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Focus: Potential change to 30% rule among considerations in pension realm

Focus
|Written By Julius Melnitzer

To a large extent, the investment space for pension funds has in the last decade reflected the exponential growth of the major Canadian funds.

“Low interest rates forced most of them to diversify their portfolios, so they all turned to things like direct investing, private equity, and infrastructure,” says Mitch Frazer, of Torys LLP in Toronto.

“And they’ve been investing in every corner of the Earth, from infrastructure in Australia to a lottery corporation in England and even airports in the Middle East.”

As it turns out, pension funds’ needs are a particularly good fit for long-term investments.

“The payment arrangements on many infrastructure projects, for example, are a good match to pension funds’ liabilities,” says Kathryn Bush of Blake Cassels & Graydon LLP.

As their returns show, the funds have been doing a good job with their expanded mandate.

“About 10 or 12 Canadian pension funds, like Teachers, OMERS, CPPIB, and the Caisse, are major players who are to a degree the envy of pension funds around the world,” says Frazer, naming some of the largest funds.

Indeed, investment professionals from around the world are checking out the Canadian pension scene.

“We’ve got the best governance structure anywhere and we subject our funds to significant scrutiny,” he says.

As it turns out, the Canadian funds had little choice but to look abroad.

“With the billions of dollars these funds have to invest, global investment was the only answer,” says Frazer.

“They’ve moved from making more direct investment to setting up their own private equity funds and to acquiring stakes in major entities, either on their own or by partnering with each other or other major players.”

It’s not inaccurate, then, to classify Canada’s big funds as major economic players.

“Their activities are bringing major attention to the Canadian economy as a whole, as well as paving the way for other Canadian companies to invest globally,” says Frazer.

To be sure, there are still limitations on pension fund investment. “The biggest one is the 30-per-cent rule, which provides that pension funds may not own more than 30 per cent of the shares in a corporation that are eligible to vote for directors,” says Frazer. “That’s one of the reasons why you see individual funds partnering with others.”

The 30-per-cent rule, however, is currently under review at the federal level.

“The federal government formulated the rule well before public sector plans started making direct investments,” says Frazer.

“The theory was that pension funds were there to provide a long-term stream of income and were not meant to be active investors.” Nowadays, however, many of Canada’s large funds have hundreds of investment professionals dedicated to ensuring they maximize the returns to beneficiaries.

“So there’s an interesting debate about whether the rule should be modified,” he says.

“What we might see are exemptions and thresholds that preclude the rule’s application, particularly to larger funds.”

Ontario, for example, has already implemented an exemption to the 30-per-cent rule for funds investing in the province’s infrastructure.

Still, Frazer cautions, the rule may not change or may remain in place only for offshore investments. “The most likely outcome, I believe, is that the 30-per-cent limit will be increased subject to stepped-up fiduciary duties,” he says.

In another development, governments are encouraging asset pooling among the funds over which they have jurisdiction.

“Ontario, for example, has enacted such legislation, and I think you’re going to see the Ontario Pension Board and the WSIB [Workplace Safety & Insurance Board] pooling their assets to turn two $20-billion funds into a single $40-billion fund,” says Frazer. “It can work out well because a $20-billion fund is mid-size, but $40 billion gets you to a whole other level and leaves more room for diversification.”

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