Can council pensions fund regeneration?

A housing scheme in Manchester is the latest development to fuel debate over the use of council pension schemes to invest in local projects. Austin Macauley assesses whether it’s likely to open the floodgates

The case for using England’s council pension funds to benefit local economies just got stronger… to the tune of £5bn. They are now worth a whopping £148bn, up from £143bn last year, according to DCLG statistics released this month. Expect that figure to bandied around over the next 12 months at any forum where the future of council borrowing or investment in local regeneration is being debated – accompanied by the question: why don’t we make more use of council pension funds?

The answer is complicated and multi-faceted, but far too important to dodge.
At a time when local authority resources are stretched like never before, when funds available for regeneration and other local projects are thin on the ground, and when even the cheapest and easiest source of funding – the Public Works Loan Board (PWLB) – has become more expensive, why aren’t councils looking at pension funds as a way to diversify their options?

Local authority pension funds are already invested in all manner of projects – from property to infrastructure – across the UK. But when it comes to funds that are focusing investment on local projects the list becomes an awful lot shorter. A report published last month by the Smith Institute, Centre for Local Economic Strategies, Pensions Investment Research Consultants and the Local Authority Pension Fund Forum sums up some of the reasons why.

The research found the primary concerns of pension funds are, understandably, to ensure a good rate of return on investment and protect the interests of members, i.e. uphold their fiduciary responsibilities. Every fund manager who took part in the research said they wouldn’t accept lower returns in exchange for delivering local social and economic benefits. Such investments were viewed as more complicated and many were concerned about potential conflicts of interest if a fund was bankrolling a local project. ‘The general view is that all investments are appraised on their own merits… rather than for a particular impact type or geography of impact,’ was the view of one respondent.

But the research did detect a growing interest in finding new ways to invest generally and in maximising the social, environmental and economic impact of pension funds.

‘This group of people are very careful, they don’t want to be in the spotlight but do “get it” and want to invest in projects with social and economic value,’ says Paul Hackett, director of the Smith Institute.

One scheme, which has ‘gone local’, is the Greater Manchester Pension Fund (GMPF). Together with Lancashire Pension Fund and other partners, it’s involved in the North West Evergreen Fund, which launched earlier this year to provide loans for commercial property development across the region. But it is its role in a smaller, far more localised scheme that’s generating a bigger buzz.

In September GMPF signed a memorandum of understanding with Manchester Council and the Homes and Communities Agency to invest in a £30m development of 244 affordable homes for sale and rent across five sites in the city. Properties which in all likelihood would never be built otherwise.

Mo Baines, Unison employee representative on GMPF, says there can be an air of opposition to pension funds investing in local projects and that directed investment in general isn’t popular, particularly with government. But so long as there’s ‘sufficient separation’, the onus is on pension funds and their partners to make it happen. ‘Our mantra has always been, will it work, will it put the fund at risk? But we’ve been vociferous in wanting to create a virtuous circle.’

Provisions are being put in place to ensure the project delivers wider impacts, for example by using local labour. ‘It isn’t just about one off procurement, it’s pushing that agenda,’ she adds. ‘If the model works and it provides returns it will provide a template for it to be applied by other local authorities.’

Peter Morris, GMPF’s director of pensions, admits ‘it’s taken us quite a while to get to where we are now’, but now the venture is out in the open he has been fielding calls from a number of local authorities both inside and outside Greater Manchester. ‘In terms of outside Greater Manchester it’s people just making inquiries about how it works. I’m sure there are local authorities who think they have sites.’ He hopes to roll the model out in other areas where there’s sufficient council interest. Given GMPF represents ten local authorities in all, it would seem this corner of the north west is the most likely destination.

GMPF has invested in the local area and its surrounding region for more than 20 years, primarily through the Greater Manchester Property Venture Fund. Examples include One St Peter’s Square, a landmark office development currently being constructed in Manchester city centre. Investments like this have increased over time, says Morris, with up to £300m allocated by GMPF. ‘We have twin aims: commercial returns and supporting the area. If you don’t get commercial returns you can’t put the investment in.’

But he accepts GMPF’s scale and location puts it into a different league to many other pension funds. ‘We are a large conurbation and are therefore capable of throwing up more investment opportunities,’ he says. ‘Alongside that, we are a relatively large fund and that gives us the opportunity to build up a relatively diverse portfolio of assets.

‘There aren’t many others [local government pension schemes] that currently undertake this kind of investment. But authorities in other areas are becoming more interested and they are speaking to us about it.’

Attempts are being made to replicate the advantages of scale enjoyed by Greater Manchester Pension Fund in the capital by creating a London Pensions Mutual. It would bring together 35 funds in all to form a pan-London investment vehicle worth £30bn, including a £2bn vehicle to invest in London’s infrastructure. However, little progress appears to have been made since the announcement hit the headlines six months ago and numerous political and technical hurdles will have to be overcome before it sees the light of day.

The twin issues of scale and perceived conflicts of interest are clearly key barriers to greater investment in local projects by council pension schemes. But two solutions put forward in recent months could offer a way forward.

First up is one of the key recommendations of the aforementioned report from the Smith Institute et al, Local Authority Pension Funds – Investing for Growth. It suggests the creation of an independent clearing house to gather data from potential investment opportunities across the UK and develop a national framework and standard for assessing economic, social and environmental value.

On top of that, a ‘pooled vehicle’ would be created involving contributions from a number of council pension funds to create a pot from which local authorities can bid for investment. By building greater clarity in the markets over what it calls ‘impact investment’, developing and highlighting good practice and investing in training for pension fund officers, researchers argue the groundwork will be laid ‘to do things differently in future’.

The second solution comes from the Local Government Association (LGA) and the Welsh LGA, who suggest forming a collective agency to raise funds from bonds markets which can then be loaned to local authorities. Similar agencies already operate successfully in Sweden, Finland and New Zealand, with France about to follow suit. It would create ‘highly rated bonds of likely interest to UK insurance companies and pension funds (including local authority pension funds)’. In an indirect way it could potentially make it easier for council pension funds to invest in local authority projects. Although larger authorities can, and do, raise their own bonds, many more are too small to do so. An agency would solve the problem.

The man tasked with taking the proposal forward is Mark Luntley, the LGA’s programme director for finance. He believes it offers a safe and reliable option to councils at a time when there’s so much uncertainty over their future finances – and an attractive investment avenue for pension funds.

‘It’s time for local authorities to be more innovative and see how they can become more self-reliant, self-financing.’

‘Pension funds can’t invest in their own areas, there are all sorts of conflicts of interest,’ he says. ‘But if councils are issuing bonds they’re effectively putting a Chinese wall between these things. For example, if the collective agency has decided to issue a tranche of bonds representing three or four councils. It’s not attributable to any one council. The council pays an attractive rate of interest and the pension funds get a decent rate of return.

‘If local authority bonds are as risk-free as the government, crucially it allows local government pension schemes to start investing in local government.’

Borrowing from government, via the PWLB, remains the most popular and, on the whole, cheapest way to access finance. But when the Treasury announced a 1% interest rate hike in 2010 it precipitated discussions across local government about alternative sources of borrowing. Paul O’Brien, chief executive of the Association for Public Service Excellence, believes that although PWLB is the most cost-efficient way of borrowing, it shouldn’t curtail the search for alternatives.

‘It’s time for local authorities to be more innovative and see how they can become more self-reliant, self-financing,’ he says. ‘In order to do that they need to be making investments not just for financial return, but also social and economic return. Where local authority prudential borrowing is exhausted they need to look at innovative ways of getting funds for their areas – for example, pension funds.’

Both solutions put forward will require backing from Whitehall to succeed. Given UK government talks frequently of its support for localism it seems logical that it would be behind any moves to help councils diversify their options and become more self-sufficient. On November 1 the PWLB will begin offering a 0.2% reduction via a ‘certainty rate’ for local authorities ‘providing improved information and transparency on their locally determined long-term borrowing and associated capital spending plans’. Commentators have taken this as a sign that the Treasury is worried about local government going elsewhere for its borrowing.

If government is less than thrilled at the prospect of councils shopping around, where does that leave these potential routes for pension fund investments? Philip Monaghan, founder of consultancy and think tank Infrangilis, believes that, provided the rates of return and risk are appropriate, council pension funds should have a presumption in favour of investment in projects which deliver wider benefits. And he argues it can happen regardless of central government support. ‘I genuinely don’t understand the need for government “permission”. If local government brings forward an investable proposal why wouldn’t that be prioritised for funding?’

But when it comes to an agency for local authority bonds, investors will want to know where the government stands, says Mark Luntley. He adds: ‘Government has talked about wanting to work with local government but discussions haven’t got very far yet. Councils already have the power to raise bonds but the message from government seems to be “you should only be borrowing from us”.

‘One of the senior local government people I know said, “if we were a company we’d be looking for diversity of borrowing”. The risk is government is almost seen as maintaining a monopoly.’

There are many hurdles to jump before council pensions become a significant source of funding for regeneration in the UK. But the issue is gaining momentum and exemplar schemes are now coming to the fore.

  • Read our series of articles on pension funds and regeneration here



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