Canada: Morneau Report: Facilitating Pooled Asset Management For Ontario’s Public Sector Institutions

In the 2012 Ontario Budget, the Government of Ontario announced its intention to create a framework that would facilitate the pooling of pension fund assets for investment management purposes. Mr. Bill Morneau was appointed to determine the advantages of pooled asset management for Ontario's public-sector pension funds and, if appropriate, a path to implementation.

On Friday, November 16, 2012, the government released Mr. Morneau's recommendations for implementing pooled asset management for Ontario's broader public-sector institutions, which are set out in a report dated October 2012.

For ease of review, included is a listing of those recommendations without commentary.

In its November 2012 communication, the Ontario Ministry of Finance is asking individual plans, affected stakeholders and other individuals to provide feedback on the recommendations.

The proposed implementation timeline is as follows:

January 1, 2014 – Establishment of the new Ontario Investment Management Corporation (the "Corporation")

January 1, 2014 - June 30, 2014 – Negotiation and Assumption of Assets - External Asset Management still in place

July 1, 2014 - December 31, 2015 – Investment Management Consolidation – the number of external managers is reduced

January 1, 2016 - December 31, 2017 – Internal asset management capacity building

January 1, 2018 – Full operation with internal management on a not-for-profit basis where appropriate

January 1, 2021 or perhaps later – Participating institutions would be free to choose to withdraw from the pooling framework.

The theory behind the Morneau recommendations is that implementation of a pooled asset management framework would reduce duplication and costs, broaden access to alternative asset classes, enhance risk management practices and support more diversified portfolios. Morneau estimates that the pooling would achieve potential savings of between C$75- to C$100-million annually and envisages mandating participation in the new pooled asset manager overseeing well over C$50-billion in assets, rather than requiring movement into an existing fund.

The pooled structure would offer a family of unitized pooled funds and would:

  • permit participating institutions to retain fiduciary responsibility and control over asset allocations,
  • operate at arm's length from government, and
  • have "world-class" governance, professional investment and risk management.

The Morneau Report cites examples both in Canada (AIMCo, bcIMC, Caisse de dépôt, OMERS, Teachers' and PSPIB) and internationally (London Pensions Fund Authority, Sweden and NY) of pooled or very large public-sector pension asset managers in existence or in development. The Morneau Report notes that both OMERS and Teachers' currently have authority to offer investment management services and that OMERS has implemented a structure to manage third-party assets.

Morneau's recommendation is that all public-sector institutions with pension funds of less than C$40-billion in assets under management and the Ontario Nuclear Funds, the Workplace Safety and Insurance Board investment funds and the Agricorp Production Insurance Fund be required to join the new pooled arrangement. The C$40-billion threshold results in Teachers', OMERS and HOOP being excluded from the new pooled structure and the report notes some other possible exceptions to the consolidation, including OPSEU/OPTrust and CAAT (both of whom recently announced that they have reached agreement with the government to be excluded), the TTC, various municipal-sector plans, and participants in the electricity sector. Morneau also recommends that a statutory indemnity be provided to current fiduciaries of the affected pension and investment funds with respect to any fiduciary liability that may arise from the legislated transfer of investment management responsibility to the new asset manager. Further, Morneau suggests that any public-sector pension plan can negotiate an agreement with Teachers', OMERS or HOOPP to join one of those plans prior to January 1, 2014 and therefore be excluded from the consolidation.

The recommendations also permit non-mandated public institutions, broader public-sector institutions' endowment funds and supplemental employee retirement plan funds to join the pooling arrangement on a "cost-recovery" basis. The report also suggests that defined contribution arrangements would be permitted access to the pooling at what appears to be a later date in order to give the new management corporation the necessary time to develop this capacity.

Morneau notes that voluntary consolidation of plan administration was something requested by some stakeholders and he saw no obstacles to such consolidation.

Morneau recommends that the board of the management corporation should have 11 representatives including a chair. Three directors should be nominated by client groups and two directors should be nominated by plan members (represented by labour officials). Six, including the chair, should be selected solely based on professional qualifications, and appointed by the board. He discusses balancing the need for stakeholder representation, expertise and independence from government on the board and notes that all board members would be fiduciaries and the government should retain the right to require a director to resign for cause and, "in extreme cases", to dismiss the entire board.

Finally, it is recommended that the government ensure that costs during the period 2014-2016 be not greater than the investment management fees that the institution would incur without the consolidation, unless the asset allocation changes. From 2017 on, the operating costs would be charged on the basis of asset-allocation decisions and the direct cost of investments. The report also recommends that the government finance start-up costs (through a loan of up to C$50-million) which apparently could subsequently be recovered from savings realized through negotiation with, and consolidation of, external investment managers.

RECOMMENDATIONS FROM THE PENSION INVESTMENT ADVISOR REPORT, OCTOBER 2012

Recommendation 2-1: Pooled asset management should only be undertaken if it achieves sufficient scale to support the development of cost-effective internal investment management teams and to attract and retain world-class leadership. The estimated scale threshold is at least $50 billion.

Recommendation 3-1: The Province should introduce legislation to establish a new pooled asset manager to facilitate pooled asset management for Ontario's smaller public-sector institutions, hereafter referred to as the Ontario Investment Management Corporation ("the Corporation").

Recommendation 3-2: The government should legislate the participation of public-sector pension funds that are expected to realize appreciable benefits from pooled asset management.

Recommendation 3-3: The government should include provisions in legislation that would indemnify current fiduciaries from any fiduciary liability arising from the legislated transfer of investment management responsibility to the Corporation.

Recommendation 3-4: All public-sector institutions with pension funds of less than $40 billion in assets under management should be compelled to pool their assets with the Corporation, subject to limited exceptions.

Recommendation 3-5: The Ontario Nuclear Funds, the Workplace Safety and Insurance Board investment funds, and the Agricorp Production Insurance fund should be compelled to participate in the pooling framework.

Recommendation 3-6: All public-sector institutions whose assets are not mandated to be managed by the Corporation should be permitted to voluntarily access the services and individual asset classes available through the Corporation, subject to reasonable terms and conditions, and on a "cost-recovery" pricing basis (i.e., voluntary participants would experience pricing on the same basis as mandated participants).

Recommendation 3-7: Broader public-sector institutions should be permitted to voluntarily access the services available through the Corporation for endowment funds and supplemental employee retirement plan funds, subject to reasonable terms and conditions, and on a "cost-recovery" pricing basis. The Corporation should be equipped to accommodate these types of funds immediately upon its establishment.

Recommendation 3-8: Any public-sector pension plan that can negotiate an agreement-in-principle to transition its assets to an existing large Ontario asset management entity (i.e., Teachers', OMERS, or HOOPP) with a signed memorandum of understanding prior to the establishment of the Corporation should not be compelled to pool its assets with the Corporation.

Recommendation 3-9: The Corporation should be structured to facilitate the management of defined-contribution assets. Defined-contribution funds would be permitted to pool assets with the Corporation on a voluntary basis, but only at such time as the capacity of the Corporation permits.

Recommendation 3-10: The Corporation should develop the capacity to offer cost-effective advice on asset allocation decisions to participating institutions.

Recommendation 3-11: The legislation establishing the Corporation should clearly define the relationship between the Government and the Corporation, limiting control and influence to specific areas, including accountability and transparency through reporting requirements. The legislation should include a mandate clarifying that the Board has a duty to serve and act in the best interests of its clients.

Recommendation 3-12: The board of directors should have 11 members including a chair. Three directors should be nominated by client groups of the Corporation and two directors should be nominated by plan members. Six, including the chair, should be selected solely based on professional qualifications, and appointed by the board.

Recommendation 3-13: All candidates for the board would be screened by the nominating committee to ensure they meet minimum qualification standards for eligibility before appointment, and selected based on the decision of the nominating committee as to fit for the Corporation board.

Recommendation 4-1: The government should commit to ensuring that in the first three years of the Corporation's operation, participating institutions would not face increased total investment management costs, except in cases where an institution changes its asset allocation. Beyond this three-year period, investment costs should be charged to participating institutions on the basis of asset-allocation decisions and the direct costs of investment.

Recommendation 4-2: Once the Corporation is established, anticipated within approximately six months following the passage of legislation, it should have arrangements in place to transfer the internal investment teams from participating institutions to support the early stages of implementation.

Recommendation 4-3: Like existing large pension plans, the Corporation should not be subject to the compensation bands of traditional public-sector entities. Compensation for directors should be comparable to other like pension funds and compensation for management should be competitive to external benchmarks. Furthermore, management compensation arrangements and perquisites should be overseen by a board compensation committee.

Recommendation 4-4: The Corporation would need to employ a unitized fund structure, providing the flexibility to accommodate the distinct asset-allocation decisions of each participating institution.

Recommendation 4-5: The Corporation, immediately after establishment, would develop and adhere to a clearly stated investment philosophy, robust risk management framework, transparent procurement policy and ethical governance and management guidelines.

Recommendation 4-6: After a cooling-off period, participating institutions should be free to withdraw from the pooling framework, as directed by their trustees or governors. This cooling-off period would give the Corporation time to negotiate lower investment management costs, rationalize external investment managers, and develop internal investment expertise. It should also allow for a significant period of full operation and a more accurate assessment of the Corporation's performance.

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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