Summary

Over the last few years the British Government has been focusing on opportunities for collaboration, cost savings and efficiencies across the Local Government Pension Scheme (LGPS) sector. One such opportunity involves pooling assets into six “British Wealth Funds.” Following on from earlier consultation on the subject in May and June of 2014, the Government’s 2015 Autumn Statement has set out ambitious plans and criteria for LGPS schemes to pool assets.

This paper is intended to provide an overview of some of the key issues to be considered by the LGPS Sector when creating asset pools.

Creating the “British Wealth Funds”:An Overview for Local Government Pension Schemes

Global Banking and Markets

Autumn Statement

With its focus on pooling assets into British Wealth Funds, the Government’s goal is not only to drive down investment costs but also to develop capacity and capabilities to become a world leader in infrastructure investment and drive growth.

As detailed in the 2015 Autumn Statement, each authority has been given discretion on how they form these asset pools. However, the submissions must consider the following four key criteria:

A. Assets pool(s) that achieve benefits of scale With a minimum limit of £25bn

B. Strong governance and decision making At both the local and pool level

C. Reduced costs and excellent value for money Including how the pool will deliver substantial savings in investment fees short term and over the next 15 years whilst at least maintaining overall fund performance

D. An improved capacity to invest in infrastructure Including how the pool can help improve capacity and capability to invest in UK infrastructure

What LGPS Need to Know

How pooling can benefit your organisationConsolidating assets into large pools will benefit schemes in a number of ways, providing:

• Economies of scale for:

– Cost savings in investment management and related fees

– Access to best in class investment managers

– Supporting diversification into infrastructure and alternative asset classes

• Improved governance and centralised administration

• Option to develop existing (or new) in-house investment management capabilities which could be utilised by other LGPS schemes

Common challenges and considerationsAlong with the benefits, however, also come various challenges and considerations that need to be examined when setting out pooling plans. As an example, these can include:

– Who are the right partners to pool together?

– How should the pool be structured?

– What is the best way to manage the governance of the pool?

– Do the projected cost savings sufficiently outweigh the cost of setting up and running the pool?

– What is the timeline for setting up a pool?

– What external support/advice will be needed to help set up the pool?

– What external support may be needed to run the pool on an ongoing basis?

What is an ACS?

The UK Treasury introduced a UK Tax Transparent Fund (TTF) in the 2013 Finance Act. Known as an Authorised Contractual Scheme (ACS), it was launched on 1st July 2013. The ACS facilitates the pooling of assets belonging to a number of different entities in a single asset pool and achieves critical mass and economies of scale. The ACS has two forms both of which are regulated by the Financial Conduct Authority (FCA):

• Authorised Co-Ownership Schemes – transparent for just income.

• Limited Partnership Schemes – transparent for both income and gains.

The Co-ownership Scheme is proving to be the more popular of the two structures as it facilitates umbrella and sub-fund structures commonly used across the fund industry.

TaxMany tax authorities “look-through” tax transparent vehicles, applying withholding tax rates as if the investor had received income directly. Investors pooling assets into a TTF should not suffer additional withholding tax on their investment income as a result. This is an important consideration for LGPS who wish to access their beneficial withholding tax treaty rates.

RegulationThe FCA is the UK regulating authority for UK registered collective investment vehicles and funds, such as an ACS. Each fund will choose to be regulated under the European investment directives – the Undertakings for Collective Investment in Transferable Securities (UCITS) and/or the Alternative Investment Fund Managers Directive (AIFMD). The directives set out restrictions regarding the asset classes and risk profiles of the fund. In the UK there are two schemes under AIFMD – Non UCITS Retail Schemes (NURS) and Qualified Investor Scheme (QIS). The PwC report on the LGPS pools names the QIS as the preferred investment scheme as it offers a wide range of investment freedoms and could accommodate many asset classes.

What are your options?With all this in mind, there are a number of options for the LGPS sector to consider when setting out their more detailed plans and difficult decisions that will need to be made.

Pool Structure: Per the PWC Design of the structure and governance of efficient and effective CIVs for LGPS Funds report released in the 2015 Autumn Statement, the UK Authorised Contractual Scheme (ACS), in particular the co-ownership version, has been identified as the most appropriate model for pooling certain LGPS assets and was the vehicle of choice for the London Councils pool which has already launched.

Investment Management: The question is not as simple as, ‘which investment managers to appoint’. Additional considerations might be whether the pool provides access to strategies run by multiple managers or single managers. Historically single manager portfolios have been used as a way of ensuring underlying investors still retain control over investment decisions at both asset class and manager level.

Asset Classes: Whilst the ACS supports the pooling of certain asset classes it is widely recognised that some alternatives such as Real Estate, Private Equity and Infrastructure may be better suited to remain outside of the ACS, in another pooled vehicle. Given the long-term investment tenure and potential need for lock-ins, corporate or partnership structures are more commonly used.

Timeline: Although the Government is looking to see progress on the pools by 2018 there is no rule that everything should be pooled at the same time. Many are leaning towards a phased approach rather than a big bang.

Pooling partners: Government consultation does not provide direction regarding how pools should be compiled. Thus far a regional approach has appeared to be the option of choice. However, it would also make sense for schemes with common investment ideologies to consider partnering.

ACS Pooled Fund

LGPS 1 LGPS 2 LGPS 3

Improved Governance

Economiesof Scale

CostSavings

Best in classAsset Mngmt

AssetDiversification

LGPS schemes retain independence and control of asset allocation,but benefit from the advantages of pooling

ACS Pooled Fund

LGPS 1 LGPS 2 LGPS 3

Improved Governance

Economiesof Scale

CostSavings

Best in classAsset Mngmt

AssetDiversification

LGPS schemes retain independence and control of asset allocation,but benefit from the advantages of pooling

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Put HSBC’s Experience to Work for You

A leading LGPS and ACS provider, HSBC has the relevant experience and knowledge to assist you in your decision making process. Specifically, HSBC:

• Is an established ACS asset pooling provider, servicing $24bn in ACS structures (over 20 sub funds and 100 investors)

• Has actively engaged with the UK government in consultation on such matters as ACS pooling

• Is a trusted banking partner to the UK Local Authority community, maintaining long-standing relationships with over 25 UK Local Authorities and LGPS schemes, encompassing Payment & Cash Management, FX, Securities Services and Asset Management

• Offers a dedicated FX execution platform for LGPS, focussing on cross scheme collaboration

• Is a Global Funds services provider, providing Depositary, Fund Accounting, Global Custody, Transfer Agency and CIPFA compliant reporting services

• Delivers fund expertise and knowledge to help our client navigate UCITS and AIFMD regulations

• Has a proven track record for managing large complex projects

For further information or to discuss how HSBC can assist in your pooling decisions please contact:

Simon Field Public Sector Banking Tel: 020 7991 0924 simon.field@hsbc.com

Alan Strang Business Development Tel: 0131 282 1228 alan.strang@hsbc.com

Fletcher Kewley Business Development Tel: 020 7005 8271 fletcher.t.kewley@hsbc.com

Hayley Willock Pensions Product Tel: 020 7005 8417 hayley.willock@hsbc.com

Your Next Steps• 19th Feb. 2016 – submission of initial high level plans

– Continue dialogue with consultants, partners and service providers to prepare for;

• 15th July 2016 deadline for completed joint submissions for pool proposals outlining commitments and expectations