Can UK councils rent their own streets to fund pensions?

Examples from the US, cited in a report by the New York Times, include the city of Tuscon, Arizona, which rented five golf courses and a zoo to itself in order to plug a sizeable hole in its pension scheme.

West Covina, California, rented its own streets, while Flagstaff, Arizona, leased its own city hall to itself.

The measures are largely in response to the country’s estimated $4.7tn ($3.3tn) public pensions black hole, that has seen states, cities and municipalities adopt increasingly aggressive investment strategies in an attempt to make up the shortfall.

Pension assets are just a gargantuan sum of money which, if only a tiny percentage is released, could release gargantuan sums of money for infrastructure for development, which in turn will provide jobs

Steven Hull, Eversheds Sutherland

In a number of cases, dummy corporations have been set up to hold and rent the assets, the New York Times reported. That corporation then issues bonds and returns the proceeds to the city, which then funnels the money into its pension fund. 

Investors are attracted to the bonds because they offer a marginally higher rate of return than is currently attainable from low interest rates, and the pension funds can then put the money raised by those bonds into other, return-seeking assets.

Lessons to be learnt?

There are important differences between the public pension systems of the US and the UK, not least, as Irwin Mitchell partner Penny Cogher told Pensions Expert, that “the main UK public sector schemes are pay as you go schemes and so have no actual funding shortfall”.

Additionally, there is a broad regulatory framework restricting those public sector schemes that are funded and which do hold investments that, like Local Government Pension Scheme funds, “restrict the amount trustees or managers can invest in employer-related investments to 5 per cent of the scheme’s resources, either directly or indirectly through any intervening collective investment scheme”. 

The restrictions, put in place in response to the Maxwell scandal, “also cover securities including shares, instruments creating or acknowledging indebtedness, instruments giving entitlements to investments, and certificates representing securities”, Cogher explained.

Contravening these restrictions could land the offending trustee or manager with a hefty fine or even a jail sentence, she added.

“Maxwell has cast a long shadow over the pensions industry and it seems most unlikely that any LGPS investment committee would go down the same route as the US funds. This is even more the case now we have the larger, super local authority funds.”

However, Squire Patton Boggs partner Kirsty Bartlett explained that the UK already has its own analogous arrangements.

“The concept of using the capital value of an employer’s assets to reduce the pension fund’s deficit, with the employer also providing an income stream to the fund in the form of ‘rent’ for using the asset, is familiar in the UK,” she said.

Special-purpose vehicles, for example Scottish limited liability partnerships, are typically used to host the asset, with the vehicle jointly owned by the employer and the trustees of the pension scheme. Unlike in the US, external investors are not involved.

“The legislative restrictions placed on how local government can raise and invest money would, I think, prevent them from issuing the types of bonds mentioned in the article that are common in the US,” Bartlett said. 

Times are changing

However, Eversheds Sutherland partner Steven Hull told Pensions Expert that “there should be no question” that the UK will begin to see developments in this area, and the importing of more funding and investment ideas from the US — “because we need it”.

“At the moment, UK pension laws allow trustees to adopt a very prudent, some might say recklessly prudent, level of investment risk,” he explained.

The market value of UK pension funds stood at around £2.2trn at the end of 2019.

“That’s just a gargantuan sum of money which, if only a tiny percentage is released, could release gargantuan sums of money for infrastructure for development, which in turn will provide jobs,” Hull said.

"So I’m desperately keen that Rishi Sunak in the next budget will come up with a proposal, which is to examine greater flexibility for using these funds, rather than just the boring, plain vanilla austerity drive.”

The alternative to the government planning for such strategies is that they begin to emerge in the gaps between regulation, rather than as the result of a careful plan, he added. 

As with the 2008 financial crash, the economic damage wrought by the pandemic will force innovation. The last financial crisis saw a whole host of bizarre arrangements, like the food producer Dairy Crest giving its pension fund £60m worth of cheese. Another pension fund was given millions of pounds in whiskey.

Hull said the question for the government is whether it wants to be proactive in legislating and regulating for these types of arrangements, or whether it will stymie by inaction something that will inevitably happen sooner or later.

There have already been numerous calls, not least from the governor or the Bank of England, for regulations governing pensions investments to be loosened in order that pension funds be tapped into to spur the economic recovery.

Bartlett cited the government’s post-Covid recovery package as a tremendous incentive for pension funds to invest in infrastructure and other asset classes “providing long-term and often inflation-linked returns, with a premium expected in exchange for the relative illiquidity”.

“However, the challenge lies in providing pension funds of all sizes with appropriate vehicles through which to access a suitable range of infrastructure assets so they can diversify their risk,” she said. 

“It’s important that funds focus on their duties to invest pension assets in the interests of scheme members; and that employers are aware of their long-term financial obligations to the pension fund and plan appropriately for that cost.”