional costs to consider.
As fully regulated vehicles, ACSs can provide services to third parties. They take time and resource to build, but should then run effectively for most types of listed asset though not for investments of limited duration, or as a home for life funds, often used for passive investments.
An ACS can also be bought off the shelf from a third-party operator. This gives speed but reduces control, so the choice must be evaluated fully.
Next is the Collective Asset Pool (CAP) which is a simpler and unregulated structure. In a CAP, the participating LGPS funds delegate substantial investment powers to a central operations group, which may be a shared service or a company. The operations group appoints and removes investment managers.
With a CAP, the offering to the pension committees is clear: choice between asset classes, so funding strategies can be set, but with the operations group choosing the actual managers.
Tax arrangements are unchanged. A CAP does not include a new fund vehicle. It does not have the same cost associated with transferring of assets but also no reductions in withholding taxes.
Regulation of a CAP is variable. Clearly, comparable processes and risk controls are necessary. These have to be worked through, particularly for internal teams managing investments. If there are external investors, regulation is required.
Whatever the choice of operational structure or fund vehicle - and investment pools may need more than one fund type - robust governance will be key.
Life company pooling
Mobius Life managing director Chris Trebilcock
The Chancellor wants pooling to "significantly reduce costs" while "maintaining overall investment performance" and to see schemes invest more in infrastructure.
Balanced against this is trustees' duty to act in the best interests of members. In practice, this means having the flexibility to deliver an investment strategy which protects the scheme's long term funding position.
So why is it that many advisers seem to be proposing the ACS as the solution and not the structure where significant pension assets are already managed? ACSs will struggle to meet the required flexibility criteria of schemes, yet we have a well-proven alternative in the life company structure that is already being used as a pooling vehicle by schemes. Life companies offer comparable costs, greater investment flexibility, faster implementation and a simpler structure.
Billions of pension assets are held in life companies. The structure is well understood, regulation rock-solid and set-up costs, when using an established life company, are minimal. Life companies also allow schemes to benefit from pooling, while retaining the flexibility to adapt their investment strategy to meet scheme-specific needs.
Proponents of the ACS could argue it offers a marginally more beneficial withholding tax treatment. They will also point to ownership of the assets - claiming that passing the assets to a life company exposes schemes to proprietary risk. In reality ACSs are exposed to similar risks. Schemes are ‘tenants in common' in an ACS, so if one asset class fails, all the members share the losses.
Establishing an ACS costs a huge amount of time and investment in comparison to using an established life company. Investment management is slow and unresponsive. Introducing a new strategy requires regulatory approval and the ACS is inflexible when moving assets.
Of course, schemes must undertake extensive due diligence when selecting a life company. Some, but not all, are exposed to investment risk. A number of life platforms will be keen to direct assets into in-house funds. But these companies are not the only options. Independent life platforms that take no investment risk exist, with billions under administration for some of the UK's top schemes.
Right now, life companies meet all of the Chancellor's expectations and provide services to millions of members, including local authorities. They offer a simple, low-cost and flexible solution for pooling. It is hard to see how establishing an ACS, with its inflexibility and governance burden offers a better solution.
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