On 19 June 2023, the Government introduced the Economic Activity of Public Bodies (Overseas Matters) Bill 2022-23 (the “Bill”), and it is currently at the Report Stage at the House of Commons.
According to the Bill itself, the Act (when in force) would operate to “prevent public bodies from being influenced by political or moral disapproval of foreign states when taking certain economic decisions”. In other words, the Act would seek to remove the possibility for public bodies, including councils, to campaign against, boycott, seek divestment from, or sanction a particular territory internationally unless endorsed by the Government’s own foreign policy.
In particular, based on current drafting the Bill would prohibit decision-makers from applying considerations related to particular foreign territories in ways that would lead reasonable observers to conclude that their decisions were influenced by political or moral disapproval of foreign state conduct (section 1(2)).
Impact on the Local Government Pension Scheme (LGPS)
The Bill contains sections specific to the investment decisions relating to the LGPS. Section 12 of the Bill provides that the main prohibition applies to an LGPS “fund investment decision” made by an administering authority within the LGPS.
When taking environment, social, and governance (ESG) considerations into investment decisions, the Law Commission has concluded that the same constraints on pension scheme trustees should apply to administering authorities, namely: (1) there must be good reason to think that scheme members would share the relevant ethical concern; and (2) the investment decision must not involve a risk of significant financial detriment to the fund.
Within this context, (absent the Bill) it would potentially be open to administering authorities to make investment decisions with the aim to boycott or disinvest from a particular country, if scheme members shared the ethical concern and the investment policy did not increase financial risk for the fund. The Government have previously attempted to remove this possibility by issuing mandatory guidance prohibiting boycotts, but this guidance was successfully challenged and found to be unlawful by the Supreme Court. The Bill, however, would provide the necessary prohibition where the guidance failed.
One aspect of the debate on the Bill in the commons is the potential ESG consequences of the Bill if enacted. In particular, there have been arguments put forward that the Bill restricts investment policy decisions made on environmental grounds.
Part 2 of the Schedule to the Bill sets out exceptions for “certain types of consideration” to which the ban would not apply. This part of the Schedule effectively permit boycotts of, or divestment from, relevant investments in a particular country, where the rationale for that decision includes “labour-related misconduct” or “environmental misconduct”. Although the labour-related exception is broad (based on applying UK labour standards to the foreign territory in question), the environmental exception is less clear and potentially more limited, as it requires there to be an offence under law. Therefore, as drafted, the Bill could be interpreted as restricting investments made on environmental grounds, where the ethical concern in question does not constitute an actual breach of law. This is potentially concerning, given for example, fossil fuel intensive industries, which may fall outside of an ESG policy, are not necessary undertaking activities which are unlawful, and so boycotting investment or disinvesting could fall foul of the Bill, if enacted as currently worded.
That said, the Bill appears to provide ways to mitigate the impact on ESG policy:
• there is an exception under the Bill which states that the general prohibition set out at section 1(2) (see above) “does not prevent regard to a consideration so far as the decision-maker reasonably considers it relevant to the financial value or practical utility of.. [the] asset [to be invested or disinvested]". It is not clear to us what “so far as” means, but it seems that if there is a reasonable financial dimension to the decision then it might not be caught, even where the decision is also influenced by political or moral disapproval; and
• to be prohibited, the investment decision must comprise “territorial consideration” (defined as consideration that relates specifically or mainly to a particular foreign territory); and
• the decision must also lead reasonable observers to conclude that it was influenced by political or moral disapproval of foreign state conduct.
Therefore, where there is any reasonable financial consideration, e.g. as to risk of lower level of return compared to investing in a different territory etc, this could mean the decision is not caught. Also, any decision that does not relate specifically or mainly to a particular country would fall under the prohibition. So, a boycott of an investment type or sector is unlikely to be caught. Finally, the moral disapproval must be towards state conduct not the conduct of individuals or companies. So, for example, investment decisions to boycott a company because of their poor environment record or environmental exploitation should not be caught.
Having said this, there might be grey areas, such as with state sponsored companies or industries.
The Pensions Regulator (“TPR”) will be given power to enforce the ban on LGPS administering authorities. However, the methods of enforcement are not especially clear. Currently section 13 suggests that the only sanction would be the issue of an improvement notice by TPR. These notices are typically used to set out the steps the person must take (or refrain from taking) to remedy the breach, but also to prevent the breach from being repeated. Although it is not clear how the improvement notice could specify the investments the administering authorities should make instead, it may require administering authorities to have training and put in place procedures/systems to ensure the Bill is complied with.
In addition to the TPR enforcement powers, section 5 of the Bill provides that breaches would also be subject to judicial review or, for matters not amenable to judicial review, under a quasi-judicial procedure provided for at sections 5(4) to (7).
In summary, if the Bill were to pass as an Act, LGPS funds should be careful when considering ESG factors in the context of a foreign investment and ensure that an investment decision is based on relevant investment factors (such as risk) rather than political or moral judgments.
The Bill continues to be debated on and there is controversy surrounding its implementation. Throughout its readings in Parliament, significant concerns have been raised about its rationale, practicability and whether it constitutes an over-reach of Ministerial authority.
More widely, the Government is placing increasing scrutiny on the investments of the LGPS in line with its ambitions in the Mansion House reforms. This is a dynamic time in the sector and we will continue to keep an eye on how policy in this area continues to develop.
If you would like further advice on any of these points, please do contact our Pensions Team.