Just two years ago the investment management arm of the Universities Superannuation Scheme (USS) had no lawyers, so the hire of general counsel Jeremy Hill was prescient, as he came on board just in time to catch the wave of regulation hitting the industry.
USS is one of the UK’s largest pension schemes, investing £32bn for 277,000 members. Hill is head of a legal team working alongside the 95-strong investment management team in London.
In 2009 and 2010 USS was faced with two significant pieces of new regulation.
From Brussels came an EU directive for alternative investment fund managers (AIFM), while in London the FSA introduced a new corporate governance code and a remuneration code.
The latter came in the wake of changes to the EU’s Capital Requirements Directive that were designed to address some of the issues connected to bonus payments in big banks prior to the financial crisis.
Hill says USS saw the two sets of regulation as being very different. The AIFM Directive prompted a lot of external lobbying, but has ended up not affecting the organisation directly in a significant way. In contrast, Hill says the FSA codes involve more internal work and examination of USS’s structure and, to a lesser extent, compensation systems.
The AIFM Directive had an impact on USS initially due to the scheme’s 2008 decision to invest in alternative funds – mainly hedge funds and private equity. USS trustees allocated 20 per cent of scheme assets to alternatives. That meant that when the AIFM Directive was published in April 2009 Hill had to get to the bottom of the implications.
“When the first draft came out we were concerned about what it seemed to be saying in terms of our ability to access US hedge fund managers or US private equity managers in particular, but we also had concerns on some of the real estate funds we used,” says Hill.
He points to the section of the first draft that places restrictions on European investors’ ability to invest in non-EU funds and managers. The signs suggested that there would be higher internal costs for managers due to increased regulation.
“All the conversations we were having suggested that these costs would be passed on to investors, including us,” Hill says.
Accordingly, USS joined the lobby against the directive.
“We went to Brussels, we participated in presentations to the European Commission and Parliament, and we spoke on FSA panels and popped up at conferences – we generally tried to make our voice heard,” explains Hill.
Although ultimately the lobbying was enough to make the final directive somewhat more proportionate and workable, Hill admits that USS’s voice possibly got lost in the clamour from London.
“From the perspective of Brussels our voice might have merged into the general London voice,” Hill says, adding that other institutional investors shared USS’s concerns about access to third-country managers, while welcoming sensible regulation.
In contrast to the lengthy and combative process that saw the AIFM Directive finally reach agreement in November 2010, the FSA’s introduction of the corporate governance and remuneration codes was quite different. For a start, Hill points out, the FSA consulted with the industries concerned before introducing the codes.
“Our key role in all of this stuff is quite weighted towards the early stage,” says Hill. He explains that in conjunction with USS’s external advisers he and his team try to identify issues that could affect portfolio managers. On regulatory issues, USS is generally advised by Linklaters in the UK and Proskauer Rose and Morgan Lewis & Bockius in the US.
Those concerns are then either fed back into the regulatory debate or used as the basis for restructuring the business. In the case of the AIFM Directive it was the former; in the case of the FSA codes the latter.
“We’ve made some adjustments to remuneration policy and are working on changes to the way the corporate structure works,” Hill reveals.
He believes the scheme’s compensation policy was already sophisticated, but it had to examine the relationship between risk and remuneration in light of the FSA objectives.
The FSA states that these are to “sustain market confidence and promote financial stability through reducing the incentives for inappropriate risk-taking by firms, and thereby to protect consumers”.
It adds: “The need to ensure that remuneration policies and practices are consistent with and promote effective risk management therefore remains fundamental.”
USS portfolio managers have for a while been paid on a risk-adjusted basis, so outstanding investment performance gained through taking extreme risks is not compensated to the same extent as the same performance at low risk.
“The area that’s changed most for us is the position of control staff,” Hill says.
More control staff are now included in the remuneration policy, and Hill welcomes the FSA’s “key message” of proportionality.
“Compared to an investment bank we’re off-the-scale small,” he points out. “If you compare that to the AIFM experience it’s been a lot easier because of the proportionality element.”
New regulation has meant the USS legal team has had to pick up a lot of skills and knowledge quickly.
“A lot of it isn’t legal legal,” explains Hill. “Understanding what the regulations say is a legal skill, understanding how the rules affect what
we do in the investment management office is legal-stroke-commercial and communicating effectively internally and externally is a different skill.”
Hill expects that regulation will continue to occupy his time as the details of the AIFM Directive are hammered out and the FSA codes come into force. His newly acquired mix of skills will continue to come in useful.