The National Pension Fund (NPF) could consist of several inter-related funds. These funds could function together to balance the availability of cash to meet pension obligations and operating costs. They could also maximise the availability of capital for investing to support the Scottish economy and the government’s strategic priorities and industrial strategy.
The allocation of capital would be governed by a framework of guiding principles set out in law as part of a statutory mandate which overrides the orthodox common law principle of fiduciary duty. The guiding principles should be derived from fundamental socio-economic and human rights which form an important element in a written Scottish Constitution, incorporating the Universal Declaration of Human Rights.
Investment principles
The legislation which establishes the NPF as an institution in law can include a statutory mandate which replaces the common law of fiduciary duty, which is central to orthodox pension fund investment.
Interpretation of fiduciary duty is contested, despite several law reviews over the last 25 years. A majority of pension fund managers and their advisers still hold a narrow interpretation of the meaning of “fiduciary duty”. A statutory mandate for the NPF could be introduced to replace the common law.
The fundamental principle
The fundamental principle governing the NPF would be based on the recognition that pensions constitute future financial claims on the productive capacity of the economy. Funds must, therefore, be invested to grow and strengthen the productive capacity of the economy so that it can provide for the needs of all citizens. Such a governing code embodies the principle of inter-generational justice and societal mutuality.
Orthodox pension fund management prioritises the allocation of funds for the acquisition of financial assets chosen to maximise financial returns for lowest possible risk, for the sole benefit of the beneficiaries – the members of the scheme. Universal membership of the NPF would eliminate the distinction between beneficiaries and everyone else. Investment decisions can be made for the mutual benefit of all citizens, now and in the future.
The NPF will provide an increasingly important source of investment funds to support the Scottish economy and the transition to a wellbeing economy. The scheme is designed so that contribution income is the primary source of cash flow to pay pensions. But the NPF will need the buffer funds to help manage mismatches between contribution income and expenditure on pensions and operating costs. However, the size of the overall fund will provide extensive capacity beyond the Cash Fund to invest without a demand for maximum financial returns. Space is opened up to consider long term, non-financial returns and the “use value” created by the formation of new socio-economic assets, such as infrastructure, an educated, highly skilled and healthy population, and environmental restoration and protection.
Accounting
Management of the fund would prioritise accounting for cash flow rather than the balance sheet. Investment decisions would be based primarily on the potential cash flows that those investments could produce. These would include profit sharing through contractual partnerships, revenues derived from infrastructure investments, such as social housing, and energy generation and distribution, or interest received on holdings of various government and corporate bonds.
There will be less overall need to undertake asset valuations to measure the balance sheet, particularly for Fund B (funds within the NPF are as described in the previous article), since the objective of those investments would not be to sell assets to make profits from arbitrage. Fund B will require a different character of asset management, distinct from the “trader” mindset: one that requires knowledge of different industrial sectors, technologies, business management, etc.
Governance and operational structure
The NPF would retain operational independence from the Scottish Government, although would remain bound by the statutory mandate, and investment decisions would be aligned with government strategic economic priorities and industrial strategy. For example, while key industrial sectors chosen for development would be investment priorities, the selection of specific companies or infrastructure projects would be the responsibility of the NPF investment teams; it would not be the role of government or politicians to “pick the winners”.
Overall management of the NPF would be the responsibility of a diverse supervisory board of 15 directors, who would be accountable to Parliament.
Investments would fall under the supervision of an investment directorate which would include the heads of the NPF Cash Fund and Funds A, B and C. The directorate would have overall responsibility for:
- balancing the funds in each of the four funds.
- maintaining adequate liquidity in the Cash Fund while maximising the availability of capital for investment from Fund B.
- monitoring compliance of investments with the statutory mandate, “licence to operate” conditions prescribed in company law or other regulations, and the socio-economic and human rights set out in the written Scottish Constitution (or Bill of Rights).
- identifying the existence of excess funds which cannot be invested purposefully, with a view to referral to the supervisory board to consider whether such funds should be –
- remitted to the Finance Department/Central Bank as part of fiscal deficit management.
- paid as dividends to the members of the NPF.
- used to finance a reduction in pension contribution rates.
- transferred to a separate Scottish international development fund. (Consideration could be given to creating a further fund within the NPF structure to fulfil this function.)
Administration
While several administrative functions would be best delivered by a centralised structure, the operations of Fund B would be delivered best through a decentralised network of local/regional investment offices, which employ a team of dispersed investment officers. The objective behind this decentralised structure is to integrate local and regional economies and communities into the investment process, allowing available capital to be directed to where it can be most effective in supporting economic development and shared prosperity. Locally based investment officers would be well placed to spot potential, and their incorporation into local networks key to building the mutual trust on which partnership-based investment can thrive.
Although most of the Fund B team would be dispersed geographically, there would still be a need for an administrative function at the NPF headquarters to handle accounting, legal services and record keeping of partnerships and other investments.
Funds A and C are likely to function effectively within a centralised structure. Both would need relatively small teams of financial asset managers and supporting administrators compared to the size of the decentralised Fund B team.
The NPF Cash Fund could only function effectively in a centralised structure. It would be responsible for:
- management of cash flows, the accounting of contributions income, and payment of pension benefits and operating expenses. This includes the accounting of transfers to and from Funds A, B and C.
- maintenance of membership records, including the contributions paid and pensions due.
- liaison with the government Tax Authority, Finance Department and Welfare Department, including reconciliation of financial records pertaining to NPF membership.
- collaboration with the pension fund managers responsible for the administration of pension transfers into the NPF.
Significant state investment in IT systems to support the NPF operations would be an essential element in the establishment of the NPF.
The NPF will evolve over time
The series of articles so far has provided a description of a possible earnings-related system for an independent Scotland. However, it would not reach full maturity for about 40 years and will evolve towards its final form during a transition period. It is important to consider some of the major elements of this transition, and that will be the subject of the next article.
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