Canada’s Pension Benefits Standards Act(the “PBSA”)provides that:
…the administrator of a plan shall not, directly or indirectly, invest the monies of the plan in the securities of a corporation to which are attached more than 30% of the votes that may be cast to elect the directors of the corporation(the “30% Limit”).
The 30% Limit generally applies to most investments in corporations, subject to certain limited exemptions. Through harmonization, most provinces have adopted this rule.
All pension plans in Ontario are subject to the 30% Limit, whether a plan is public or private and regardless of the nature of a plan’s investment program, asset size, governance or investment management capability. Furthermore, all pension plans in Canada operate under similar restrictions related to the 30% Limit. There are variations in some details, but the differences, although not minor, do not have as significant an impact on pension investments as does the overall effect of the 30% Limit.
The 30% Limit has been in effect since the 1980s, before NAFTA and globalization. At that time, pension funds were largely passive investors, the pension pool was much smaller relative to the economy as a whole and investment opportunities were far less competitive globally. For instance, in 1985, the OMERS fund was valued at $7.5 billion and invested 70% in debt. Today, OMERS is a $50 billion pension plan with the goal of meeting at least 70% of its funding obligations from investment returns with the remaining 30% from employee/employer contributions. To achieve this goal, OMERS must pursue a more active investment strategy and increase its holdings in private assets which more closely match its liabilities. From a commercial perspective, the 30% Limit prejudices the ability of plans like OMERS to invest and meet the goal of matching long-term obligations with superior risk-adjusted returns to secure the pension promise.
The 30% Limit is a disincentive in attracting investment partners because of the complexity and costs associated with implementing complex structures and maintaining regulatory compliance. The rule forces pension plans to take a sub-optimal proportion of desirable investment opportunities and prevents them from exercising share purchase options at the optimal time. The 30% Limit inevitably results in co-investors demanding a price for their tolerance of the complex structures or causes pension plans to cede commercial rights previously negotiated.
Many attempts have been made to change the 30% Limit. In 2001, three national industry associations recommended that the 30% Limit(plus various other quantitative restrictions)be replaced by the prudent person concept. This concept requires that plan administrators, their employees and their agents exercise the care, diligence and skill in the investment of the pension fund that a person of ordinary prudence would exercise in dealing with the property of another person. The large pension plans have also made several representations to governments and regulators to rely on the prudent person rule rather than quantitative constraints.
Governments should not fear the elimination of the 30% Limit. What will remain in place is an extensive framework of controls which will continue to regulate all investment activities of pension plans. In addition to the 30% Limit, the PBSA has restrictions on conflicts of interests and prohibitions on related-party transactions. Further, pension law requires plan administrators to exercise prudence and the relevant skill and knowledge when investing plan assets. The administrator is also required to establish written statements of investment policies and procedures and to submit annual audited financial statements to the regulator. These limits and controls are all in addition to laws that have been established for social, economic or other public purposes such as the Competition Act, the Securities Act in each of the provinces and the myriad of other laws and regulations which impact investments of a pension plan on a day-to-day basis.
The time is right for a modernization of the regulations which severely limit the ability of Canadian pension plans to optimize their returns and hence meet the pension promise. Many jurisdictions successfully rely primarily or exclusively on the prudent person rule as the standard for pension investments, including the United States, the United Kingdom, Australia and the Netherlands. The time has long passed for Canada and the provinces to fall into line with their trading partners.
Michael Nobrega is the president and chief executive officer of OMERS