27 November 2002

Dear Sir/Madam,

1. I wrote to you on 15 November 2001 about a range of proposals to ensure the maintenance of an effective and efficient regulatory framework for the investment of local authority pension funds in England and Wales. In particular, your views were sought on introducing flexibility to the prudential benchmarks set out in Schedule 1 of the 1998 Regulations (paragraphs12-15 of my earlier letter) and amending the limit on investment in partnerships (mentioned at paragraphs 26 and 27).

2. In the light of responses to that initial consultation stage, and with the agreement of Ministers, this letter now seeks comments on several, specific proposals.

3. As explained in the November 2001 consultation document (paragraphs 2-3), the policy objectives of the current Regulations are:-

to ensure the prudent management of local authority pension funds;

to achieve a reasonable rate of return on funds’ investments;

to ensure an effective elected member stewardship of local authority pension funds;

to maintain the continued solvency of individual pension funds as required by the Local Government Pension Scheme Regulations 1997; and

to prepare and maintain a Statement of Investment principles as required by the Local Government Pension Scheme (Management and Investment of Funds) Regulations 1998.

4. These aim to set a clear framework, so that each pension fund's investment strategy, within its Statement of Investment Principles, will be characterised by an appropriate balance between prudence, diversification and the achievement of reasonable rates of return.

5. Against that background, the objective of this exercise is to seek views on the scope for some additional flexibility within the overall regulatory framework, while ensuring that any use of the proposed flexibility by authorities remains prudent, transparent and fully accountable.

6. The flexibilities set out in Annex A seek to respond to a general desire within the LGPS pension fund fraternity for a margin of statutory-based flexibility to ensure that investment opportunities are not lost because of extant regulatory limitations on LGPS pension fund authorities.

7. As things stand there is no policy intention to remove the prescribed prudential benchmarks altogether, given the linkages between LGPS pension fund solvency, local authority employers' pension costs, the structure of local authority financing, and fiscal accountability.

8. However, this letter invites your views on the proposition to widen the range of investment limits in the categories described at Annex A.

9 LGPS administering authorities could be permitted, in prescribed circumstances, to manage investments, subject to Schedule 1 of the 1998 Regulations, within a flexible but regulatory-based headroom. The use by administering authorities of this flexibility needs to be subject to appropriate safeguards. Consequently, any amending regulations would need to make a clear distinction - in terms of their requirements on authorisation, control and transparency - between authorities' investment decisions up to the existing Schedule 1 limit, and those relating to investments between that limit and within the new upper headroom.

10 In addition, any regulations would probably also need to ensure that :-

the use of the new headrooms must only be decided by elected members, having taken proper advice, and not by officers working under delegated authority;

once a formal decision has been taken by the responsible elected members, the policy must be published in the authority's Statement of Investment Principles, within two calendar months and be brought to the notice of contributing fund employers within that period. Any future changes to that policy must be made on the same basis; and

any decision to revert to a lower percentage must be similarly considered and actioned by elected members, and the SIP duly modified and information promulgated in the same timescale.

11. Such an approach would additionally need to set out the basis on which the use of any headroom was authorised; the specific investment type(s) to which it would apply, and the relevant percentages; the length of time for which the authorisation applied and the projected review point. There would also need to be confirmation that the decision complied fully with the 1998 regulations with specific regard to diversity and prudence. It should also be noted that the earlier undertaking to increase the limit on investments in partnerships will be addressed by the proposed changes to Schedule 1 and shown at Annex A. Views on the administrative safeguards and the extent of the flexibilities are invited.

12.. Comments are sought on whether or not any amending regulations, or some form of notifications, should require that the relevant investment committee or panel making the decision to use the additional headroom must comprise at least one member who has received the appropriate certificate from the Local Government Pensions Committee to demonstrate attendance at the "Trustee Training" course (LGPC Circular No 121 refers).

13. Any final amendment package will, of course, need to come within the ambit of simplifications/Plain English approach which has characterised previous regulatory changes.

14. In the light of responses received to this informal consultation exercise, and subject to Ministers’ eventual decisions, draft amendments to the current regulations could be brought forward for statutory consultation early in 2003. We are very willing to discuss the merits and details of the changes suggested above with interested parties. If helpful, a working seminar could be organised for all interests as a focus for debate on these issues.

15. Any comments on the proposals in this letter are requested no later than Tuesday 21st January 2003 and should be sent to Nicola Rochester LGP Division, Zone 2/E6 at the above address. Please direct any requests for meetings to Margaret Dunleavy at the same address or telephone 020-7944 6012 or email margaret.dunleavy@odpm.gsi.gov.uk

16. Following on from the Regulations which came into effect on 9 August - the Local Government Pension Scheme (Management and Investment of Funds) (Amendment) Regulations 2002, SI 2002/1852 - administering authorities will by now have revised their Statements of Investment Principles to record the extent to which they comply with the ten principles of investment practice set out in the CIPFA guidance published in April 2002.

17. To help us assess the extent of compliance across the LGPS as a whole, can I please ask those Chief Executives/Directors of Finance/County Treasurers with pension fund responsibilities, who have not done so already, to send a copy of their authority’s revised Statement of Investment Principles to the Department. Please ensure that a copy of your revised SIP is sent to Nicola Rochester here within 4 weeks of the date of this letter.

18. Those examples which have already been sent to the Department display a very welcome degree of high quality both in terms of compliance and presentation.

In the list below, the % shown in brackets beside the name of each type of investment is the limit currently set out in Schedule 1 to the Regulations - the maximum % of its pension fund(s) that an administering authority is permitted to invest in that type of vehicle.

The % shown in the headings represent our proposals on the maximum % of its pension fund(s) that an administering authority should be able to invest in the named types of investment. So in respect of any single underwriting contract for instance (see 1), an authority could invest up to 5% - giving them a new optional extra 4% of "headroom" to invest compared with the present limit, subject to compliance with the new regulatory requirements on authorisation and accountability mentioned above.

Any single sub-underwriting contract (1%)

All contributions to any single partnership (2%)

All contributions to partnerships (5%)

All deposits with a person specified in paragraph 12 or 13 of Schedule 2 to the Banking Act 1987, and all loans (10%)

All investments in unlisted securities of companies (10%)

Any single holding (10%)

All deposits with any single bank, institution or person (other than the National Savings Bank) (10%)

All sub-underwriting contracts (15%)

 

All securities transferred by the authority under stock lending arrangements. (25%)

10. All investments in…..units of unit trust schemes….or…open ended investment companies…. managed by any one body (25%)

11. Any single insurance contract (25%)

Addressees :

The Chief Executive of:-

County Councils (England)

District Councils (England)

County and County Borough Councils in Wales

London Borough Councils

South Yorkshire Pensions Authority

Tameside Metropolitan Borough Council

Wirral Metropolitan Borough Council

Bradford Metropolitan City Council

South Tyneside Metropolitan Borough Council

Wolverhampton Metropolitan Borough Council

Other Metropolitan Councils

London Pensions Fund Authority

Environment Agency

Town Clerk, City of London Corporation

Clerk, South Yorkshire PTA

Clerk, West Midlands PTA

The Secretaries of:-

Local Government Associations

LGPC

SOCPO

SOLACE

ALACE

CIPFA

New Towns Pension Fund

Trades Union Congress

UNISON

TGW

GMB

MPO

Audit Commission

UCEA

The Secretaries of:-

Investment Management Association (IMA)

Association of British Insurers (ABI)

National Association of Pension Funds (NAPF)

London Investment Banking Association (LIBA)

Financial Services Authority (FSA)

Government Departments:-

GAD

DOE (NI)

SPPA