October 29, 2014
Lisa Pezzack
Director, Financial Sector Division, Finance Canada
90 Elgin Street, 13th floor
Ottawa, Ontario
K1A 0G5
Email: [email protected]
Re: Proposed Amendments to Certain Regulations Relating to Pensions Benefits
Standards Act, 1985 -- Canada Gazette, Part I, Vol. 148, No. 39 dated September 27, 2014
The Portfolio Management Association of Canada (“PMAC"), through its Industry, Regulation &
Tax Committee, is pleased to have the opportunity to comment on the proposed regulatory
amendments to the Pensions Benefits Standards Act, 1985 (PBSR), and more specifically, to
the modernization of the investment rules (the "Proposed Amendments").
As background, PMAC represents investment management firms registered to do business in
Canada as portfolio managers. PMAC was established in 1952 and currently represents almost
200 investment management firms that manage total assets in excess of $1 trillion (excluding
mutual fund assets). Our mission is to advocate the highest standards of unbiased portfolio
management in the interest of the investors served by Members. Member firms are in the
business of managing investments for clients in keeping with each client’s needs, objectives
and risk tolerances. For more information about PMAC and our mandate, please visit our
website at www.portfoliomanagement.org.
PMAC is supportive of modernizing and strengthening the framework governing federally
regulated private pension plans. Collectively, our member firms manage investment portfolios
for most of Canada’s pension plans and, as such, have special experience with the issues faced
by pension plans, their administrators, advisers and portfolio managers with regard to the
investment of pension plan assets. We support a regulatory framework for pension plan
investment managers that provides greater flexibility to pursue investment strategies that
mitigate risk, optimize return and allow appropriate diversification to meet plan liabilities. In
this regard, we support the objective of modernizing the investment rules and our comments
will be focused on this part of the Proposed Amendments.
Modernizing the Investment Rules
We are in general agreement with the Proposed Amendments to the PBSR and support the
modernization of the investment rules. Set out below are some specific comments.
1
a. Amendments to certain definitions
We support updating the definitions applicable to the investment rules as contemplated.
However, we would like clarification on the following issues.
i.
Definition of “investment fund”
The exception to the 10% Rule for mutual or pooled funds that comply with Schedule III is
replaced with an exception for “investment funds” that comply with Schedule III. The
definition of “investment fund” is more broadly defined in that it requires such a vehicle to
have a purpose of investing the moneys of two or more investors. We understand that there
may be times when only a single client in invested in a pooled fund that is intended to be
available to, and invested in by, multiple investors. For example, this may be the case in the
start up phase of the fund, where a pension plan client provides the initial seed capital for the
fund. Alternatively, a pension plan could find itself offside this definition, through no fault of
its own, in the event that it holds units in an investment fund that satisfied the definition of
“investment fund” at the time of purchase, but from which other investors later redeemed. In
our view, the definition seems to exclude these scenarios. We note that the definition of
“mutual fund”1 under securities legislation does not require a minimum of two investors and
we query why the definition of “investment fund” under the regulations contains this
requirement. We, therefore, ask the Department of Finance to provide additional clarity to
ensure that a pooled fund will come within the definition of “investment fund” so long as it is
made available for investment by multiple investors. In our view, this new definition should
create additional flexibility instead of narrowing its application. We also request clarification
that an exchange traded fund (ETF) is included in the definition of investment fund.
Finally, we note that the definition of investment fund contemplates that the fund is
established by a corporation, limited partnership or trust. In many cases the fund is the
corporation, LP or trust itself. We suggest there be some clarity around when the fund is one
of these entities itself and not technically created “by” another legal entity.
b. 10% Rule
Schedule III imposes several quantitative investment restrictions on pension plans that in our
view, are difficult to interpret and apply in practice. These quantitative restrictions are
especially problematic where a pension plan invests its assets through one or more pooled or
mutual funds, which themselves are subject to different set of quantitative and other
investment restrictions under their governing documents or Canadian securities laws. The
ultimate result could be to: (1) hamper an investment manager’s ability to prudently manage
the portfolio of a pension plan in accordance with its investment mandate; (2) arbitrarily
restrict a pension plan’s pursuit of investment opportunities that are in the best interests of its
beneficiaries; and/or (3) cause pension plans to develop costly legal structures and
arrangements which effectively permit the pension plan to circumvent a particular restriction.
Prudence is the cornerstone of a pension plan administrator’s legal responsibility vis-à-vis the
investment of a pension plan’s assets. Our Members, as investment managers, recognize that
diversification is a key characteristic of a prudent investment portfolio. We therefore support
the Department of Finance’s efforts to modernize the 10% Rule with an aim to promoting the
appropriate diversification of pension plan investments. The principles of a prudent portfolio
1
For example, see section 1.1 of the Securities Act (Ontario): “mutual fund” means an issuer whose primary purpose
is to invest money provided by its security holders and whose securities entitle the holder to receive on demand, or
within a specified period after demand, an amount computed by reference to the value of a proportionate interest in
the whole or in part of the net assets, including a separate fund or trust account, of the issuer.
rests on diversification, which are, however, malleable
response to considerations such as market, economic and
In our view, if quantitative investment restrictions will
objective of achieving diversification should be achieved
the application of the principle of prudence when directing
concepts that change over time in
social factors such as demographics.
continue to be in place, then the
through flexible rules that allow for
the investments of a pension fund.
The Proposed Amendments to the PBSR contemplate a change to the method of calculation of
the 10% quantitative restriction in section 9 of Schedule III to the PBSR (the “10% Rule”). At
present, the 10% Rule prohibits a plan administrator from investing, or lending, more than 10
percent of the total book value of the plan’s assets in, or to, any one person, two or more
associated persons or two or more affiliated corporations; however, the Proposed Amendments
seek to replace the book value test with a test based on the current value or market value of a
pension plan’s assets.
We applaud this long anticipated change and believe that a recalibration to “market value” will
create greater alignment with investment restriction rules included securities legislation
applicable to mutual funds, which will thus enable consistency in plan management and
approach. PMAC is a strong supporter of harmonization and a regulatory regime that promotes
enhanced efficiency. The consistent application of regulatory requirements is also paramount
to ensure fairness and a level playing field for all plan participants and administrators.
While we are generally in agreement with the proposed change to a market value test, we are
concerned that, as currently drafted, the 10% Rule could be interpreted to apply on an ongoing
basis. In our view, an ongoing market value test is inappropriate, as it would unduly increase
the compliance burden, and cost, of the 10% Rule to pension plans. In particular, since the
market value of a pension plan’s assets will fluctuate over time (as opposed to the book value,
which is a constant), a plan that prudently invested its assets in accordance with the 10% Rule
could later find itself offside the rule due to market movements that are not within its control.
In order to mitigate the risk of such an outcome, pension plans could be forced to develop and
implement systems and/or hire third parties (such as investment managers or custodians) to
monitor the ever-changing market value of their investments and, potentially, to engage in
frequent trading over time to ensure that each of its investments remain with the limits of the
10% Rule. Both of these actions would come at a significant additional cost to the pension
plan, which could impact the amount of plan assets available to pay benefits to plan members.
We also note that an ongoing market value test under the 10% Rule would be inconsistent
with similar quantitative restrictions existing under other statutes and regulations. For
example, National Instrument 81-102 – Mutual Funds (“NI 81-102”), prohibits a mutual fund
from purchasing a securities of any issuer if, immediately after the transaction, more than 10%
of its net asset value would be invested in securities of any issuer. 2 We therefore recommend
that the language of the 10% Rule should be revised to clarify that the market value test
should apply, immediately after the transaction or purchase.
The Proposed Amendments introduce a new exception to the 10% Rule for investments that
involve the purchase of “a contract or agreement in respect of which the return is based on the
performance of a widely recognized index of a broad class of securities traded at a
marketplace”3 (i.e., a derivative instrument). In our view, the language of this exemption is
too narrow because, as currently drafted, it would allow a pension plan to invest more than
10% of the total market value of its assets in an index-based derivative, while appearing to
prohibit a plan from investing an equal amount in an index investment fund. We believe that
this is not an appropriate result. Index funds are inherently diversified. Like the derivative
2
3
See section 2.1 Concentration Restriction of NI 81-102.
Proposed subsection 9(4) of Schedule III.
instruments contemplated by the proposed exemption, a unit of an index fund would provide a
pension plan with exposure to a broad class of securities comprising the index. We therefore
recommend that the language of proposed section 9(4) of Schedule III be revised to clarify
that the exception is available to both derivative instruments and investment funds that seek
to replicate the performance of an index comprised of a broad class of securities traded in a
marketplace.
c. Related Party Transactions
The proposed exception to the Related Party Rule for transactions with a related party in the
operation or administration of the plan provided that the transaction is on market terms and
conditions is a welcome clarification; however, the existing wording allows for such
transactions on terms and conditions that are at least as favourable to the plan in question
than market terms and conditions. It is odd that the Proposed Amendments remove such
language. We recommend that the language be softened so as to allow for transactions
“consistent with” market terms and conditions.
In addition, we do not believe the language included in subsection 17(2)(a)(ii) is necessary
given the additional layer of regulation pursuant to NI 81-102. In our view, so long as the
investment fund complies with applicable securities laws and any exemptions thereto, it is not
necessary to also then be subject to Schedule III.
The deletion of the nominal value/immateriality exception means that administrators will no
longer be able to invest directly in related parties, even if the investments are nominal and
immaterial. In the case where an administrator may account for 1-2% of the TSX, purchases
of securities in the administrator for the plan will not be permitted. We believe that in this
case, some additional allotment be permitted to provide flexibility and account for market
fluctuations.
We support the exception that will allow for investments in “investment funds” that invest in
related parties provided that investors other than the “administrator and its affiliates may
invest” in it as well.
We recommend that proposed section 17(3) of Schedule III be revised similarly to proposed
section 9(4), to clarify that the exception is available to both derivative instruments and
investment funds that seek to replicate the performance of an index comprised of a broad class
of securities traded in a marketplace.
The Proposed Amendments strengthen the prohibition in section 16 of Schedule III of the PBSR
on investing or lending the monies of a pension plan in or to, or transacting with, a related
party of the plan (the “Related Party Rule”). We understand that one of the underlying policy
rationales for of the Related Party Rule is to mitigate the risks and conflict of interest that arise
when a pension plan transacts in or with a related party, and generally agree with this
objective. However, we note that the proposed elimination of certain of the existing
exemptions from the Related Party Rule will make compliance with this rule extremely difficult,
if not impossible, in practice. One such change is the proposed removal of the exemption for
related party securities acquired on a public exchange. 4 Investment managers are frequently
asked to assist their pension plan clients in complying with the Related Party Rule. However,
where such clients wish to invest their assets through an investment fund, compliance is
rendered extremely difficult. Investment managers often do not have access to information on
all of the related parties of a pension plan. Even if such information were available, an
4
See Section 17(2) of Schedule III.
investment fund (particularly an index fund) that was restricted from purchasing securities of
any related party of any of its pension plan investors, would be unable to meet its investment
objectives. At present, investment managers may rely on the public exchange exemption in
order to avoid this outcome, while ensuring that investment funds remain eligible investments
for pension plans. However, as currently drafted, the Proposed Amendments would eliminate
this possibility. This could have the unintended result of preventing pension plans, particularly
those of companies whose securities are included in a large number of indices, from investing
in investment funds that are benchmarked to an index in which their employer securities are
included, and forcing them to invest their assets through less diversified funds, index
derivative instruments or separately managed accounts. Not only could such a result be
contrary to the Department of Finance’s stated objective of diversification, there could be
added risks of investing in derivative instruments or costs of investing a plan’s assets though a
separate account that could negatively impact the amount of assets available to pay benefits
to plan members.
We appreciate that direct investments in the securities of a related party (such employer
securities) may cause a pension plan’s assets to become vulnerable. However, we believe that
the risks of investing in related party securities are lessened where such securities are acquired
through a diversified investment fund because, in such case, all investment decisions are made
at arm’s length from the pension plan by an investment manager that has a duty to act in the
best interests of the fund.5 In addition, the diversified nature of the investment fund mitigates
the risk of undue exposure to related party securities. We therefore request that the
Department of Finance retain an exemption from the Related Party Rule for related party
securities purchased through an investment fund on arm’s length terms and conditions, such
as the terms and conditions on which securities can be acquired by an investment manager at
a marketplace.
Finally, we support the 5 year transition period contemplated by the Proposed Amendments.
In particular, we believe this will be helpful when liquidating a non-compliant related party
investment.
~~~~~
We would be please to discuss the comments included in this submission. If you have any
questions, please do not hesitate to contact Katie Walmsley
([email protected]) at (416) 504-7018.
Yours truly;
PORTFOLIO MANAGEMENT ASSOCIATION OF CANADA
Katie A. Walmsley
President, PMAC
5
See for example section 116 of the Securities Act (Ontario).
Scott Mahaffy
Vice President & Senior Counsel
MFS Investment Management Canada
Limited
PORTFOLIO MANAGEMENT ASSOCIATION OF CANADA
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