Canada: Consolidation Of Ontario Public Sector Pension Plan Investment Management Function - Part II

Background

As noted in a previous issue of Pensions@Gowlings, in its Spring 2012 Budget (the Budget), the Ontario government announced its intention to improve efficiencies in the investment management of Ontario's defined benefit public sector pension plans (DB Plans) by pooling pension fund assets. Following the Budget announcement, the Minister of Finance appointed Bill Morneau as his special advisor in this matter. Following consultations with the industry, Mr. Morneau's report (the Report) was released on November 16, 2012.

Consolidation Recommendation

The Report identifies a "significant opportunity" for public sector pension funds to benefit from pooling assets through reduced duplication and costs, broader access to additional asset classes and enhanced risk management practices. Mr. Morneau projects potential cost savings of between $75 million and $100 million annually once a pooling framework is fully implemented. One of the principal sources of cost savings identified is in the investment management function itself, i.e., the internalization of significant investment management activities and the ability to negotiate lower investment management fees due to increased economies of scale. Mr. Morneau also sees internal investment and risk management as keys to improving control and potentially performance over the longer term, including through increased and more cost-effective access to alternative investment classes.

While the Budget contemplated that asset pooling might be achieved either by the creation of a new investment management entity or by having certain existing larger Ontario public sector pension plans take on this role, Mr. Morneau concludes that the creation of a new investment management corporation (notionally, Ontario Investment Management Corporation or OIMCo) is preferred.

Critical Design Considerations

Mr. Morneau's recommendations are subject to a number of stated critical design considerations:

  • Participating institutions must retain fiduciary responsibility and control over asset allocation.
  • OIMCo must create and offer a "family of unitized pooled funds" to ensure that asset allocations can be effectively implemented.
  • OIMCo must operate at arm's-length from government and be responsible to an independent and representative board of directors.
  • OIMCo must feature world-class governance, professional investment and risk management, competitive compensation and effective oversight.
  • OIMCo must achieve at least $50 billion in assets under management to support investments in a broad range of asset classes at the most competitive costs.

Mandatory Participation for Certain Clients, with Exceptions

In the Report, Mr. Morneau recommends that all Ontario public sector institutions with pension funds of less than $40 billion in assets be required to participate in the pooling framework, subject to limited exceptions. He also recommends that certain Ontario public sector non-pension funds, namely the Ontario Nuclear Funds, the Workplace Safety and Insurance Board insurance funds, and the Agricorp production insurance fund, be required to participate.

Exceptions would include:

  • Large Ontario public sector plans, including the Ontario Teachers' Pension Plan (Teachers), OMERS and the Healthcare of Ontario Pension Plan (HOOPP) with assets exceeding $40 billion; and
  • Any public sector pension plan that can negotiate an agreement-in-principle to transition to Teachers', OMERS or HOOPP prior to the establishment of OIMCo.

While Mr. Morneau recommends their inclusion, he notes that the Ontario government could determine that exceptions might include:

  • Certain public sector, jointly-sponsored pension plans, where the plan is large enough to achieve economies of scale in traditional asset classes;
  • Certain municipal plans that are not currently managed by OMERS; and
  • Public sector pension plans in the Ontario electricity sector, which the Report indicates have been in discussions with regard to a potential merger to create an electricity sector plan.

The Report recommends that, for those clients whose participation in OIMCo is mandatory, their participation be mandated for a minimum number of years. This would ensure that OIMCo has a sufficient and stable asset base in its formative years to enable it to reach its full potential. Mr Morneau anticipates this period would be seven years. Following this period, institutions should be permitted to move some or all of their assets out of the pooling framework if they so choose.

Voluntary Participation for Certain Clients

The Report recommends that:

  • Ontario public sector institutions that are not mandated to participate;
  • Broader Ontario public-sector endowment funds and supplemental employee retirement plan funds; and
  • Ontario public sector defined contribution pension plan funds (DC Plans)

should be permitted to voluntarily access the services of OIMCo on a "cost-recovery" basis. In the case of DC Plans, this would be at a future time when the capacity of OIMCo so permits. DC Plans would be more complex to administer, given that their investments generally are member-directed.

Other recommendations

The Report includes a number of other specific recommendations, including with respect to:

  • The composition of the OIMCo board (the Board), Board member competency, client representation and Board independence;
  • The implementation of transitional arrangements with certain client investment management teams and their ultimate transition to OIMCo;
  • The compensation policies of OIMCo to ensure that compensation for directors is comparable to "like pension funds" and that management compensation (to be overseen by a Board compensation committee) is competitive to external benchmarks;
  • The need for OIMCo to be able to offer cost-effective advice on asset allocation decisions to participating clients;
  • The "freezing" of individual client total investment management costs during the initial three-year period, and providing statutory protection to fiduciaries from fiduciary liability arising from the legislated transfer of investment management functions to OIMCo;  
  • The need for OIMCo to develop and adhere to a clearly stated investment philosophy, robust risk-management framework, transparent procurement policy and ethical governance and management guidelines; and
  • The cost of creating OIMCo being financed through a loan extended by the Ontario government to OIMCo of up to $50 million. The loan would be repaid through cost savings realized over time.

Other Observations

In the Report, Mr. Morneau observes that:

  • Some stakeholders indicated to him that the consolidation of plan administration services was as important as the consolidation of investment management services, and that his recommendations should pose no obstacle to the voluntary consolidation of administrative functions by public sector pension plans.
  • "[A]dditional actions may be required to ensure the sustainability of Ontario's public-sector pension plans, but they are beyond the scope of this report."

Next Steps

The Ontario government has indicated that the next step in the process is for affected plans, affected stakeholders and others to provide feedback on the Report. Such feedback will be used by the government to assess the Report and develop an implementation plan. At the date of publication, no deadline has been announced for providing such feedback.

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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