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© Copyright 2000 Rogers Media. The following article first appeared in the July 2000 edition of
BENEFITS CANADA magazine.
Links to good governance
Too few pension plan sponsors understand how to improve their plan governance. There is help
available though.
By Kathy Byles
Imagine yourself as a pension plan sponsor or trustee being challenged over the performance of your plan
and how it's being run. As our population ages and more people focus their attention on the state of their
pensions, the potential for this scenario will grow.
Pension governance is promoted within the industry as a way to avoid or refute accusations of improper
management. Generally, the term refers to a process or structure that lets a plan sponsor direct and manage
the affairs of the pension plan in accordance with statutory requirements, and in the best interest of plan
participants.
In 1998, the Senate Standing Committee on Banking, Trade and Commerce issued a report on the governance
practices of pension plans. The report recommends that all pension plans in Canada above a specific asset
threshold--still to be determined--adopt a set of governance guidelines and report annually to plan members
on how they comply with or exceed these guidelines.
According to the report:
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Pension plans should have a clear mission.
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Pension plan administrators/ trustees have a principal fiduciary duty to plan beneficiaries.
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Responsibilities/accountabilities should be allocated clearly and roles should be defined.
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Performance should be measured and reported.
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Pension plan administrators/ trustees should be qualified and knowledgeable.
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Governance self-assessment should take place.
Enacting these principles could force a sea change in attitude among pension plan sponsors, many of whom
don't have the resources or staff to deal with the wide ranging changes that may be required. As a result,
an increasing number of employers are turning to their custodians for help.
Today, custodians are being challenged to assist in the administration and governance of pension plans.
Plan sponsors are looking for help with portfolio risk management and governance issues. They want
assistance in monitoring compliance with their policy guidelines, and need immediate access to this
information.
There are at least three areas where custodians can help support pension governance programs: performance
measurement, investment compliance reporting and proxy voting (exercising the voting rights that come with
share ownership on behalf of individual pension plan members).
MEASURING PERFORMANCE
Administrators have always recognized the need and importance of measuring and assessing the investment
performance of their pension fund. Tough decisions about investment strategies, asset allocation and the
appointment of investment managers must continually be made and evaluated.
It's important to confirm if appropriate performance reviews are being conducted, who receives the reports,
if they are being read and understood, how frequently they are delivered and in what manner.
The custodian is familiar with each account and has direct electronic access to the portfolio and its
history. That puts them in a position to provide necessary information through investment analytical
programs.
As plan assets grow, the ability to handle non-standard transactions, as well as faster and more flexible
analysis, requires direct access to the data. Custodians do this for a number of plan sponsors. They can
also provide the experience and knowledge to put returns in the context of the overall market.
Many custodians also provide performance measurement information online. Rather than wading through stacks
of paper to assess results, plan sponsors can download data and make their own reports.
INVESTMENT COMPLIANCE
Pension investment regulation is complex and can place a heavy burden on pension administrators and
investment committees. Although the responsibility for compliance ultimately rests with the plan sponsor,
the investment manager has the front-line responsibility of ensuring that the selected investments are in
compliance with the plan's guidelines and pension investment regulations.
Many investment managers have online reporting systems that alert them if a non-compliant trade is
processed. Corrective action is then taken in time. In addition, most custodians have the technology to
provide reports on investment compliance. While it's possible to bring the whole portfolio together from
across multiple managers to assess compliance, these reports are issued on an
after-the-fact-basis--analyzing data that is already in the portfolio.
Custodians cannot always prevent improper transactions from occurring, but in most cases they can report on
guideline breaches. Many also have in-house systems and analysts that can review the portfolio periodically
and report non-compliance matters. In many cases, these reports can be produced as frequently as required.
Reports come with a cost but it's low compared to the risks associated with non-compliance, or of putting
internal review and control mechanisms in place. Some sponsors find that their pension governance programs
also require periodic reports from an independent adviser.
PROXY VOTING
Today, a handful of institutional investors--mainly pension funds--own half the equity of North American
publicly traded companies and account for close to three-quarters of the trading value on Canadian and U.S.
stock exchanges.
Indeed, institutional investors comprise 80% of the value of all trading on the Toronto Stock Exchange. At
the end of 1999, Canada's 100 largest pension funds held more than $480 billion in assets. Clearly, the
power these funds exert on Canadian stock exchanges is enormous.
Pension funds face tax consequences on any amounts in excess of current foreign property limits, which were
recently increased to 25%. This rule presents a problem for some of the larger pension funds because as
their assets increase, it becomes more difficult to sell. The sale of significant blocks of shares may
actually depress the value of the securities, making some holdings almost illiquid.
In these circumstances, the proper exercise of voting rights becomes an important strategic tool. By taking
an active interest in the management of the companies it holds, a pension plan sponsor can maintain the
value of its holdings by voting for the business strategies it thinks will add the most value.
In the past, voting was often left in the hands of custodians, who would generally vote in favour of
management unless directed otherwise. The assumption was that if the plan sponsor or investment manager
disagreed with a management style or policy, the holdings would be sold.
Selling out, rather than staying and having an effect on how a business is run, is sometimes referred to as
voting with your feet. But this assumption no longer holds. The proxy vote is becoming increasingly
important.
Many proxy votes require direction from the authorized investment manager or the plan administrator. In the
absence of direction, a proxy vote is not submitted.
Normal practice is for pension plan administrators or trustees to delegate proxy voting to the investment
managers. However, this does not relieve the plan administrator of responsibility for proxy voting. As with
any other agency appointment, the administrator has an obligation to supervise the investment manager in a
prudent and reasonable manner.
As more plan administrators and trustees become aware of their fiduciary obligation to vote proxies, they
are questioning their custodians and investment managers about proxy voting procedures and reports.
Custodians can help by monitoring how investment managers direct a vote, and by determining which fund
managers are not actively directing proxy voting.
In the end, responsibility for good governance rests with the plan sponsor and trustees. However, a good
custodian can go a long way in providing the necessary information and tracking the mechanisms needed to
demonstrate how well the plan sponsor's governance program is working.
Kathy Byles is director of compliance, Royal Trust Global Securities Services in Toronto.
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