Scotland's big idea: what a merger of council pensions might mean

"We are the builders," he added, "and to build, you must build on solid foundations."

The chancellor did not have new taxpayer cash to pay for all this construction. But he did have pensioners' money.

His aim: to re-style and refocus 89 local government pension funds, the future incomes of hundreds of thousands of public-sector workers, in to engines of economic regeneration.

Six superfunds, together worth some £200 billion, would be big enough to save hundreds of millions in fees and costs and pay for new schools, bridges, homes and prisons.

Party loyalists cheered.

Less than a year later Osborne was gone, his political career ended by Brexit. Whitehall become engrossed in the complexities of leaving the European Union. And pension funds underwent their own tricky process of pooling and merging.

Gradually, though, the funds started to put money in to infrastructure. Local Government minister Rishi Sunak last summer said he wanted the funds to put a 10th of their investments in to infrastructure. That would be £20 billion.

Watching the English reforms were Scottish ministers. They, like Osborne, hoped to unleash the power of council pensions on the real economy. Last summer, with little fanfare - and no cheering supporters - the Finance Secretary, Derek Mackay, a former council leader himself, announced an independent consultation on how to do so.

Should Scotland's 11 funds - worth more than £42 billion at a recent count - merge in to one? Should they team up to run pooled individual investment funds, rather like what is happening in England? Or should they simply work more closely together?

And what, if anything, would such reforms do to lure some Scottish pension money out of global financial markets in to real-world investments closer to home.

The stakes could barely be higher. Just matching England's aspiration of investing a 10th of local council pension funds in to infrastructure could release £4 billion, or £4.5 billion. That is a lot. To give just a sense of the scale, it would be enough to pay for three more Queensferry Crossings, four Aberdeen bypasses or five new super hospitals such as Glasgow's Queen Elizabeth.

Any government, local or national, has a wishlist of capital projects but, in an age of austerity, far from always the access to cash to carry them out. And that is not just a current budget problem. Getting credit is also an issue.

The Scottish Government has a capital borrowing cap of £450m a year and no more than £3 billion overall. There are various schemes - such as the old private finance initiative or the new non-profit distributing (NPD) - for bringing in private money. And the UK Government has also been contributing through City Region Deals.

Late last year, Mackay signaled capital projects of some £5 billion in his 2019-20 budget. But he and others want more. So getting well-funded local government pension funds to invest - usually in return for safe, fixed long-term returns - is a priority. Some funds, such as the giant Strathclyde one (which is nearly as big as the rest put together) are already putting pensioners’ money in Scottish bricks and mortar. The problem? Some of the funds are just too small to front the kind of money needed on their own. Hence talk of reform north of the border.

Mackay, in an introduction to the formal consultation, clearly set out that he was not looking for institutional change for change’s sake. “There are currently excellent examples of fund authorities collaborating on infrastructure

projects in Scotland,” he said. “We look to fund authorities to improve their already positive impact on the economy thereby contributing further to sustainable economic growth, creating more jobs and supporting the delivery of key capital infrastructure needs.”

The stakes are not just financial. They are also political. And human: around 400,000 Scots are in the current 11 schemes. The SNP has already seen at least one centralizing project - the national police force - become a political football. A single scheme - already referred to by some as Pensions Scotland - would have to endure unprecedented scrutiny over its decision-making, not least on whether its investments were ethical. Even more pooling of funds to pay for national projects could thrust council pensions on to the political front line. “There is a risk pensions would look like a piggy bank for politicians,’ said one source.

So political insiders - if not pensioners and the general public - seem wise to this potential hazard. That may explain why Mackay and the Government are treading carefully. Informed sources say the Finance Secretary and his team have no firm view on the future shape of local government pension funds. They are awaiting the outcome of the consultation, which closed last month.

An independent body, the Pensions Institute, is collating responses. Its findings will go to a an obscure body, the Scottish Local Government Pensions Scheme Advisory Board, sometimes this spring. The board, made up of councillors and trade unions, will then report back to Mackay. But battle lines are already drawn.

THE EVANGELIST

Simon Watson is leading the charge for a national scheme. He is a Unison organiser and, among other things, one of the trade unionists representing future and current pensioners on the advisory board.

He sees ‘Pensions Scotland’ as an opportunity to get better returns from more ethical investments and still boost the real economy with jobs-creating infrastructure. That is a lot of bang for your council pension buck. Mr Watson said he thought government and local government was taking reform seriously. “We were concerned there might be a strong view of people looking after their own backyards,’’ he said, “to keep their own schemes for the sake of it rather than the greater good. But there is a wide variety of views.”

He added: "Because of the state of public sector finances, there is an overwhelming case for merging the funds and the wider benefits that will give to spending and services. We hope Mr Mackay will look a long those lines.”

Better performance for pension funds is fiscally significant. Mr Watson reckons improvements in returns could offer austerity-hit local authorities the chance to pay less in employer contributions. Even a modest drop in such payment could help council bottom-lines. In 2016-17 they paid nearly £1 billion into schemes.

Watson reckons too many people - including private funds managers and advisors - are taking a cut out of pensions as things stand. So a central fund, he believes, would be more efficient, with more in-house expertise on everything from emerging markets equity funds to Scottish prison construction.

But it is not just the pension funds that need more expertise, said Watson. Public bodies need to be better at pitching. He said: “There is an ‘ask’ of the Scottish Government to co-ordinate better the investible opportunities.

“A national pension fund would still have to get due diligence done. Most of what would come from the government would be relatively low risk. Slightly lower return than sone of the more high risk opportunities. The Forth Bridge might have been an opportunity. If there was an increase in council housing, that might be an opportunity too. Or more road building, or business parks to develop new industries.”

Unison, like other unions and some campaigners, have a problem about where some of their pensions are currently invested. “ People paying in to the funds have an ethical view,’ he said. “ If relatively small funds are looking at ethical investments they tend to be very conservative about it. They tend to say ‘oh, no’, if something is a slightly higher risk. So the err on the side of caution, not making the best opportunities of ethnical investments, We think a single fund would give greater expertise in that.”

FRONTLINE VIEW

Richard McIndoe is not convinced that big is beautiful. Or more ethical. And he runs Scotland’s largest council pension fund, the mighty Strathclyde, worth around £21 billion, including a billion already in infrastructure.

McIndoe is no enemy of the unions but he stressed that they do not need to worry about pensions, which are underwritten by councils and so will be paid however badly the funds reform. He said: “There is a mismatch of risk. If you start using the pension fund to promote campaigns in a political way, who pays the costs if it goes wrong? It is the local authorities side. Not the trade union members.” A national fund, he suggested, “would give unions a lot of influence with much less repercussion”.

Strathclyde, as the biggest fund, has taken the biggest heat on its investment decisions. Should it have money in fossil fuels? Or arms firms? Or cigarettes? All three are important parts of the Scottish economy. McIndoe bemoans what he calls “a lack of proportionality” in criticism.

He said: “Part of the trade union argument is that you can create a bigger fund and it would have more influence. You can pretty much have the same influence by just jointly signing a letter. You have still got the same number of shares whether two pension funds own then or one. So it is a bit of a hollow argument.” Strathclyde was one of the big institutional investors which late last year forced Royal Diutch Shell to link executive bonuses to carbon targets (The executives, smiled McIndoe, ‘will be all right’). His fund also championed living wage. Like Mr Watson, he thinks this makes business as well as ethical sense. But he is not trying to change the world?

“We are an active investor,' he said. "An activist is slightly different. But we play an active role."

McIndoe has been watching events in England. He has not been impressed. “Because they have been forced to collaborate with each other, because they have going through a process of very hurriedly getting together, it has been chaotic and we have kept out of it.”

Strathclyde, which is administered by SNP-run Glasgow City Council, has made a formal submission to the review. Essentially it echoes McIndoe’s view that size is not everything. It said: “Merging investments is certain to involve a concentration of risk. A full merger of Scottish funds might have slightly increased probability of success. But size is no guarantee of success, and the impact of failure would be very significant.” The biggest potential downsize? A “concentration of risk”, said the fund.

It added: “A full merger of Scottish funds could increase investment in infrastructure, but this would depend on the investment strategy of the merged fund and those managing it. However, merging the funds simply to achieve more investment in infrastructure, which is not a primary pension fund objective, would be a perverse decision.”

Strathclyde, meanwhile, wants to keep council pensions in council control - even if in reality only 11 of Scotland’s 32 local authorities have administrative power over the funds. It said: “At the extreme, merger into one fund would be likely to break the direct link between the scheme and local government by taking the fund out of local government control.”

Strathclyde is big. So big McIndoe does not consider investments of under £10m. Yet he stresses that big funds can do badly. Britain’s two largest, Universities Superannuation Scheme and the British Telecom Pension Scheme , manage about £50 billion each. Both have funding deficits of more than £10 billion.

So which Scottish pension fund does best? Mr McIndoe laughs. That, he said, would be tiny Orkney.

SMALL IS BEAUTIFUL

Scotland’s smallest local government pension fund is also the country’s most successful, at least in terms of funding. A private fund runs Orkney’;s fund, which around £300m under management. It makes great returns. But it invests nothing in infrastructure. Why? Because, it says, there are no opportunities on its scale.

In a formal response to the current consultation, it said: “The principle impediment to investment in infrastructure for small funds is the lack of suitably attractive investment opportunities that are packaged in a manner that make them easy to access.”

It added: “If there were a suitable investment vehicle that offered the pension fund a route into infrastructure investment with an appropriate return for the level of risk, that might be persuasive.”

Like Strathclyde, Orkney does not like the principle of reforming pension funds to squeeze out more money for government projects. That, it said, “could be a hugely costly mistake”.

It added: “Those charged with stewardship of the pension schemes require to invest the funds for which they are responsible to earn the maximum return possible for the level of risk taken. Just as investments in arms, fracking, fossil fuels etc may be controversial, if they are on balance the best investments to meet the objectives of pensions funds then that is where pension funds are invested.”

Orkney’s take-away? If government wants pensions money, then it should put together some wrappers.

Back in Glasgow Mr McIndoe conceded his fund would be willing to team up with smaller ones, opening up projects to smaller stakes. That he said would be “absolutely feasible….and desirable.”

WORKING TOGETHER

Over in Edinburgh, the Lothian Fund is already co-operating, with neighbouring Falkirk, Fife and the Borders and even Northern Ireland. Between them, these funds have put some £20m in to infrastructure.

Unlike Strathclyde and Orkney, it is very keen on a national fund, on a voluntary basis. Why? Because it believes governance would be cleaner and costs lower.

Lothian already has an inhouse investment team, the only one of its kind, and a model for the kind of central fund Unison wants.

The fund’s formal response echoes Mr Watson’s concerns about massive hidden costs in the pension system. It said profits to private fund managers and advisors could be as high as £90m a year. Current accounting rules, it said, mean fees are under-reported. Its conclusion? As much as £70m in fees could be saved a year by taking expertise inhouse.

It said: “The lack of transparency of investment fees and general lack of comparability of other aspects of the pension schemes hinders policymakers.”

The big advantage of a single find would, it said, would be a “greater proportion of assets being managed in-house. "Further, the benefits from initial savings will compound over time”.

TRANSPARENCY FEAR

Moreover, Lothian is concerned about the transparency of decision-making too. Some critics are concerned that existing structures contain a conflict of interest between funds and their administrations. But Lothian’s take is that many of the people who oversee funds, including councillors, do not know what they are doing. It said: “Governance is also inefficient. In the region of 150-180 people are involved in the pensions committees, many with limited knowledge and experience of pension matters.”

Its formal response to consultation suggests collaborations and pooling of funds could raise even more issues over accountability. It wants a bespoke governance system for a national fund. Why? Partly because it wants to guard against what it called a potentially increased risk of central government interference. That hazard was cited by almost every source contacted by The Herald on Sunday, including those in government.

'SHOW ME THE DEALS'

What do hard-nosed pension funds managers think when they hear politicians, whether at Westminster or Holyrood, seek more cash for projects? Some are already investing, and not just British ones. The fund representing Ontario teachers, for example, has been ploughing money in to UK bricks and mortar – and even Scottish gas networks.

Strathclyde Pension Fund director Mr McIndoe summed up: “Show me the deals. Show me the terms. What are we putting in? What are we getting back? In what period? Would we invest more in infrastructure? On the right terms, we would.

“For us, infrastructure is fairly new. We have not been doing it that long. For most UK investors, it is fairly new. We will increase that investment. But how quickly we will increase our allocation will depend on the opportunities available.”