LGPS update,26 January 2021

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Moderator: We've got two sessions today of 40 minutes each, first we're going to hear from Lorraine Bennett, who's a senior pensions advisor at the LGA, then Bob Holloway, who's the esteemed advisory board secretary at the LGA, and from Catherine McFadyen from (mw 00.23) Robertson, who's the head of LGPS consulting about good governance. We'll then have a ten-minute question and answer session at the end and then we'll take a break, 10:50 until 11:00am. At 11:00am we're going to hear from (inaudible 00.39) and Joshua Kriskinans from Ninety One, who are an investments company. Just to mention of course, this time last year just about we were actually holding our face-to-face conference. Seems 100 years ago now, of course. I should say that we are hoping to run a conference, a proper face-to-face conference, next year on the 20th and 21st January in Bournemouth, so hopefully that fingers crossed we'll be in a situation we can do that, but apart from that I hope to see you there, and I'll remind you at the end, but, oh, the last thing as well, we are recording the session today so there will be a recording available at some point afterwards, and also we'll be providing you with a copy of the slides as well, if you wish. So, without more ado, I'm going to pass you over to Lorraine Bennett.

 

Lorraine Bennett: Thank you, Carl, and good morning, everyone. I'm just going to share my, my screen with you. Hopefully you can all see my slides. I have had some problems with my sound this morning, so I hope you can all hear me and I hope one of my colleagues will let me know if you can't. So, yes, good morning, I hope you're all well. I'm going to spend the next fifteen to twenty minutes talking about some of the main issues impacting on the LGPS at the moment, and then I'm going to touch very briefly at the end on some of the upcoming issues. So, what's on the agenda? So, I'm going to be talking about the topics that are showing on the slide at the moment. I'm sure all of these will have appeared on your local pension board and pension committee meeting agendas in recent times, so hopefully the information won't be completely new to you, and then as Carl has already said, I'm going to pass over to my colleague, Bob Holloway, who will talk to you about the work the scheme advisory board is doing on responsible investment and the recently introduced employer flexibilities. So, I'm going to start with a topic that I'm sure you're all completely sick of hearing about, I know I am, and that is COVID-19. Unfortunately we aren't where we all hoped we'd be by now, and the image shown on the slide at the moment, or something similar, will still be a reality for at least some of the administration staff in the LGPS.

 

We've run various surveys since lockdown first started in March last year, covering topics such as resilience, so how LGPS administering authorities are holding up to the various challenges, cash flow and governance issues, and in August last year we ran a follow-up survey which covered the three topics in one survey, so resilience, cash flow and governance, to see how things had changed since we first ran those surveys in March, April last year. We generally have a very good response rate to our surveys, a response rate of around 80 LGPS funds to each one, so we do get a good picture of what is going on in the field, so to speak. So, for those of you who aren't aware, the LGPS is administered locally by 87 different administering authorities in England and Wales and eleven in Scotland, and unsurprisingly around 80% of those administering authorities reported that almost all of their administration staff were working from home last summer, and I imagine that that figure will be pretty much the same now as, as we're in yet another lockdown. When we asked them what their-, what authorities' plans were for future working arrangements, the majority said they expect to offer a more flexible working environment in the future, so a mix of home and office working, but 13% of respondents reported that they expect the majority of their staff to return to office working on a full-time basis in the longer-term.

 

The survey responses did indicate that administering authorities adapted differently to the challenges, again, not surprisingly. Some were already offering home working and found the transition relatively straightforward, whereas others who didn't were in the position of having to source equipment such as laptops and phones to enable staff to work from home, which obviously took some time. Most authorities experienced postal issues, which in the main have now been resolved, but in the early days many authorities had staff taking it in turns to visit the office to scan post, print off letters and send them, etc, and inevitably there has been a move to electronic communication, which as long as it's secure is a good thing, but it has been a step change for most authorities and, and something that we think will continue to grow. There is a high level of confidence across all authorities about processing the core workload, and by that we mean paying current pensions, processing and calculating new retirements and deaths. 96% of respondents were very confident they could continue to pay current pensions and 81% were very confident they could process new retirements and deaths. The confidence level wasn't quite so high in the ability to process other work with the normal performance standards, so for example, calculating transfers or early leaver benefits.

 

The main areas of concern around the ability to process this type of work were staff absences due to COVID, staff well-being, where some employees will be struggling to work from home, they'll be working from their kitchens, their sofa, bedrooms, often with children at home, and the impact that this and the situation generally has on mental health and long-term productivity. Also of concern are difficulties with recruitment and training staff virtually, and the pressures on workloads arising from the new requirements such as McCloud and the exit cap, both of which I'll be talking about a little bit later. So, on the governance side most pension committees and local pension board, pension boards, are now meeting virtually, although there does appear to be a desire to return to face-to-face meetings. Only 19% of respondents said they would continue with the virtual only format when face-to-face meetings were possible. Employers experiencing difficulties paying their contributions or at risk of leaving the scheme due to COVID, the COVID situation, are thankfully in the minority. Where there are difficulties they tend to be in the charity and leisure sectors, with some colleges and private contractors also experiencing difficulties. Of course, we don’t know how these types of organisations will hold up going forward as we main in lockdown, but administering authorities will no doubt be watching closely and will enter into discussions with any employers where necessary.

 

So, in summary the LGPS has held up pretty well to the COVID challenge so far. There were some initial difficulties adapting working processes, but pension benefits are still being paid, new benefits are still being calculated, then the main concerns going forward are staff well-being, long-term productivity, training staff and the impact on workloads of complying with the new national requirements. And this brings me neatly onto one of those national requirements, which is what we refer to as McCloud, and McCloud judgement, so when the government reformed public service pension schemes in 2014 and '15 they introduced protections for older members, and in December 2018 the Court of Appeal ruled that those protections amounted to unlawful age discrimination in the judges' and the firefighters' pension schemes. The government has since confirmed that there will be changes to all public sector schemes that provided similar protections, and this includes the LGPS, and those changes will seek to remove that age discrimination. The Ministry for Housing, Communities and Local Government, LCLG, is the government department that makes the regulations in England and Wales, have published a consultation on removing the age discrimination, and they published that last year, as did the Scottish Public Pensions Agency in Scotland.

 

Both of those consultations closed in October, and we understand that MHCLG don’t expect a response to their consultation in full until this summer, but when they do it should include regulations. They do plan to make a ministerial statement, however, at the end of February, and this will confirm high level policy decisions in, in the area, so hopefully will allow administering authorities to start planning. We don’t yet have a firm timing for the Scottish response, but we understand that it will be March at the earliest. As you will know, timing is very important, administering authorities need enough notice to plan effectively and ensure that software suppliers can programme the necessary changes, and this is something that we have been and will continue to push government on. So, the protection provided to older members in the LGPS is called the underpin, and it's essentially a final salary underpin, so if the pension a scheme member builds up in the reformed career average scheme is less than the pension they would have built up in the old final salary scheme, they will be paid the higher amount. The age discrimination will be removed from the LGPS by also providing this underpin to younger members who fall in scope, but the new underpin protection will go beyond the current protection, because it will also-, because it will also take into account the different retirement ages of the two schemes, the old scheme and the reform scheme, which the current underpin doesn't. This is a flaw in its design.

 

The normal retirement age in the final salary scheme was 65, whereas in the career average scheme it's linked to state pension age with a minimum of 65, and for those of you who aren't aware, the normal pension age is the-, is when a member can take the pension they've built up in full without a reduction for early payment. The underpin-, the underpin protection will then end for all members from April 2022, so from that point forward all members will build up a career average pension without that final salary underpin protection. So, when the regulations have changed to introduce the new underpin, LGPS administering authorities will need to revisit all their levers from the dates the schemes changed, which is 2014 for England and Wales and 2015 for Scotland. To do this they will need the hours of service break data, which hasn't been collected in many cases since the schemes changed, because it's not needed to calculate benefits in the new career average scheme, so this will be no mean feat. We have around 16,000 employers in the LGPS in England and Wales alone, many of which have changed pay or providers more than once since 2014. So, when we talk about revisiting leavers from 2014 in England and Wales, '15 in Scotland, this will include not just looking at those people who've left and either taken payment of their pension benefits or kept them in the scheme, but also people who've left and transferred out to another pension scheme, people who've died, and people with small pensions that have taken them as a one-off lump sum, and of course the underpin will need to be calculated for all leavers going forward as well.

 

There is still some uncertainty about what will need to be included in members' annual statements, whether we'll need to include the underpin amount in that and how that will be done, there's also uncertainty about how transfers out will be worked out, and the tax implications for members who are awarded a retrospective increase to their benefits. So, there's still a lot of unknowns, it's a huge undertaking, and as you would imagine a cause of concern for administering authorities. Some administering authorities report that they've undertaken some initial analysis of their pension records, and around 25% to 30% of those pension records are likely to be impacted and to have to be looked at again. So, the final topic I'm going to cover and move on to is the exit cap, and it doesn't get any cheerier I'm afraid. The exit cap is commonly referred to as the £95k cap. It doesn't have an impact north, north of the border, so any Scottish listeners can breathe a sign of relief, this doesn't apply in Scotland. So, the government first consulted on the exit cap policy in 2015 with the stated policy aim of ensuring better use of public money. Now, some of you may have seen the headlines in certain papers talking about large payouts to town hall fat cats. However, in reality it's not just high earners who will be impacted by this policy, it will also affect a significant number of scheme members who have substantial membership in the scheme and are not high earners.

 

It applies to public sector exits from 4th-, from the 4th November 2020, and it puts a limit on the amount of-, the amount public sector employers can pay when an employee leaves their employment, and that limit is £95,000. In the-, in the LGPS it has most impact where employers are aged 55 or over and made redundant or leave their employment due to business efficiency. This is because the strain cost is included in the exit cap calculation, so it counts towards that £95,000, and the strain cost is the amount of money the employer pays to the pension funds so the employees can receive their pension early. Unfortunately HM Treasury decided to bring the cap into effect whilst MHCLG were in the middle of consulting on changes to the LGPS regulations to accommodate it. This means that we're left with a clash between the two sets of regulations. The LGPS regulations provide that where a member aged 55 or over leaves their employment due to redundancy or business efficiency, their pension benefits must be put into payment immediately without a reduction for early payment. The member has no choice in this, however, the exit cap regulations do not allow the employer to pay for this if the total cost of the exit is over £95,000. Employers can apply for the cap to be waived in certain circumstances, for example, due to undue hardship, or where workplace reform would be inhibited.

 

The process is convoluted to say the least, and although the regulations say the power to waive the cap is delegated to the full council in the case of local authorities in England, it still has to be approved by both MHCLG and Treasury, so it is quite unclear about how that power is actually being delegated. The way the process in Wales is different, for any Welsh listeners, and we understand that Welsh ministers are currently working on how this will work. So, this leaves LGPS authority-, LGPS administering authorities and employers in a bit of a pickle, and on screen is a headline from the LGC magazine last October, just highlighting this. MHCLG's opinion is that the doctrine of implied repeal applies, and this is essentially that where a piece of legislation conflicts with an earlier one, the later legislation takes precedence. So, in MHCLG's view the exit cap regulations take precedence over the members' right to an immediate payment of an unreduced pension under the LGPS regulations, and they think that where the cap is exceeded administering authorities should pay reduced pensions to these members or provide them with a deferred benefit, which they can take later, and the employers should pay the employee a lump sum equal to the amount of strain cost they're able to pay under the £95k cap, and this is called a cash alternative payment.

 

So, instead of paying the strain to the pension fund because they can't pay that, they would pay a lump sum to the member themselves up to the £95k cap limit. However, the scheme advisory board to the LGPS in England and Wales obtained council's opinion, which states that, that, that they don’t think implied repeal does apply, and that if LGPS administering authorities do-, authorities do not pay immediate pension benefits without reduction to these members there is a high risk of challenge. The board's advice is for LGPS administering authorities to pay an immediate reduced pension or offer a deferred benefit, and for the employer to delay payment of the cash alternative until the legal uncertainty is resolved, and they've recommended this on the basis that it minimises the financial risk to both employers and administering-, and administering authorities, because whatever the outcome they will not be in a position of trying to recover payment from members. Now, the, the legal uncertainty is, and we've all thought it, it's going to be brought about by a challenge to the regulations. Initially we thought this might come from a member complaint reaching the pensions ombudsman who would then make a determination, however, on the 22nd December three requests for judicial reviews were granted permission to be heard.

 

They were from a combination of unions, the lawyers for local government and ALICE, which is a representative body for local authority chief executives. Because of this the pensions ombudsman is prevented from making a determination on a complaint, on a-, from a scheme member on the exit cap. The applications for judicial review include a total of £16,000 and they cover the legality of the exit cap regulations themselves, the questions of their impact-, of the, their impact before the LGPS regulations can be amended, and the status of the directions which accompany the regulations and set out the waiver process, and the judicial reviews will all be heard together on March 24th or 25th. So, it seems it's going to be a little while before this legal uncertainty will be resolved, and we understand that because of this MHCLG are now minded to delay bringing in their regulations, which will change the LGPS rules to accommodate the cap until the outcome of the judicial reviews is known, so we're stuck with this legal uncertainty for a little while at least. So, when MHCLG consulted on the regulation changes to amend the rules to accommodate the cap, they also consulted on further changes to local government exit pay, and, and the proposed changes that they're planning to reduce will limit the amount of discretionary compensation pay that can be paid to all employees, and provide that where employees aged 55 or over leave due to efficiency or redundancy they will be-, they'll be provided with more choice.

 

So, so as we've said, the, the, the proposals will accommodate the cap, and they will do this by allowing an employee to take a partially reduced pension, where the employee is not able to pay a full, full strain cost because of the cap, or they'll be able to use their own funds to lower the reductions to their benefits, and they will also have the option to not take their benefits at all immediately, take them at a later date should they wish to. Where the employer pays the strain cost payment, the employer-, the proposal suggests that the employer will have-, will no longer be entitled to also receive a discretionary compensation payment, as they are now, except in the rare cases where the discretionary compensation payment exceeds the strain cost, and finally, but probably most controversially, if the employee is entitled to a statutory redundancy-, to statutory redundancy pay, the strain cost the employer can pay is reduced by that amount of statutory redundancy pay. This means that under the new proposals a member's pension will be reduced even if the cost of their exit is below the £95k cap. However, the member could elect to give up their statutory redundancy pay in exchange for an unreduced pension should they choose to. As with all consultations, these are just proposals at the moment, and we don’t know what form the regulations will take once they are enacted.

 

We understand that MHCLG received around 700 responses to the consultations, with many of those commenting on the inequity of reducing the strain cost if a redundancy payment is payable. So, there's a lot of uncertainty ahead, and it's really difficult for employers who are trying to plan workforce reform at the moment. We have heard that some employers have been putting off redundancies, hoping that the MHCLG regulations will be introduced before April and therefore this legal uncertainty will be removed. However, it seems that their judicial reviews have put paid to that, so it looks like the, the situation will not be resolved in the short-term at least. And finally, this slide here just mentions some of the other issues that are on the horizon and likely to impact on the LGPS. These include pension dashboards, which will allow users to see all their pension benefits from all providers, including the state pension, in one place. Although implementation has been delayed until 2023 administering authorities will need to start work to make sure their data and pensions software systems are dashboard-ready.

 

We understand there are also likely to be more changes to LGPS survivor benefits as a-, as a result of another legal challenge, and this may require more backdating of survivor pension benefits, which is the situation that administering authorities found themselves in a couple of years ago, and finally we understand that administering authorities may need to make changes and, and revisit transfers out previously paid due to yet another legal challenge, this time in relation to GMPs, which are guaranteed minimum pensions, which are really quite complicated, and I'm not going to bore you with the detail now, but it's basically how the LGPS used to interact with the payment of the state pension benefits before 1997. So, there's lots of work ahead, lots of uncertainty, and lots for administering authorities to do. So, that's the end of my update. I'll be happy to take some questions at the end, but for now I will pass over to Bob, thank you.

 

Bob Holloway: Thank you very much, Lorraine, and good morning to everybody.

 

Bob Holloway: While there's no doubt at all that issues like £95k cap, McCloud, pension dashboard and Covid-19 are probably uppermost on most of your minds at the moment, we shouldn't forget that there's a huge amount of work looming on responsible investment. So, what I'd like to do over the next ten minutes or so, let me start my timer, is to go through very quickly-, this is going to be a bit of a gallop, I'm afraid-, the work that the boards have been doing on responsible investment, and it really consists of two main strands. So, let me first of all talk to you about the soon-to-be-established responsible investment advisory group. When we met a few weeks ago, the bought investment committee agreed the names to populate the responsible investment advisory group. So, we have a number of representatives. I can't name them yet because this is going to have to be approved by the scheme advisory board when it meets on the 8th February, but we had representatives from administering authorities, from pool companies and partnerships, asset managers, special interest groups, consultants on a rota basis, PLSA. So, a very wide-ranging group of people. Now, the board will have two main functions. One of those functions, which I'm going to perhaps expand on in a minute, is to act as editorial board for the, again, soon-to-be-established A to Z online responsible investment guidance. The main other function it will have is to act as advisory board to both the bought investment committee and to the board itself. So, a lot of work involved there, and my guess is that the first real major chunk of work the board will have to advise on is that the soon-to-be-expected public policy consultation from MHCLG on TCFD reporting. We know that there are regulations afoot to require private sector schemes to report on TCFD, and the government and MHCLG have made it perfectly clear they expect the same to be for the LGPS.

 

So, a major chunk of work there for the new responsible investment advisory group to advise the board on how it should respond to that particular consultation. The next really major chunk of work the board's been doing is on an A to Z online guidance on responsible investment. This is going to be a, a major piece of work. It has been approved by the scheme advisory board and the investment committee, and as we speak, we have a web design team that is well into the project. We are expecting to see a online live version of this at the end of January just for internal review purposes. So, we'll have a look, make sure everything works. We'll then spend February working with the project team to populate the underlying SQL database with the intention of it going live we hope sometime towards the end of March. Now, this is going to be a dynamic and hopefully a very lively database. The first version of the database online you'll see is what we have populated at the secretariat. So, we have pored over all sorts of websites, we've asked administering authorities to let us have their case studies. So, it's very much a sort of place holder to start with. The intention is that over time, perhaps over the first five or six months, the database will become more and more up-to-date and more and more topical. So, how are we going to achieve that? Well, we will give certain parties, in particular administering authorities, direct, direct access to the underlying database, so they can populate the database themselves with their own case studies. Other parties will have the facility as part of the online website to feed in ideas in, on how they would like to see the content grow. So, there could be examples of case studies. There could be new organisations that we haven't thought of. These will then go to the responsible investment advisory group who will then recommend to the scheme advisory board on a regular basis the content that should end up on the responsible investment advisory group's website.

 

So, the, those are the two main strands that we're working on. A couple of other things that are related to that. I briefly mentioned TCFD reporting. So, that, this is going to be a major chunk of work, but we can't really get into that until we see MHCLG's consultation. The other area of work which some of you will be aware of-, you may be aware that the LGPS all-party parliamentary group has just launched an enquiry into just transition. So, this is very much being led by the LAPPF, and it's the idea that in transitioning from, so, a non-green economy to a zero-carbon economy, that we, we shouldn't leave, sort of, communities, jobs and people stranded. We should-, everybody should benefit from that just transition to a zero-carbon economy. That enquiry will run till 30th April. We will be considering, when scheme advisory board meets on 8th February, the extent to which scheme advisory board should respond to the enquiry. I've had a couple of feelers from fund authorities that think that, that they should, and I fully suspect that that'll be the case. Again, this is where the, this new responsible investment advisory group can come to the fore in recommending to the scheme advisory board how it should be responding and the ways in which, in particular, investment decision makers in the LGPS actually can contribute to this just transition. That's really all I want to say on responsible investment. If I haven't covered anything, or if there's anything you want to ask, please do use the Q&A session below and we can do our level best to answer the questions when we come to the end of the sessions. I just want to spend my last couple of minutes talking about new employer flexibilities. These are flexibilities that came in to the scheme regulation in September, and it's really about better managing the ESIC gateway for those employers, who-, this is a bit of a cliché, I know, but who can't afford to be in the scheme but can't afford to leave the scheme. So, there are three sort of weapons, if you like, in the armoury.

 

There could be a review of employer contributions mid-term between final valuations. There can be a debt-spreading arrangement, i.e., that's the exit payment spread over a period, or that debt can be deferred to a point in time in the future. MHCLG are working on statutory guidance to assist admin authorities and employers. Scheme advisory board is also working on guidance which is more operational, more detailed. Now, the purpose of these two sets of guidance really is to try to strike a balance. The LGPS is, is a maturing scheme and if too many employers leave across the piece, then that does impact on funding. It does impact on cashflow, so this needs to be a measured approach. It, we can't afford to open the floodgates and let everybody leave the scheme, so it has to be right, and has to be right both for the employers who want to leave the scheme but also right for those employers who are left in the scheme and can't afford to pick up those outstanding liabilities, and also good for the fund as a whole. So, it's about really serving everybody's purpose. Once these guidance goes out, hopefully, we're now thinking about probably mid-February, we'll also continue to monitor the position. So, I think it's very, very clear that we need to keep a watchful eye on how these new flexibilities are working. Anecdotally, we understand that there are some employers who think, under the impression their administering authorities won't even exercise or won't even consider operating the new flexibilities, which is slightly worrying. So, yes, we will be monitoring how the new flexibilities are working over a period of time. I, I'm now, sort of, going to finish there because we're very keen to end on time. So, I'm now going to hand over to Catherine McFadyen who's going to talk to you about the Good Governance project.

 

Catherine McFadyen: Good morning everyone. I hope you can hear me and I hope you can-, you can see the screen okay. As, as Bob said, I'm just here this morning to provide a, a brief update on how the Good Governance project has been progressing. We have-, we have still been making progress over the last year or so, although it has been slowed significantly by, by, by Covid and, and, and some of the other projects and things that have been mentioned this morning, we, we've definitely had other demands on stakeholders' time that, that have meant that, that progress has been slower than was first intended. However, the implementation group has been working hard over the last few months. We've been collecting information and, and feedback from lots of, of different stakeholders, and we are preparing papers-, working hard on preparing papers just now to take to that scheme advisory board's meeting that Bob mentioned earlier on 8th February. So, I thought I would take this opportunity this morning just to remind you briefly of the, the scope of the Good Governance project, the areas that it's looking at and that will be included in that report to the scheme advisory board. The slide on the screen shows some of the, the areas that were highlighted for attention in the phase one and phase two reports. Those reports are available, I think, on the scheme advisory board website, but also at the links shown on the slides there. So, as the-, as the graphic on the slide shows, the, the, the, the groups that worked on, on phase two in particular recommended a senior LGPS officer-, so this was really someone who, to take overall accountability for the delivery of the LGPS function, and the groups have worked hard on explaining what that role is and, and, and what the role will, will be and, and specifying the detail of that. The, the, the working group's also recommended that we have an enhanced governance compliance statement, where much of the change and much of the recommendations out of the phase one and phase two will, will effectively be reported and recorded, and also that all of this would be enacted through changes to the statutory guidance on governance of the funds.

 

We have been engaging with MHCLG throughout the process. MHCLG, as you'll be very aware, are quite stretched for resource just now, as well, dealing with some of the, the issues that have been touched on this morning, but we are still working with them and talking to them about when, when resource might be available to, to take this forward after it goes to the scheme advisory board. The next phase would, would be a, a, a wider consultation. So, just to touch briefly on the areas that are included. So, one area that was highlighted was how the LGPS manages its conflicts of interest, and this wasn't really talking about, kind of, conflicts of interest for, for specific individuals that, that are often declared at the start of committee meetings. This was really talking about how the LGPS administering authorities address the conflict that's inherent in the fact that, that some councils are playing a, a dual role of both being administering authority and an employer in, in the fund. So, really asking for just some clarity and visibility on how those tensions are, are, are managed and resolved. The other area covered was representation, and this is really addressing who has a seat and a voice at the appropriate governance bodies and committees. So, we already have a very structured pension board representation, but this was looking at the role of other employers in the fund, not the administering authority. So, other councils and other employers which, which may include academies, other higher education bodies, and, and third sector employers that participate, how their views are represented and taken into account in, in the governance of the fund. The third area considered was, was knowledge and understanding, and this was really making sure that everybody who's involved in the governance has the right level of knowledge and understanding to help them undertake that role. So, this really looked at particularly the role and the, the training that's required of committee members.

 

That would include elected members of committee, but also those who, who may represent some of the bodies that I mentioned earlier, the, the employer bodies, and making sure that they have the right level of knowledge and understanding to be able to, to perform the role that, that they're being asked to perform. It also looked at the knowledge and understanding of, of officers who, who have a role in the LGPS as well. So, particularly looking at Section 151 Officers and also finance directors of other councils or other participating bodies and making sure that they've got enough of a working knowledge of the LGPS to, to allow them to participate effectively in, in its governance. The final area that was touched on as an area to, to look at was the oversight of, of the service delivery, thinking about things like the business planning process, how, how it's decided, how much money the, the fund will spend each year in order to deliver its service and what it will spend that on, making sure that that process is transparent and, and goes through-, goes through the appropriate governance arrangements. So, those were the areas that were touched on, and then at the bottom of the screen, the last two were, were looking at the kind of oversight processes for that and the phase two report recommended an independent governance review of each of the funds, and also recommended that it might be appropriate for LGA to consider extending the peer review process that I believe is available for other areas of local government to, to allow something specific for the LGPS. So, those, those were the key areas. The phase three implementation group has been focussed on some of the, the, the trickier areas of that to, to, to implement. A lot of work and a lot of feedback and a lot of conversations around developing and specifying that senior officer role.

 

Also, the phase two report, as part of the service delivery recommendations, asked for some KPIs, so we've done quite a lot of work on that, and then, the, the other area that a significant amount of effort has gone into is looking at what a new governance compliance statement might look like. So, taking what was in the existing statement and adding in the, some of the areas that, that, the, the project recommended were enhanced to pull it together into, to one document. Just now, sorry, we are still, still working on the independent governance review process and pulling together some of the implementation recommendations from that, looking at exactly what form the training requirements might, might be, and, and specifying that and also going into some more detail on, on the guidance on the, the type of conflicts that administering authorities might see specifically and asking what's in place to, to address them. So, these are the, the areas that we're working on as we pull together the final papers. Just a, a quick note on that timeline. So, we've spent November and December collating some input. We are very busy just now drafting those, those papers for the scheme advisory board in a week or so, and that we, we hope to be able to take those papers to the scheme advisory board at its meeting in February, and thereafter, it, it, it really is for the scheme advisory board to, to make their recommendations to, to MHCLG. So, that was all I was going to say this morning. I think it's my job to hand back to the chair.

 

Moderator: Hello. Yes, we're to have our question session now. Thank you, Catherine, Bob and Lorraine. So, I'm going to hand over to Rachel who's going to put the questions to you. So, I've also just sent a little message to everybody to say that you can upvote questions you would like answered by clicking the little thumbs up icon next to the question, but I'll just hand you over to Rachel and the panelists. Thank you.

 

Rachel: Perfect. I hope you can all hear me. Thank you very much for the questions you've put in. I've tried to answer some of them as we go along, but plenty of them coming, and I have to say, Lorraine, you're very popular today.

 

Lorraine Bennett: Oh dear.

 

Rachel: Always. Shall we start with McCloud? We've had a couple of questions about resourcing. So, from what you know, what do you think the-, how prepared are funds for McCloud? How much resources are they making available for this what's going to be a huge project?

 

Lorraine Bennett: I think it's probably a mixed picture. As I've already mentioned, the LGPS is administered by 87 different administering authorities in England and Wales, so some, some are probably more ahead than others. I am aware that some funds are looking to recruit new, new staff and they're looking at that at the moment. Of course, recruitment is a bit difficult in the current climate, so, but yes, I would say it was a mixed picture-, a mixed picture. Some have already done some analysis, as, as I mentioned during the presentation, of how many members they think will be impacted and are starting to prepare for that recruitment, and, and some are probably not, not quite so well advanced.

 

Rachel: Moving on to the exit payment cap, obviously very high on people's priorities at the moment, you've talked about some of the legal challenges we already know about. Are we expecting any challenges on the grounds of age discrimination? Potentially, maybe, related to the cash alternative, and also, are the, the grounds that the current judicial reviews, are they available to people to see at the moment?

 

Lorraine Bennett: The, the grounds, we believe, are in the public domain from the various applicants, and those grounds are on a-, I think I mentioned some of the grounds during the presentation. Some are on the grounds that the, the exit cap legislation is unlawful. One of them is because it's not made under the right part of the act. One is that-, another ground is that it, the exit caps extinguish contractual rights that shouldn't be extinguished, and accrued pension rights. So, there, there are various grounds, and some of the grounds are equality issues, in equality grounds. I'm not aware of any challenges on age discrimination, but I can see how that-, how that could be applied.

 

Rachel: There's someone else asking about whether the LGPS is differently affected by the, the cap than other public sector organisations because of strain costs. So, do we know whether any other public sector pension schemes include strain cost, and if not, are members of the LGPS being unfairly penalised with the introduction of this change?

 

Lorraine Bennett: The other public service pension scheme would have strain cost, so they would calculate the cost of an early retirement and those employers would need to pay that to the respective schemes. However, the difference, probably, why the LGPS is more impacted is because in the LGPS members have to take payment, under the current scheme rules, of their pension benefits if they're made redundant or retired on business efficiency grounds if they're over age 55, and that is not commonplace in the other public service pension schemes. So, that's why the LGPS is more impacted than others, but yes, strain costs are payable in other public service pension schemes, too.

 

Rachel: We've had one question's been upvoted, so I have to ask it to you. Who can employers turn to in order to get advice on their exit package choices?

 

Lorraine Bennett: We would say probably get legal advice. We have put out some, an information note for employers which is available on our administrator website, and that takes you through the steps that we think employers should follow and points, points employers to the MHCLG's advice and the scheme advisory board advice. That's available on LGPSregs.org, but if they want specific advice on how to deal with individual exits, then I'm afraid that, that's more likely to be legal advice.

 

Rachel: Give Lorraine a break for a minute. Bob, we had a couple of questions asking what TCFD stands for. We've answered them in the chat, but it might be worth just explaining a little bit more rather than just, you know, the acronym.

 

Bob Holloway: Yes, this is the Task Force on Climate change Financial Disclosures. This is a body that's been in existence for a number of years now, and it's really taken off big scale in terms of the private sector. They'll be required to report against TCFD recommendations. This is really-, it's around transitioning to a green economy, and it's about reporting the actual cost of climate change risk. Now, the LGPS at the moment isn't subject to the same regulations that would be imposed on private sector schemes very shortly, but as I said in my, my introduction some time ago, the government and MHCGL have made it perfectly clear that LGPS administering authority will be subject to the same sort of broad requirements of reporting, but in a way that sort of suits the LGPS, which will be different from a lot of private sector schemes. So, it won't be identical to what private sector schemes are having to report on climate change risk and financial disclosures. We are expecting this policy-, it will be a policy consultation. It won't be a consultation on regulations. We're expecting that from MHCLG shortly, so again, this is another watch this space and I'm afraid more work for you all to do.

 

Rachel: Now, this question is not that specific, but hopefully-, it came in at 10.32, so I think it's one for Bob. So, should administering authorities implement applications from employers ahead of statutory guidance coming out?

 

Bob Holloway: Yes, I'm a bit-, yes, I'm not sure whether application is, is, is the right word to use here, and in fact, the, our, the scheme advisory board guidance does go into great detail on how the sort of process kickstarts. How do reviews, how does the deferred debt agreement or the debt-spreading agreement begin? I think my advice at this point is to-, is to wait and see. I think if, as an administering authority, you get requests or applications from the scheme employer, I would say just acknowledge at this stage, just to say you've received it, but then make it quite plain that you won't start any consideration of that application or request until you've seen both sets of guidance. The original timetable was for them both to be published at the end of January. I think that's going to slip by a few weeks, so we're probably talking about mid-February, I would hope, and touch wood, but I think both as an administering authority and as scheme employers, I think you really do need to look at this guidance in quite detail before you start thinking in any sort of great detail about the way in which applications might go.

 

Rachel: Thank you very much. So, moving on to Catherine, I have to say these ones I have not vetted yet because they came in as of pretty much the start of the questions. So, do you see a role for, for the independent member of the local pensions board in these new governance proposals?

 

Catherine McFadyen: For the independent member of the local pension board? So, the, the, the governance for the pensions board was, was, was set out in the-, in the public sector pensions act, so nothing that, that we're doing here really touches specifically on the role of the pensions board. We're, we're, from, we're looking at, at the other elements of governance, but I think what, what has been clear as we-, as we've gone through this is that different, different administering authorities have, have interacted and worked with their, their pensions boards in different ways, and some of the earlier reports tried to capture some of the, the kind of best practice or some of the ideas and, and, and some of the successful ways of engaging. So, we're still keen to share some of that as part of the best practice, but the scope of this is focussing on other elements of the governance.

 

Rachel: One question's come in from anonymous. Why add another level of bureaucracy by introducing an independent review process? Is that not what the pension boards are supposed to do anyway?

 

Catherine McFadyen: So, this was a recommendation that came out of the-, of the phase two part, and I-, and I think a lot of this was about-, the project has, has tried to be as light touch as possible, and really it's tried to set out what is existing best practice and, and tried to encourage everyone to, to aspire to what the existing best practice is, and that was very much the, the focus of the, the conversations during the working groups. However, there, there were-, there were those who were saying, 'Well, that's not good enough because those who are good will, will still be good and will continue to, to seek out best practice. We need some kind of mechanism for that, that so what (ph 48.26) piece to, to ensure that we are raising the bar for, for everyone.' So, the, the independent governance review process is really-, is really part, part of that, and again, the, the, the, the, the working groups were trying to be as pragmatic as possible and, and introduce something that has, is kind of, as, as, as little of a burden as it can be while still achieving that goal of making sure that we are applying the best practices across the board.

 

Bob Holloway: I think it's also important to point out that this independent review really is a tool for the scheme advisory board to monitor how standards of governance and administration are improving across the scheme. Of course, there'll be a lot going on at individual admin authority level in conjunction with their own local pension board, but the scheme advisory board is very keen to monitor how things are improving across the whole scheme, and that independent review would be part of that process.

 

Rachel: Sorry, I'm just going through to see if we've got any last-minute questions that have come in. So, one more general, whoever wants to pick this one up, so, turning back to the point of the Covid-19 and the impact of working remotely, how do we seek to ensure that remote access works well for those members who have limited ability or means to seek such access? Anyone?

 

Lorraine Bennett: Could you-, ask-, is it about staff or members themselves, or-, sorry, I couldn't-,

 

Rachel: Members. So, I assume, yes, keeping-,

 

Bob Holloway: Are we talking about scheme members or electing members?

 

Lorraine Bennett: So, scheme members, okay. Scheme members.

 

Bob Holloway: Scheme members.

 

Lorraine Bennett: Okay. Well, I, the pensions regulator has mentioned this in their advice, that pension schemes should make sure that their communications reach all members. So, not just do everything online. Where people aren't able to communicate electronically, they should make provision for that. So, administering authorities should be looking at that and making sure that they're getting through to everyone and those members who, you know, who can't access information online or via email.

 

Rachel: I think we're pretty much out of time, as Carl has popped up. We've had a question, the last question, about ESG, but just to let you know, our next session is about that so I'm not going to answer that one now. We'll come back to it later on. Pass on to you, Carl.

 

Moderator: Thanks so much, Rachel, and thanks to our three speakers. Really interesting presentations. We are going to take a break now until 11.00am, so I'll just put a break sign up there and hopefully see you back sharpish at 11.00, and we'll hear from Atole Schin (ph 51.06) and Joshua Kriskinans from Ninety One at that point. Thank you.

 

Joshua Kriskinans: Sure. Thanks very much, Carl. Carl, can I just check that you can see the slides and everything's clear?

 

Moderator: Yes, I can see them. Yes, no problem.

 

Joshua Kriskinans: Okay, thanks, Carl, and morning, everyone, and thank you for joining us. So, I, I'm Josh Kriskinans and I work as part of the LGPS client team here at Ninety One, where we manage around £100 billion worth of assets on behalf of our clients, and actually around 40% of our UK book of business is managed on behalf of LGPS pools and partner funds. I'm pleased to be joined today by my colleague, Atole Schin, and Atole, do you want to quickly introduce yourself now so that people know you're on the line?

 

 

Atole Schin: Morning, thank you, Josh. Yeah, my name's Atole Schin, I'm part of the multi-asset team within Ninety One, and I spend a lot of time with portfolio managers who invest in environmental solutions.

 

Josh Kriskinans: Thanks, Atole. Great, so I mean, firstly important to point out we are really, really delighted to be sponsoring the LG fundamentals training programme again this year, which we have done since 2003, and it's great to see so many of you on the call today, I think we've got about 200 on the line, which is great to see. For those of you not familiar with Ninety One, you may previously have know us as Investec Asset Management, and since March of last year there's been a few changes on our end. We've lost our zebra, we've demerged from the broader Investec group, and I'm delighted to say we've successfully listed as an independent asset manager, Ninety One. We've changed our name but we are very much still the same business, still run by our founding members, proud of our emerging market heritage, and deeply committed to sustainability, and we're really excited about the journey we're on, and the LGPS community continues to play a huge part in that as we move forward.

 

So, in the first session, Lorraine, Bob, and Catherine provided updates on the McCloud and exit payments, updates from the scheme advisory project, and the good governance project, which leads really nicely into how ESG impacts the investment that LGPS schemes make across the country. Atole and I have a 40 minute presentation for you today, split broadly into two sections, so I'm going to take the first half, run through some ESG technology and do a bit of jargon busting, and run through why it's important for the LGPS to consider ESG, whether that's ESG integration or various other things, highlight a quick case study, and also flag a few things it's important to keep an eye on over the coming months. We'll finish by taking a look at why ESG presents both risk and opportunity for investors, which hopefully dovetails quite nicely into the-, into Atole's presentation on climate change. So, I wanted to kick off by highlighting three key takeaways from my part of the presentation today. Number one, ESG is crucially important, and remember, the primary responsibilities of local authority pension funds are to pay members' pensions, so your fiduciary duty is members of the pensions board and pensions committees, are to do so. The risk to the schemes and investment can arise from a number of factors, some common ones like inflation and interest rates, but also ESG is definitely one that we should be considering when thinking about risk to the pension fund, it can affect the share price of the companies you invest in and, and in turn the scheme's investments on, on behalf of members.

 

Number two, I would really encourage you to challenge your investment managers on ESG integration. Can they show you that they're taking ESG factors into account when they're making investments? If they can't, they might be doing something that we call greenwashing. What I mean by that is giving you a false impression that they take ESG seriously. Some managers might be talking to the talk, but they really need to be walking the walk as well and integrating ESG throughout their investment strategies. Number three, I think it's important to raise that ESG factors present both risk and opportunity. Whilst ESG can and does provide risk to the funds that you all run respectively, with governance around the world looking to pursue a green and sustainable recovery from the Covid pandemic, now more than ever we're presented with opportunities to really make some money from some sustainable, sustainable investing themes that are arising. So, let's kick off with what we really mean by ESG, and this is very much starting with the basics. I've used MSCI's categories, MSCI are, are a rating agency, here, to give you types of-, an idea of the types of issues that crop up underneath the three banners E, S, and G. Firstly, the E is environment, it's probably the most talked about, I would say, especially in the last twelve to eighteen months, of all the three, given various net zero commitments from government around the world, Joe Biden in his first day in office in the White House even rejoined the Paris Agreement on day one.

 

So, as a reminder, the Paris Agreement is the international treaty on climate change, which has the goal of limiting global warming below two degrees. Other things to consider under the E banner are whether companies are taking into account their environmental impact, what is their carbon footprint, are they polluting, or maybe using finite resources. Second thing is S, where we look at social factors. So, do the companies work with suppliers that hold the same values, do they look after the well-being of their employees, or are they interacting with the local community? And very much from the LGPS' perspective, you do loads of great work in and around your local areas, so, so the S is often a big focus for the LGPS, I would say. And finally, G, so governance considerations, for example does the company have a diverse board of directors, is it well structured, or for example, do they operate a structure with an independent chair as well as the CEO, or is that one in the same,person, 'cause that might, might raise some concerns. Executive pay is also a common topic to engage one-, underneath the governance, governance label.

 

So, moving on through the, kind of, terminology and jargon busting section. So, divestment versus engagement is a hot topic of conversation in ESG and will continue to be so. Different funds will definitely have different approaches to this across the LGPS, to spend-, depending on a variety of different things, and looking at your investment strategy statement will again, will be a great place to start to build up your own understanding of your fund's approach this issue. You can find this online with your annual report or the governance compliance statement, they're usually all saved in the same space, so take a look, take a read through, and try and familiarise yourself with some of the, the kind of, the key features of your ESG and engagement philosophies. There's often strong pressure to divest in fossil fuels and other-, from pressure groups. I know, for example, Greater Manchester Pension Fund, a client of ours at Ninety One, have actually had members of Extinction Rebellion chain themselves to their offices in protests about not disinvesting today from fossil fuels, and actually they would choose, like we would at Ninety One, to engage with these companies over the long term, and try to enact some change. At Ninety One, as I've said, we really believe in the power of engagement in order to preserve and grow value for our clients, and these engagement can be held over the short medium and long term, over a variety of different areas, that they can resort in real benefits to society and the businesses themselves.

 

These engagements can span across a range of issues, from diversity to executive pay, to climate change, and, and the really-, the opportunities to engage are endless, really. Different industries will often have different themes for engagement. So, for example, a lot of engagements at the moment with big tech companies around data privacy or engaging with oil companies such as Shell or BP on their respective commitments towards renewable energy, and that is likely to continue. So, finishing up on this section now, so-, and another common theme you're likely to come across, especially increasingly as-, as these strategies come to light, is impact investing, and increasingly LGPS funds are looking to take their next step from ESG integration and looking to make positive impact with their investments. We'll go on to look at ESG integration a little bit more closely in a second, but simply put, ESG integration is ensuring that your investment managers have analysed risks and opportunities from ESG and really included them and taken those considerations throughout the investment process. So, if we take that a step further, with that in mind, and take that forward to impact investing, I would say there's three key things to consider when differentiating the two. The first is intent, and intentionality is really, really key here. The investment-, if impact investments are to have impact, they need to set out to achieve a goal at the start. This could be investing positively to tackle climate change or into social housing products, for example.

 

Second, contributions. So, these investments need to be making a valid contribution not the overall achievement of that goal, so, 'is my electric vehicle company actually making a contribution to a net zero world,' for example. And finally, you need to be able to measure the impact these investments are having. So, this will vary form type to type, but its' really important to be able to measure progress and, in, in a number of these areas. Before we move on, a few other things to note, I think, to kind of highlight some important points. So, impact investing doesn't mean that you have to sacrifice investment returns, very often impact investing can be made in areas of real structural growth and actually enhance your investment returns as well, as well as having impact. Impact investing can also be achieved through public and private markets, so whether that's holding shares in listed equities, so holding shares in companies focussed on the stock market, or having direct investment into private markets, areas include wind farms, for example, if, if you're focused on having climate impact.

 

And finally, as the age profile of LGPS funds change, like all other pension schemes around the UK pensions industry, you're likely, likely to see increase demand for impact investments. I mean, I, I know millennials and, and then that era are often very, very focused on impact, and it's, it's really a hot topic within the younger cohort of pension scheme members, so it's important to try and, kind of, listen to your investment consultants when they're talking about impact investments and just try and build out your understanding slowly as different-, different options get put in front of you.

 

So, hopefully that sets the scene nicely in doing-, doing a little bit of jargon busting, and I think it's important to understand for you why ESG is so important for the LGPS. We've already mentioned that this is part of the fiduciary duty of, of local authority pension funds, to pay members' pensions, so really, really important to be aware of any risks to the scheme. ESU factors can have both positive and negative impacts on, on the scheme's investments, and we'll go on to look at one of the negative examples a bit later on. Catherine talked about knowledge and, and understanding this morning, and as of 2016 it's been a regulatory requirement for schemes to acknowledge ESG issues in your investment strategy statement, and that very much falls under the knowledge and understanding bracket, and these documents really are, I know I said earlier, but they're great places to come and, kind of, boost your knowledge on, on our scheme's approach to these, these issues. I've included a screenshot there of a London, or of Southwark's pension fund statement, and they're very much looking to reduce their fossil fuel exposure, and take a nice approach in splitting that out into short, medium, and long-term goals. So, making it quite easy to digest. There's also significant reputational risk. So, we're increasing being, as an active manager, asked for various freedom, freedom of information requests, whether that's about aerospace and defence companies or climate, climate-considered holdings. So, again, continual focus and scrutiny on the LGPS around the reputational risks of holding certain investments.

 

And finally, pooling. It wouldn't be an LGPS presentation without mentioning pooling, and pooling very much offers, especially for the smaller funds, operation-, opportunities, sorry, for collaboration and engagement. Large pools of assets behind engagements are very often more powerful and have great impact. These big companies are much more likely to listen when you have big pools of assets behind these engagements, and the LGPS really are leaders in this space, challenging companies like Glencore and more recently HSBC on their climate initiatives.

 

So, moving on to ESG integration. As I mentioned at the beginning of the presentation, I would really encourage you to challenge your investment managers on how they're integrating ESG throughout their investment processes. Can they prove it's integrated at each stage of their investment process, are there meaningful outcomes from engagements? These are all the kinds of questions you should definitely be asking. And really, ESG integration is, is important right from the start. So, is it considered in the universe of countries or companies that your investment manager looks to for ideas, do your managers include it in their company analysis, are they active owners of the positions they hold in the portfolio, do they engage with companies, and this, this should all be reflected in the final portfolio, and risks should always be sized appropriately. So, if there's a risk to investments and ESG is one of those risks, then maybe a smaller size in the portfolio is, is worth having. High-quality integration also means understanding sustainability risks, as well as pricing those risks appropriately. We call these risks negative externalities. It's about understanding if these externalities are reflected in the share price of the companies that you invest in, or we invest in on your behalf, and it's a role of us as investment managers to understand these risks and communicate them to you. Your investment consultant should also be a strong partner in this exercise and very often consultants will give ESG ratings for various strategies that they buy rate.

 

One last thing to point out on the ESG integration is different asset classes very much pose different challenges for investors, so if you hold equity in a company, if you hold your own shares, it can be much easier to be influential on engagement, and this is a lot more difficult in fixed income investment, where you're lending money and not holding shares in the business. Lothian Pension Fund, one of the Scottish pension funds in the LGPS, have a nice way of phrasing it, saying, 'Engage on equity,' is engage when you're holding shares, and look to deny in debt if you don't believe companies are, are pulling their weight on ESG. So, a very quick case study on Volkswagen. This is one that a number of you, I'm sure, will have heard of, which happened back in 2015, and quite a famous example of how ESG risk can very quickly become financial risks. You can see there, on the-, just before the graph falls off on around September 18th that the Environmental Protection-, Protection Agency actually announced fines against Volkswagen for cheating on their emissions testing for diesel vehicles. The share price quickly dropped 15% on the back of this news, there were New York law firms involved, class actions, Volkswagen then went on to confirm that 11 million of their cars worldwide actually included this defeat device in the software, which meant that they could report up to 40 times less emissions in their vehicles. The share price fell again, falling from around 170 at its peak to nearly down to 100. So, you can see the huge impact that this ESG news can really have on companies, and the CEO ended up resigning a few days later.

 

So, it's really crucially important for investment managers to integrate ESG considerations, but also important to flag that these can often be very hard to spot and hard to find if, if fraud is, is, is taking place behind closed doors, and sometimes these can come of surprises to investment managers. So, last couple of slides now from me before I hand over to Atole. What to keep an eye on in the coming months, so as ever, rules and regulations are continually increasing, both for the LGPS and also for pension funds across the industry. The SFDR, so that's the Sustainable Finance Disclosure Regulations, is one that you might hear about, and the-, and the EU taxonomy. Now, the EU taxonomy applies to countries within the EU, so that obviously Brexit has had an impact from our perspective there. You may also have investment managers that operate outside of the UK, so that could be a consideration, but what's, I would say, the one piece of info that's important there is that the UK will largely follow a similar approach in the coming months, taking sensible parts of the EU plan and-, and apply those. And SFDR is really broadly, as a lot of these things are, about increasing disclosure and information for people around sustainability. TCFD, so as Bob mentioned, that's the Task Force of Climate Related Financial Disclosures, that-, that very much started in the private sector, and us, at Ninety One, as a business will be releasing our own TCDF report later in 2021. Private sector schemes will a,so have to fall in line from 2022, but the same is gonna probably come, there's a lot of work to be done for LGPS schemes going forward, so the MHCLG will accept the same for them, and I'm sure the scheme advisory board will do al to of great work in g uiding you through that process.

 

Moving on to the UK stewardship code, so again, new requirements for sustainability reports, which need to be more outcome focused. These will be-, these will be approved by the financial reporting council. Just another thing to be aware of when you hear these, kind of, phrases down the line. And finally, net zero movements continue to build, so the UK, the US, and China are all now committed to net zero, the Paris Agreement is becoming far more real, far more movements from around the-, from the different governments around the world. So, increasing regulation is, is something that you're gonna see continue, continuing. I thought Bob also made a really nice point about the just transition there, and it's a really important one to make. With all these new regulations and, and all these new laws that are coming in place, it's important to focus on not leaving communities behind, and the LGPS have always been very much focused on that, which is great to see.

 

Okay, finally, just before I wrap up, we've spent-, well, I've spent quite a lot of time discussing, looking at the risk that ESG poses, and it's important to say there are also a lot of opportunities that, kind of, arise from ESG. If you look back, looking back on 2020, it was definitely a knockout year for ESG in terms of investment performance, with ESG funds performing pretty well on the whole. This by no means, means that all ESG strategies have outperformed their respective peers, or non-ESG equivalents, but there were certainly a number of key ESG winners throughout, throughout the sector. And looking forward, if I put myself in your shoes, there's gonna be a huge amount of new investment strategies launched from various asset managers across the industry, both in public equities, fixed income, private markets, so really important to consult your investment consultants on this. Be careful in selecting the right ones, I mentioned greenwashing earlier, that's another important factor that be again considered when you're looking at new managers, are they just talking the talk or are they walking the walk in terms of the, the ESG integration or impact they're looking to make.

 

So, if I just round off before I hand over to Atole, my three key takeaways which I'd like to reiterate at the end, number one, ESG is crucially important and-, and part of your fiduciary duty as board and committee members. Number two, please do, please do encourage your managers to (mw 01.11.43) integration and watch out for greenwashing, and finally, which is quite a nice (mw 01.11.47) into Atole's session, ESG factors can often present risk and opportunity, and Atole's gonna take a closer look at climate change and why we think climate change poses both risks, but also one of the biggest structural growth trends for investors today. With that, Atole, I can hand over to you.

 

Atole Schin: Thank you very much, Josh. I think it, it's a really important topic, or-, albeit slightly ironic that it's snowing outside, or there's snow outside when we're talking about global warming, but nonetheless global warming for us is, is a really important issue, our winters aside, and what we'll talk about now is firstly we'll start off on a somewhat pessimistic note and describe how bad the situation un fortunately is, is looking, but then as Josh said, seeing what we can all do to improve things and importantly for us as investors with responsibilities to, to members etc., what we can do to, to, to benefit from some of the many initiatives that are taking place to address this challenge. If we move to the next slide after this, Josh, and this is the problem facing us all un fortunately. We are currently, currently on a trend of global warming which will be unsustainable for the future of the planet, for our children, our grand children, their, their children. This is a chart you may have seen before from the UN, the United Nations, and the red set of lines show a range of outcomes of what would happen if we did nothing to combat climate change, and their estimation is by the end of the century we'd see a five degrees rise in temperatures. The yellow set of outcomes relate to a range of possible outcomes based off current policies, and in that scenario you're still seeing a pretty meaningful increase in temperatures of about three and a half degrees. What's many less well understood is the green set of scenarios relates to what we need to do in order to keep global warming to one point five degrees, which is largely considered as an acceptable pace and level of, of global warming.

 

But that requires $2.4 trillion every year for the next fifteen to 20 years, in order to shift the curve downwards and to move to that trajectory. The problem, however, on the next slide, and there's am range of estimates as to what is needed each year, and I showed from the UN, $2.4 trillion, other sources vary from $1.6 trillion to $3.8 trillion. The problem is that the line at the bottom, the squiggly line at the bottom, is what is currently being invested into climate finance. You can see it's, it's a proportion, a small proportion of what is required at only about $500 billion. Now, you might say, 'Well, we're all in lockdown, when we were in lockdown in March and April last year there's a lot of press around carbon emissions reducing, and isn't, isn't gonna solve everything?' Well, if we show on the next slide, we would describe the benefit of those lockdowns to the global economy in terms of-, sorry, the global environment in terms of the carbon emissions were just a tiny blip. 2020 ended up being the third hottest year on record, with the first and second hottest years also being within the last five years. And this chart shows the temperature differential last year versus the average of the temperatures around the world from the 1980s to 2010, and almost everywhere, particularly in the ice cap Siberia region, there are significant increases in,- in temperature. So, I think it's clear to everyone, and particularly policy makers and governments, that this is something that we can't ignore, and so you'll hear a lot of the word 'decarbonisation,' which simply means doing things to reduce the amount of carbon that is emitted. And when we look at the prospects for decarbonisation, we identify three drivers that are key to that place of decarbonisation. The first of them is regulation and policy, and actually we find ourselves slightly in a minority of liking regulation and policy in respect of what we do. And we've certainly seen a lot of it on the environmental and climate and carbon basis in recent months.

 

Atole Schin: Last year we saw China, Europe, Japan, Korea and the UK either committing or recommitting to carbon net neutrality for the economies, ranging from ten years out to 40 years out, leaving a situation where, as we speak now, 45% of the worlds biggest emitters have committed to net zero policy in the future. This exclude the US, once, when when those policies go through, that adds another 18% or so. So, we're looking at over 60% of the global emitters committing to net zero policy. So, the regulation policy side of things is, is very supportive to this journey.

 

If we look at the next slide, technology is another key driver. Now, if we rewind ten years ago, we would maybe be all aware of the fact that many sources of renewable energy were expensive, they relied on subsidies, whilst electric vehicle batteries were also expensive, cumbersome to put together and, and not very well used. Well, the good news is because of technological advances, we've seen a significant reduction in the costs of renewables as well as electric vehicle batteries, meaning that for the majority of consumers they'd become much more affordable, and for providers of those solutions they, they're able to generate profits as a result.

 

The final driver, which is somewhat harder for us to quantify, is around consumer behaviours, and I think I'm not alone in having more of a focus on, on recycling than I would have done five years ago, for, for example. There was, I think, a worry amongst some people that the COVID pandemic and the implication of that might've stopped the trend that we had been seeing. If anything, the, the trend has continued with this, this chart for instance, it shows in Europe the number of new electric, so, the number of new auto car sales over time, and what you can see toward the right hand side is the blue line which relates to electric vehicles overtook the white line which relates to diesel vehicles. So, for the first time ever in Europe, in September more electric vehicles were sold than diesel cars. Furthermore in the UK, in December Tesla, an electric vehicle producer, sold the most cars out of any other brand including traditional combustible engine cars. So, the trend is continuing in areas like electric vehicles, and in many other places such as in investment portfolios too.

 

So, I've talked about the, the problem. Let's now talk about the solution and what that might look like. But before that, before we do that, I think it's important to take a step back and understand what we're talking about when we, when we say words like carbon footprint. And as this slide goes, goes into detail, carbon footprint is essentially the total climate change impact pertaining to all the greenhouse gases that are caused by various goods or services that, that, that we use, and it's, it's normally calibrated to, to relate to carbon dioxide to have a, kind of, common measure. So, interestingly, methane and nitrous oxide will be, will be captured in carbon footprint measures typically.

 

There's a stat there which is the average person in the UK has an annual carbon footprint of around fifteen tonnes, and we're very aware, we talk about beware of carbon toeprints, and the point we're making here is, really, and it applies not just to us as individuals and consumers but it also applies to companies that we invest in as we'll see later, you, you can focus on the very immediate things that you do such as how much you drive your car or how many planes you get, and you can calculate how much carbon you, you produce, but possible what's more important or more relevant is the, the carbon emissions that are produced by all the goods you purchase, or all the things that you use, and the next slide is a good example of that.

I don't know how many of you have a tea or a coffee, you know, at your desk as I, as I speak. And this is a somewhat trite example, but it's really to make the point that, well, when you boil, when you make a cup of tea, not many people I know measure out exactly how much water they need for that tea. You tend to fill it up with more, so that's using probably more carbon than, than you need to. But actually, if you're a fan of a latte, or if you drink your tea in the incorrect way of having much more milk than you have tea and water, then that significantly increases your carbon footprint because of the amount relating to, to milk. Now, given I said in the last slide that we capture methane within the carbon footprint, it doesn't take too much of an imagination to make the association as to why milk, milk from cows can be quite a, a, a large carbon emitter.

 

But maybe a bit more, more seriously onto the next slide. From a company perspective, when we're investing in companies, it's very common for companies to talk about these concepts called scope one and scope two carbon emissions, and a scope one emission simply relates to direct emission from, from the fuel burned on site or the vehicles that you own, so in other words, what comes out of your chimney pipes or your exhaust pipes. Other companies will also talk to you about their scope two emissions. So, these relate to indirect emissions from the generation of electricity that are purchased. However, we think looking at scope one and two alone is a carbon toeprint rather than a carbon footprint, and what really matters and often is not well understood and significant in nature is on the next slide, what's known as a scope three footprint.

And scope three footprints relate to everything that feeds into how you manufacture your goods or services, as well as we subsequently use your goods or services, the, the emissions that, that entails. And just to give you an example, a company like Amazon, its scope one and two emissions represent about 15% of their total emission. The scope three emissions are much more of, of, relating to scope three.

 

If we then take that one step further and talk about why, why that is important, you might be asking, 'So what?' Well, increasingly managers like us are assessing companies not just in relation to their, their financial prospects but also, you know, in relation to the impact they have on, on the environment and on society, as Josh talked about earlier. As with any financial analysis of looking at accounts of companies etc, when you're looking at the carbon analysis, it's really important to understand what you are looking at, and we've compared Apple and Samsung here as a really stark example of, of where there can be misconceptions or, or, or inaccuracies around carbon side of things. So, Apple, you may be familiar with, operate a business model of outsourcing different components that go into the phone to different companies. So, when they report their scope one and two emissions, they're very much focused on what they do in relation to the one and two that I talked about earlier. Whereas, a company like Samsung, they're much more what we call vertically integrated, so they don't outsource as much, they do most of the, the cooking as it were within the company. And so, their emissions are substantially higher, and you're not really comparing like for like, you're not really comparing apples and apples in this instance. So, a lot of our focus is on trying to make sure that we are comparing like for like, and that's why the incorporation of scope three is really important to additionally compare.

 

We take it one step further on the next slide, and we, we look into a concept called carbon avoided. And essentially, carbon avoided, it relates to the carbon emissions that are avoided by using a product that has fewer carbon emissions than the status quo. So, an electric vehicle, electric vehicles are a great example where the actual manufacturing of electric vehicles is more carbon intensive than a car, a standard combustible engine vehicle. However, when you actually buy the electric vehicle and operate it, the emissions that are subsequently the case are far, far fewer than if you're using petrol or, or, or diesel, So, there's a significant carbon avoided on an electric vehicle compared to the status quo.

We then combine that analysis on the next slide, Josh, with focus, with a focus on which companies are actually contributing to environment, environmental solutions, and we broadly see that as being in three categories. So, you have renewable energies, clearly a, a big part of that. Something we call electrification, so that includes electric vehicles, obviously, but other processes to, to electrify goods, services and manufacturing processes. And something we call resource efficiency, so getting more out of electricity that, that is being used, or other energy that is being used. So we combined a focus on, on these types of companies which generate environmental revenues with an assessment that they produce carbon avoided, and the result of which is a bunch of companies, over 700, which we believe are key contributors to a decarbonisation future.

I will just conclude before we open up to questions, I see there's a quite a few questions so thank you for those. I'll just conclude by, by reminding about this slide, which I think really starkly shows the challenge that we all have as individuals, but also as representatives of pools of money. It's something that we think needs to be done, but importantly this isn't charity, this isn't altruism on our part. We genuinely believe that these companies can drive structural growth in the future and can be rewarded for investors over the long term.

 

Moderator: Thank you so much for that, excellent Joshua, terrific presentation. Gonna hand you over now to Rachel, who's gonna ask some of the selected questions from the, from the Q and A. Okay.

 

Rachel: Yes, questions are rolling in very quickly, so I'll get through as many as we can. So, one of the first questions was about timing, so how quickly should funds be thinking about getting out of fossil fuel investments and also moving to funds with a low ESG rating, so about the timing of those decisions?

 

Atole Schin: Well, I, you probably won't be surprised for me, to hear, but, like, imminently, now. The, for a couple of reasons, not just for the way temperatures are, are going up and, and the impact that will have on the environment, but also, this is a trend that other investors are starting to pick up on. Now, whilst we see it as a multi year, multi decade trend, there are benefits from being earlier on, on that trend, so you wouldn't wanna wait too long.

 

Josh Kriskinans: I think, I think, also important on, on that point, actually, where you do hold positions in these companies that maybe are high on the fossils fuels emissions list, important to try and engage with those companies and, and then try and effect long term change. I mean, a, a, a lot of (mw 01.30.37) investors are very much long term investors and, and they should be considering their decisions and how they can effect change, and take a real long term view on what is a long term problem, and there's still opportunities to change companies' business models and various other things over time with the correct engagement.

 

Rachel: Sorry, I think connected with that, so, is it your view that engagement to divest is more appropriate than something, someone's asked about target reductions instead?

 

Josh Kriskinans: I think, I think the divestment versus engagement one is always gonna be one that splits opinion across the industry and people will have their own views. Our view at 91 is very much that, bar a small list of exclusions that we, we have on a company level, that actually engagement and trying to speak to these companies about their plans to transition to net zero and plans for renewable energy and other things is, is, is very much the best way to go. Clearly there is other options, and, and some funds choose to pursue the route of going down the exclusions, which is absolutely fine, and, and there's more than one way of doing it. It's just, kind of, I suppose you have to consider these on a case by case basis wherever you are, really.

 

Rachel: There's a couple of questions about concerns about batteries, and so whether electric vehicles are a good idea.

 

Atole Schin: Yeah, absolutely. I think it's, it's, it's the biggest challenge to that sector whereby the, the actual process of mining the, the, the raw materials, be it cobalt or, or, or lithium etc, can be quite intensive and there are associated ESG risks with them. And I would say that technology is getting better, methods of extraction are getting better, and, like, needless to say, in, in the selection of any related companies, you, you need to pay attention, a lot of attention to the ESG risks associated with it. More, more broadly around electric vehicles, I don't think anyone can deny that they're, they are going to be an increasing part of our future. Just to, just to put some statistics to that, last year there were around four million sales of electric vehicles globally. In our view, in order to meet a two degrees scenario in 2050, that needs to ramp up to over 120 million sales of electric vehicles, so massive, massive, kind of, multiple of where we are now. As, as more companies enter this space, the, the practices are gonna improve, standards are gonna be risen, are gonna be raised, and, and, but there'll still be opportunities for the selection of the right companies, and certainly ESG is a, is a key consideration there.

 

Josh Kriskinans: I, I would also just add on that, I mean, if you look back on the last ten or fifteen years and how far technology has brought us, technology is rising and improving at an exponential rate in terms of a hockey stick curve that goes like that, and I think the ability for technology to, to help improve the waste and, and other negative (mw 01.34.04) that are, kind of, related to some of these batteries and electric vehicles is, is no doubt gonna improve and help us on that journey.

 

Rachel: Someone has asked about how you measure carbon emissions, so if the supply chain, there's so many guesses involved in working out the whole footprint, how, how do you calculate it and how reliable are those figures?

 

Atole Schin: Yeah, it's, it's a great question. I'll, I would say at the moment it, it's somewhere between art and science, in that standards are improving across the board, but there are, there's still a, a long, a long way to go. So, a fair proportion of companies now will report the, their scope one and two emissions. Not many report their scope three because it is really hard to, to, to do. With the companies that we invest in and we work with, there's a couple of external bodies that we work with to try and help the companies to report their, their, their scopes. But the, the, the, I would say in conclusion that it is a challenge. Companies are aware that they need to start doing this and I would expect in the next few years this to be a massive area of increased disclosure by companies. There will also be more intermediary companies like MSCI or Agentum or Carbon Disclosure Project, which are all there to raise those standards as well.

 

Josh Kriskinans: And also we spoke about engagement earlier Atul, and I think the ability to hold these companies, and not divest, and engage with them on, on, on their various scope one, two and three disclosures is a really powerful thing, and if you're able to hold investments in companies and engage with them over time then you're gonna help drive that change and improve the data quality in the industry.

 

Atole Schin: Absolutely.

 

Rachel: Thank you. Nice, nice simple question for me, so, should social factors, so the S of ESG, should that take into account quality issues, so diversity of boards and that sort of thing?

 

Atole Schin: Yeah, absolutely, and that I think, kind of, segues, segments into the governance side of things. Josh, did you have any more to add?

 

Josh Kriskinans: No, no, I would say absolutely. I mean, there's often a little bit of crossover between some of the issues, but yeah, 100%.

 

Atole Schin: I, I, I'd maybe give an example from our personal experience, which is we invested in a couple of Japanese companies, and Japanese companies are infamous for the lack of gender diversity on the boards, and we certainly do engage with them, we, we on a regular basis will press them, and we'd like to think as a industry the whole industry is driving change there. There is a cultural challenge there though, so it can take a bit of time, but absolutely, it should count in companies diversity and equality as well.

 

Rachel: And now a very long question which I'll do my best to summarise for you. So, this is asking about passive investment vehicles and particularly banks, and whether there is scope for passive investment vehicles that exclude such banks where those banks perhaps don't meet your expected targets on ESG.

 

Atole Schin: Yeah, it's, it's a question that we, we often get asked about, the broader sense, as to what role do, do we think passive carbon index can play within concentrated active strategy like our own, and firstly I would say on carbon indices there's an increasing number of them out there, and I would only expect that number to increase significantly over time, particularly when you have regulations, as Josh talked about, in the EU. You're starting to have some indices claiming compliance with Paris climate accord basis, which we find a bit difficult to believe at the moment. So, I would expect to see in the future indices to develop to factor into account things like the, the scope three. Having looked at some of the indices that exist at the moment, one thing which is clear is they will typically underweight carbon emitters on a scope one and two basis, won't always reflect scope three emissions very well, but ultimately still have a decent amount of exposure to some of the biggest carbon emitters of, of the world. So, in isolation we don't think these carbon indices are the solution by themselves. They're, they, they contribute to the solution and they're certainly better from a carbon impact perspective than otherwise is the case, but they, they're not, they're not the, they're not the panacea of carbon reduction.

 

Rachel: We have a couple of questions that possibly Bob might be better placed to answer, if Bob's still available to pop in, if he's here. So, one is asking, Bob, about squaring the duty to maximise the value of a pension fund to enable it to pay pensions with political decisions related to disinvestment from fossil fuels etc.

 

Bob Holloway: Okay, this is a long running issue that really has yet to be (TC 01:40:00) resolved fully. I mean, there's no doubt at all, and certainly it's the Law Commission's view that the primary aim of any, sort of, funded pension scheme is to maximise those long term financial returns. But of course, it also made quite clear there are numerous ways in which to achieve that long term aim. It's not just about, you know, getting into high, high return assets. You can, you can afford to, to make certain lower returns for ESG reasons, responsible investment type reasons. So yes, it is quite, quite within the remit of a pension fund committee to divest. The only word of caution I would add is I think we, we need to be a little bit clear what we mean by divestment. I think there's, Josh said earlier, I don't think it's about getting out tomorrow, because that might not be in the best interest of the fund and the best interests of the scheme member. I think it's about managing that transition out of fossil fuel investments that, that best suits all parties. So, there's, there's certainly a political movement that we must, sort of, divest, but I think we just need a little bit of caution in how we actually achieve that in practical terms, and better manage that exit from, you know, from fossil fuel investments to green investments. It's all part of a long process.

 

Rachel: And who should be driving that agenda? So, we've had a question whether it's the pension fund committee, or the investment manager of the pool itself?

 

Bob Holloway: I think it's a collegiate approach. Pension fund committees have a very vital say because they, they are responsible for having their investment strategy statement. I think there's a clear role for local pension boards as well, to, to, to monitor what is going on and that the, those policies are spot on in terms of what the government is driving, and I think on that point, I think government have a clear role. They certainly have a clearer role for private sector schemes at the moment compared to public sector LGPS. So yes, it, it's an all party approach.

 

Josh Kriskinans: I would back that from an investment manager's perspective as well, Bob. I think it's definitely part of our role as partners with our clients and partners with various pools we work with, to help provide information and also provide the right investment solutions to be able to take clients and then, and the LGPS within that bracket, on that journey to, to wherever we need to get to in terms of a few years time.

 

Bob Holloway: Yes, I'm just (inaudible 01.42.27), I think part of the, part of the confusion or, or problem at the moment is that everybody is trying to achieve roughly the same thing. I think all we would like is a bit of clarity and a bit of clear leadership, perhaps from the Government, in the direction of travel.

 

Moderator: We're just over time now. Just remains to say thank you very much to our presenters, all our presenters today, some terrific presentations, thank you for those, and thanks Rachel for bringing the questions to our presenters as well. And thank you to all of you who have attended today, hope you found it useful. We'll be sending some feedback forms out, or a link to Survey Monkey as I think most people use nowadays. There will be a recording available of the session available shortly afterwards, we just need to top and tail it and make sure it's all compliant with Government regs, you know, with subtitles etc. It will be copies of the slides available too. Other than that, I hope everyone enjoys the rest of their week and goodbye.

 

Josh Kriskinans: Thank you.

 

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