IN this week’s article we will continue with the focus on the potential for local government pension scheme (LGPS) funds to provide “productive finance” to support the economy and the building of the infrastructure Scotland needs to make a rapid transition to a zero-carbon economy.
With assets valued at about £55 billion in 2021 there is huge capacity for providing this financing, so the Scottish Banking & Finance Group has been investigating to find out why this capacity is not being used and to gain a better understanding of what the constraints are.
The group has contacted several of the LGPS funds and a constructive dialogue has enabled the group to explore what the constraints are. To their credit, at least some of the LGPS funds are doing as much as they believe they can within the constraints they operate under, and investment in vital infrastructure such as renewable energy for example is taking place, although at a relatively modest scale compared to the overall assets being managed.
In our article on July 12 we argued that local councillors who are members of LGPS pension committees have the power to determine the terms of the investment mandates of the funds. Further investigation has revealed, however, that pension committees themselves are constrained. The constraints arise from the legal and regulatory framework governing both private and public sector pension funds. Two issues in the legal framework stand out as significant constraints on LGPS investments.
Firstly there is the concept of “fiduciary duty” derived from Trust Law, which is incorporated into the regulatory framework governing LGPS funds. This is a duty to act in the “best interests” of members of the fund. As the law currently stands this duty explicitly excludes consideration of the wider public interest of taxpayers when making investment decisions.
We will turn to the meaning of “best interests” later in this article.
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The second issue is that there is a presumption that “investments” means “investment opportunities available in markets”. Such a conception of “investment” limits a pension fund to consideration of what opportunities are available in financial markets and implies that investment can only take the form of the buying, selling or holding of financial securities which can be traded in financial markets.
This definition of “investment” is incompatible with investment in the form of “productive finance”.
From this it follows that “best interests” is reducible to the maximisation of returns from investment in the form of decisions to buy, sell or hold a diversity of financial securities that can be valued and traded in financial markets. These are the overriding considerations.
It is only where there is a neutral choice between two or more “opportunities” that other factors can be applied to determine which of two or more financially equal options is chosen.
With these constraints revealed, it is easy to see why pension funds focus on financial asset trading to maximise asset values and investment income rather than on productive finance as a source of cash flows. It also explains why funds prioritise amassing financial assets as the means of meeting future liabilities to pay pension benefits to future generations.
In our view this is a flawed way to define inter-generational obligations. The current generation has an obligation to future generations to provide the means of creating prosperity for everyone. Under the current regulatory regime pension funds are behaving like squirrels. Instead of hoarding nuts to provide for the future, everyone will be better served if pension funds were planting the trees we need to provide a reliable future supply. Inter-generational prosperity cannot be built on the froth and volatility of financial asset bubbles. In our view the “best interests” of pension fund members are the same “best interests” of all citizens because prosperity for all of us relies on the productive capacity of our economy.
It is in the best interests of nobody that we allow the productive capacity of our economy to be neglected because if our economy fails to produce what we need to live well and in harmony with nature then inter-generational conflict will emerge in a competition for limited resources, inflationary pressures will arise due to shortages, the currency will weaken and ultimately there is the risk of complete collapse in the legitimacy of the state.
The fate of the Weimar Republic in Germany in the 1930s should be a lesson for us all. The explosion in the printing of money during this period was not the cause of hyperinflation, it was a symptom of the complete collapse in the German currency and the economy which was unable to provide for the needs of the people.
The best interests of all citizens will be served by pension funds providing more productive finance and less assets trading.
If the legal and regulatory framework is constraining their ability to do this then what we need is regulatory reform.
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