On September 19, 2014, the federal Department of Finance announced the third tranche of proposed amendments (Proposals) to the Pension Benefits Standards Regulations (PBSR). The Proposals support amendments to the Pension Benefits Standards Act, 1985 (Canada) (PBSA) that were passed in 2010 but are not yet proclaimed in force. They would also give effect to the federal government’s separate proposals to modernize the investment rules applicable to pension plans, announced in conjunction with the 2010 changes to the PBSA.
The Proposals can be divided into three categories: amendments to the portions of the PBSR comprising the Federal Investment Rules (FIR), which will affect all federally registered plans as well as all plans registered in Ontario, British Columbia, Alberta, Saskatchewan, Manitoba and Newfoundland & Labrador (which have incorporated the FIR, as amended from time to time, in their provincial pension legislation by reference); amendments affecting the design and day-to-day administration of federally regulated plans or portions of plans only; and technical amendments to the Pooled Registered Pension Plan Regulations,Solvency Funding Relief Regulations, Solvency Funding Relief Regulations, 2009 and Canadian Press Pension Plan Solvency Funding Relief Regulations, 2010. This bulletin focuses on the first two categories.
If enacted, the Proposals will come into force at a later date to be proclaimed. In the meantime, the Proposals will be formally released for public comment with official pre-publication in the Canada Gazette on September 27, 2014. Stakeholders may make representations on the proposals within 30 days of their publication in the Canada Gazette.
Amendments to the Federal Investment Rules
As noted above, these amendments will apply to federally registered plans as well as plans registered in Ontario, British Columbia, Alberta, Saskatchewan, Manitoba and Newfoundland & Labrador.
Subject to enumerated exceptions, section 9 of Schedule III under the PBSR currently prohibits an administrator from lending or investing more than 10% of a pension fund’s moneys by book value in respect of any one person, group of affiliated corporations or group of associated persons (10% Rule). The Proposals will recalibrate the 10% limit from book value to market value and will clarify that the 10% test is based on the aggregate of all of the plan’s loans and investments in a person or group. Many Statements of Investment Policies and Procedures (SIP&Ps) refer to the current book value limit. If the Proposals are enacted, administrators will have to revise their SIP&Ps to reflect the new market value threshold.
The Proposals are not clear whether the new 10% limit applies only to new investments or whether it also applies to existing investments that, while compliant with the 10% Rule at the time that they were made (whether by book or market value, as the case may be), became non-compliant because their market value increased or the market value of the remainder of the pension fund decreased. If the new rule is meant to apply to aggregate investment holdings as opposed to new investments only, the Proposals provide no window in which an administrator may liquidate all or a portion of an existing investment that becomes non-compliant by virtue of subsequent fluctuations in market value. To complicate this risk further, for certain types of investment (such as a single piece of real estate), it may not be possible to quickly liquidate only part of the investment in this situation to bring the plan back into compliance. It is expected that stakeholders will raise this uncertainty in the consultations following publication of the Proposals.
Member-directed defined contribution and additional voluntary contribution accounts
The Proposals will clarify that a SIP&P need not pertain to the portion of a plan relating to a “member choice account”: that is, an individual account under which a member is responsible for making investment choices either under a defined contribution (DC) component or in respect of additional voluntary contributions.
The FIR do not currently specifically contemplate how the 10% Rule is to operate in the context of a member choice account. The FIR will be amended to clarify that the administrator must not permit a member to invest more than 10% of the market value of a member choice account in any one person, group of affiliated corporations or group of associated persons, subject to the same general exceptions as applicable to a plan, and subject to a further exception if the member choice account is invested in an investment fund that complies with the so-called 30% rule, which prohibits an administrator from investing assets of a pension plan in securities to which are attached more than 30% of the votes that may be cast to elect directors of a corporation. The government’s rationale for broadly excepting all investment funds from the 10% Rule as it relates to member choice accounts, so long as they do not hold more than 30% of the voting securities of a corporation, is unclear.
Related party transactions
The Proposals will amend the FIR to prohibit direct loans to a “related party” (as defined by the FIR) or direct investments in securities of a related party. These stricter limitations will replace the current exception allowing the administrator to invest in securities of a related party acquired on a “public exchange.” A new provision will permit indirect investments in a related party if they are held in an investment fund or segregated fund in which investors other than the administrator and its affiliates may invest and that otherwise complies with the investment restrictions applicable to a plan under Schedule III to the PBSR (where the bulk of the FIR appear).
The Proposals will also delete the current provision of the FIR that permits administrators to enter into a transaction with a related party if its value is nominal or if it is immaterial to the plan. Administrators will need to review and reconsider the provisions of their SIP&Ps dealing with nominal value or immaterial transactions.
The deletion of the nominal value/immateriality exception, coupled with the more stringent related party restrictions summarized above, means that administrators will no longer be able to invest directly in related parties, even if the investments are nominal and immaterial. Given the broad definition of related party, administrators may need to re-evaluate their plans’ current investment holdings and liquidate nominal positions that were otherwise permitted under the current rules.
The Proposals provide that an administrator has five years to liquidate a non-compliant related party investment beginning from the later of the date when the Proposals come into force or the date that an investment becomes a non-compliant related party investment.
Finally, the Proposals will clarify that the administrator of a plan may engage the services of a related party for the operation or administration of the plan so long as the engagement is on market terms and conditions (or better).
Modernization of references to collective investment vehicles and financial markets
Replacement of “mutual fund” or “pooled fund”
The Proposals will replace the current definition of “mutual fund” or “pooled fund” in the PBSR (which is used throughout the FIR) with the broader concept of an “investment fund.” The new definition will specifically include funds established by a corporation, limited partnership or trust, the purpose of which is to invest contributions of two or more investors.
Replacement of “public exchange”
One exception to the 10% Rule relates to investments in a fund that replicates composition of a widely recognized index of a broad class of securities traded at a public exchange. However, the term “public exchange” is currently defined narrowly. It includes defunct exchanges, such as the Spokane and Salt Lake City Stock Exchanges, but excludes other significant exchanges, such as the Tokyo Stock Exchange, the Hong Kong Stock Exchange and the Deutsche Börse. The term will be replaced with a broader definition of “marketplace,” which encompasses any exchange as well as quotation and trade-reporting systems and other platforms through which derivatives are traded.
Design and Administrative Changes to Federally Regulated Plans
Separately, the Proposals make a number of changes to the PBSR meant to enhance or modernize certain concepts applicable in relation to federally regulated plans or portions of plans, including changes to give effect to the remaining 2010 amendments to the PBSA that remain unproclaimed in force. These include the following:
Variable benefits under DC components
Once the Proposals are enacted, federally regulated DC components may allow for annual variable payments pursuant to a formula similar to that applicable to life income funds. The Proposals set out the minimum and maximum annual payments permitted and a new Form 5.2 for obtaining spousal consent to variable payments. Sponsors of DC plans or components that currently require a retiring member to transfer his or her account balance to an insurer or to another retirement savings vehicle may wish to consider whether to give effect to the new design, although doing so will increase the administrative burden and cost associated with the DC plan or component.
New disclosure requirements for “member choice accounts”
The Proposals will require the administrator to give members who are responsible for investment choice under their DC or additional voluntary contribution accounts prescribed information, including a statement describing, among other things, each investment option’s objectives; performance history (and a statement that past performance is not necessarily indicative of future performance); and fees, levies and charges (expressed as a percentage or a fixed amount). Some of these required disclosure items assume that the member-directed investment option would be an investment fund rather than specific securities. It is also unclear how frequently the administrator would need to revise this disclosure.
Enhanced disclosure (including statements to former members)
The Proposals will expand the contents of annual and plan termination statements for DC, defined benefit (DB) and negotiated contribution plans. They will also require that annual statements be provided to former members.
New prescribed forms
The Proposals will prescribe a new Form 3.1 for obtaining spousal consent to the transfer of pension benefit credits to locked-in registered retirement savings plans and life income funds.
The federal government’s announcements have significant ramifications for employers, administrators, trustees and pension service providers (including investment advisors).