Canada: Prudent Investment Practices For Derivatives

Financial Services Commission of Ontario publishes draft investment guidance note for public consultation

On October 24, 2014 the Financial Services Commission of Ontario (FSCO) published for public consultation a draft investment guidance note entitled Prudent Investment Practices for Derivatives – IGN-002 (Note). The Note, a copy of which can be found here, applies to pension plans registered in Ontario.

The Note is intended to provide guidance to Administrators with respect to prudent investment practices related to derivatives including guidance to assist Administrators who indirectly invest in derivatives through a pooled fund or master trust arrangement that invests some of its assets in derivatives. The principles outlined in the Note should also be applied to repurchase agreements.

The Note sets out FSCO's expectations in relation to the Administrator's standard of care of a prudent person in the administration of a pension plan and how this fiduciary standard must be met in respect of investments in derivatives, specifically: (i) Documentation, (ii) Risk Mitigation, (iii) Risk Monitoring as well as outlining risk management practices (RMP) and due diligence procedures for investment in derivatives through pooled funds. Each is discussed in turn below.

DOCUMENTATION

The Administrator of a pension plan must ensure that the plan's Statement of Investment Policies and Procedures (SIP&P) documents the authorization for the use of derivatives including a listing of each category of derivative and the proportion of the fair value of the plan's portfolio that may be invested in derivatives. The extent and terms to which assets of the plan may be pledged as collateral must also be clearly set out in the SIP&P.

The Administrator must establish RMP documentation, review it annually and update it promptly for any change of statutory requirements and investment processes. RMP documentation must include:

  • the uses and strategies to which derivatives will be put in light of the prudent person rule, the overall investment objectives, risk appetites and risk tolerances of the fund and the nature of the plan benefit liabilities, taking into consideration the funding and solvency of the plan and the ability of the plan to meet its financial obligations
  • risk management considerations which include, among other things, descriptions of the main types of risks associated with derivatives positions, risk measurement methodology, risk mitigation strategies, timely risk monitoring and reporting as well as the establishment of specific and unambiguous limits on derivative activities
  • identifying the individuals or organizational units authorized to trade, settle, value and/or manage the risk created by derivatives positions having regard to segregation of responsibilities and management oversight

RISK MITIGATION

The Note outlines a number of risk mitigation best practices that can be applied by market participants in respect of non-standard OTC derivatives (defined to mean a derivative that does not trade on an exchange and includes swaps, options and swaptions), exchange traded derivatives and OTC derivatives, whether the investment is done directly by the Administrator or through delegation to an external investment manager. In cases where an external manager is used the Administrator must conduct "appropriate operational due diligence....to ensure that appropriate RMP are employed". FSCO's expectations regarding risk mitigation include:

  • Administrators should use independent value measurement methodology for non-standard OTC derivatives and should not rely on counterparties as the exclusive source of derivative values
  • appropriate legal documentation with appropriate collateral requirements should be used with counterparties of non-standard OTC derivative trades and repos
  • appropriate legal advice should be obtained and appropriate legal due diligence completed, including consideration of the ability to contain potential losses
  • the Administrator will not enter into non-standard OTC derivative or repo contracts with a counterparty or associated counterparties where the exposure or mark-to-market position of all contracts with the counterparty or associated counterparties is greater than 10% of the fair value of the fund's investment assets (net of investment liabilities), or such other limit as may be prudent
  • compensation policies are set so as to discourage excessive risk-taking

RISK MONITORING

The Note reinforces that although derivatives are subject to the same risks as other investments, because of the lack of transparency and the leverage effect of some derivatives, more precise assessment and more frequent monitoring of such risks are required including an evaluation of market risk leverage, liquidity risk, counterparty and basis risk as well as operations and systems risk. FSCO's expectations regarding risk monitoring include:

  • appropriate mechanisms in place for precise and frequent monitoring of the risks associated with all investment positions, including derivatives
  • fund portfolio monitoring with a view to triggering loss mitigation mechanisms
  • initial approval and ongoing review of counterparties in non-standard OTC derivatives positions performed by persons independent of those engaging in derivative transactions
  • counterparties who suffer a credit rating downgrade by an independent credit rating agency are automatically reviewed
  • ongoing monitoring is conducted to ensure that the exposure or mark-to-market position of all non-standard OTC derivative and repo contracts with a specific counterparty or associated counterparties does not exceed 10% of the fair value of the fund's investment assets (net of investment liabilities), or such other limit as may be prudent in the circumstances

POOLED FUNDS AND MASTER TRUSTS

The Note emphasizes that notwithstanding that a pension fund invests in derivatives indirectly through a pooled fund or master trust arrangement it is still necessary for Administrators to implement appropriate risk management policies and procedures. Before deciding to invest in a pooled fund, Administrators should

  • review available relevant information or disclosure regarding the proposed arrangement
  • consider whether the operation of the pooled fund, as described in its constitutional documents, meets the standards set out in the Note
  • consider the suitability of any investment manager of the pooled fund assets
  • consider any risks associated with the lack of control over the investments in the pooled fund
  • having considered the above factors, consider the percentage of the fund, if any, that it is prudent to invest in the pooled fund; and
  • obtain such independent advice or expertise as is prudent and reasonable

If after due consideration, the Administrator decides to invest in the pooled fund, the Administrator should carry out such supervision or monitoring of the investment as is prudent and reasonable.

Similarly, where all investors in a Master Trust are all pension funds governed by pension plans that have related employers and sponsors, FSCO has an expectation that the investment in derivatives through the master trust, will be made in accordance with the Note.

Deadline for submissions on the Note is November 24, 2014. If you would like assistance in providing comments to FSCO please contact the author or your usual lawyer in BLG's Pension & Benefits Group.

About BLG

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.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Similar Articles
Relevancy Powered by MondaqAI
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions