By restricting the free flow of Canadian pension savings for over three decades, the Foreign Property Rule(FPR)directly cost Canadians billions of dollars in foregone returns in their pension and RRSP funds. For example, in a 1995 critique of the FPR, I placed the 1985-1994 cost at $20 billion for Canadian pension funds alone.

As is often the case with market restrictions, the indirect costs of the FPR may have been just as high, if not higher. For example, how do you put a cost on the lack of incentives for Canadian suppliers of pension fund and RRSP investment services (e.g., money managers, investment bankers, custodians)to become full-fledged participants in the global financial markets? Or, how do you put a cost on the design and implementation of all the convoluted pension fund and RRSP fund strategies put in place merely to circumvent the FPR’s limitation on investing outside Canada?

DOUBLE JEOPARDY
Maybe the greatest irony of all is the likelihood that the FPR did not even lower the cost of capital in Canada over the course of the last 30 years. There are two reasons to hold this view:

• Firstly, the FPR forced Canadian funds to hold more local securities than they would have on their own, causing them to extract a risk premium ‘surcharge’ on their Canadian holdings. • More importantly, the FPR sent a signal to foreign investors to stay away, leading them to under-invest in Canada relative to other developed capital markets.

Ironically, the FPR was also set to undo much of the good work Canada did during the 1990s to reform the finances of the Canada Pension Plan(CPP). The cornerstone of CPP reform is the build-up of a financial reserve fund that will eventually finance 25% of future benefit payments, with the other 75% continuing to come from future payroll deductions.

Clearly, the size of future payrolls depends heavily on the future health of the Canadian economy. The FPR would have forced most of the financial reserve fund to be invested in the Canadian economy, and thus also be dependent on the Canadian economy’s future health. From a risk management perspective, such a ‘double jeopardy’ makes no sense at all.

With the complete elimination of the FPR in the recent budget, all of these costs, inefficiencies and unnecessary risks have been swept away. As a result, fund return enhancement and diversification strategies can now be implemented without any restrictions on foreign investing. The Canadian investment services industry must now become globally competitive. Convoluted, expensive FPR-circumvention strategies have lost their rationale. Foreign investors are already looking at Canadian financial markets with renewed interest. The CPP Investment Board can now devise investment strategies for the CPP reserve assets which take into account the reality that the CPP’s biggest assets continue to be future payroll deductions for Canadian workers. For all this, federal Finance Minister Goodale deserves to be congratulated.

LESSONS LEARNED
Before we close the book on it, it is worth asking what the FPR tale has taught us:

• The FPR story confirms the truth in the dictum not to interfere with free market outcomes unless there are very, very good reasons.
• The second reality is that every long journey begins with a single step. It was over 20 years ago that a few of us sat together in a room and decided to begin a lobbying effort with the ultimate goal of abolishing the FPR.
• Lobbying for effective pension legislation and regulations should be seen as a never-ending challenge. Clearly, articulated positions and perseverance are key.

The final chapter of the FPR tale proves that every once in a while, lobbying efforts produce a major payoff. This is one of those times.

Keith Ambachtsheer is President of KPA Advisory Services Ltd., a strategic advisor to major pension plans around the world, based in Toronto, keith@kpaadvisory. com

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Copyright © 2020 Transcontinental Media G.P. This article first appeared in Benefits Canada.

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