Canada: Introducing Private Equity @ Gowlings - Inaugural Issue

Last Updated: October 4 2010

Edited by Alan James and Rob Blackstein


  • Changes to Canadian Pension Investment Rules
  • Where To Form Your Latin America Focussed Fund
  • PE Investing Trends

Changes to Canadian Pension Investment Rules
By Daniel Hayhurst

Pension reform has been a hot topic in Canada over the past several years.  One of the topics heavily debated in the context of pension reform has been the pension investment rules that govern Canadian registered pension plans.

In Canada, the pension investment rules generally are governed by provincial law, although many of those laws adopt the rules that apply to federally-regulated pension plans, as set out in Schedule III to the Pension Benefits Standards Regulations, 1985 ("Schedule III").  While there are some differences in the investment rules amongst jurisdictions, generally the rules include a qualitative aspect (in all cases, prudence), economic conflict-of-interest rules (addressing investments in or transactions with related parties), and a number of quantitative rules for investment. 

The focus of debate has been the quantitative rules for investment.

The 30% Rule:  One of the hotly-debated quantitative rules is the so-called "30% Rule", which (subject to a number of exceptions) generally provides that the administrator of a pension plan may not invest the assets of the plan in securities of a corporation to which are attached more than 30% of the votes to elect directors.  The larger Canadian plans that make direct investments have roundly criticized the 30% Rule indicating, among other things, that complying with this rule increases their costs of investing.   In a recent statement, the federal government announced that it has no present intention of changing the 30% Rule, stating that the 30% Rule "remains appropriate at this time for prudential reasons".  

Nevertheless, changes are afoot with respect to other quantitative rules. 

The 5%, 15% and 25% Rules:  Effective July 1, 2010, the federal government repealed the quantitative rules set out in Schedule III relating to real estate and Canadian resource properties (the so-called "5/15/25% Rule").  In doing so, express acknowledgment was made that, in a prudent person environment, these rules were considered "unnecessarily cumbersome and no longer required".  For those provinces that adopt Schedule III as amended from time to time, these changes took effect on July 1, 2010.  For other provinces, these changes will only be effective if and when the applicable provincial regulations are also changed.

The 10% Rule: Subject to a number of exceptions, the so-called 10% Rule prohibits a pension plan from investing or loaning more than 10% of its assets, on a book value basis, to any one person, any two or more associated persons, or any two or more affiliated corporations.   In a "Backgrounder" published by the federal Department of Finance ("Finance") in October 2009, it was announced that the 10% Rule would be amended to change it from a book value test to a market value test.  Finance also stated that a further exception to this rule would be implemented, namely to permit more than 10% of plan assets to be invested in pooled investments over which the sponsoring employer does not exercise direct control (e.g., mutual fund investments).   In the Regulatory Impact Analysis Statement published by Finance relating to the repeal of the 5/15/25% Rule, Finance stated that the changes to the 10% Rule, as well as a general prohibition on pension fund investment in the shares of its sponsoring employer, will be addressed in future regulatory amendments.

In August 2010, Ontario (the home jurisdiction of the majority of Canadian pension plans) announced that it intends to adopt the federal changes to the pension plan investment rules and continue to review the appropriateness of the 30% Rule for pension investments for Ontario plans.

Stay tuned.

Where To Form Your Latin America Focussed Fund
By Alan James

International sponsors of private equity and real estate funds may choose from a variety of different fund structures when forming investment vehicles to acquire assets in Latin America. An increasingly popular choice among sponsors involves the use of Canadian limited partnerships. 

While the laws of Latin American countries differ from country to country, many of these countries have adopted a civil law system that is quite similar in many respects. For instance, in many Latin American countries, limited partnerships may be formed under local laws. However, such limited partnerships are not ideal investment vehicles for private equity or real estate funds since such limited partnerships are not tax transparent and are subject to strict, and often out-dated, corporate governance rules. These limitations frequently lead international sponsors to establish their funds outside of Latin America, although the investment objective of the funds may be limited to investing in Latin America. 

A number of jurisdictions that are ordinarily preferred for forming funds may not be ideal if the fund sponsor intends to invest primarily in Latin America. For instance, many US States, such as Delaware, have well established laws that are modern and flexible and ordinarily highly suitable for forming private equity and real estate funds. However, since the form of entity most commonly used to establish such funds is a limited partnership, and since limited partnerships are separate legal entities in many such jurisdictions, this can be problematic when investing in Latin America. This is because, while a limited partnership may be tax transparent under the laws governing the jurisdiction in which the partnership is domiciled, a limited partnership that is a separate legal entity will often not be tax transparent in Latin America. To ensure optimal tax treatment, it is therefore often necessary to form the fund in a jurisdiction in which the limited partnership is not a separate legal entity.

For a variety of reasons, some investors are hesitant to invest in jurisdictions perceived to be tax havens, which discourages some international sponsors from forming limited partnerships domiciled in these countries, even if such limited partnerships would otherwise satisfy the Latin American requirements to ensure tax transparency.

Fortunately, all Canadian provinces have limited partnership legislation that provides for the establishment of limited partnerships. This provides international sponsors with an opportunity to form investment vehicles in reputable jurisdictions, such as Ontario, Québec, British Columbia or Alberta, that offer flow-through tax treatment to investors while providing such investors with limited liability protection. The legislative framework governing limited partnerships in most Canadian provinces is also quite flexible, allowing fund sponsors the ability to customize the terms of limited partnership agreements to suit their particular preferences. Furthermore, these Canadian limited partnerships are not separate legal entities and are therefore suitable for investing in some Latin  American countries since they preserve tax transparency.

Limited partnerships domiciled in Canada need not have a general partner that is incorporated under the laws of, or resident in, a Canadian province. Furthermore, since under Canadian tax law, income is typically taxed only to the extent that it originates from a Canadian source (in the case of passive income such as dividends, interest or royalties) or results from business carried on in Canada, most Canadian domiciled limited partnerships that carry on business primarily in Latin America and that earn no Canadian situs income, if structured properly, should not be taxed in Canada.

Easy to form, highly customizable, limited partnerships, in a stable, reputable jurisdiction with minimal tax consequences or administrative obligations may make Canada the ideal place to form your next Latin America-focused limited partnership.

PE Investing Trends
By Myron Dzulynsky

Only a few years ago, established sponsors could raise new PE funds with little resistance to the traditional 2 and 20 economic model.  While PE funds continue to raise money, the heady days appear to be over, at least for now, and the pendulum appears to have swung away from sponsors and in favour of investors.   This shifting paradigm has resulted in a number of investment models or approaches.

Pressure on Sponsor Economics

There has been overall pressure on the quantum of "base fees", being annual fees, often calculated with reference to either capital commitments or invested capital (or some combination of the two).  Such pressure has resulted in reductions to as low as 1%, or sliding scales depending upon fund or investor size.  In some segments of the market, there has been a more philosophical attack on base fees as being representative of a misalignment of risk/rewards.

Sponsors have also been pressured on the carry aspect of sponsor economics.  In some cases, the pressure has focussed on whole-of fund carry calculations rather than deal by deal, while in other cases the pressure has focussed on higher hurdle rates or lower carried interest percentages.

In an effort to ensure that PE funds attract sufficient capital from investors, it is becoming more common for sponsors to develop fund structures that accommodate multiple base fee calculation methods, with different groups of investors paying different fees based on their preferred fee model.

Finally, investors have increased scrutiny on fees receivable by sponsors and their affiliates, often demanding full management fee offsets.

Direct Investing

Canadian pension funds have long been world leaders in direct investments.  Some of the early leaders in this area continue to be active but have now been joined by some of the other parts of the very large pension fund fraternity.   The increase in direct investment typically comes, in part, at the expense of investing in funds. However, a number of pension plans have indicated that they will continue to invest in funds as part of their overall investment strategy, at least for the purposes of obtaining co-investment opportunities. 

While at this point, lacking the investment infrastructure of their larger brethren, medium and smaller pension funds have also indicated an increasing appetite for direct investing.   This appetite has been manifested through a combination of bespoke fund investments and the formation of consortia, or clubs, of like-minded investors.


Some pension funds are wholly or in part abandoning the PE sponsor model, choosing instead to retain asset or investment managers.   Pursuant to this model, compensation is typically based on a fixed percentage fee, often declining as assets under management increase.  While increasingly there may be some sharing of upside, it is a far cry from the 20% carry that is typical of traditional PE funds.

Absent a crystal ball, it is difficult to predict as to the future of institutional investing.  No doubt it will be influenced by a variety of factors.  However, it is clear that some institutional investors are actively considering whether the traditional PE fund model suits all, some or none of their needs.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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