There is a new kid on the block.
Some employers sponsoring large and/or multiple registered pension plans (RPPs) have recently begun outsourcing most if not all of the investment functions that are typically handled in-house. The reasons motivating this is a perceived lack of internal resources and expertise to effectively deal with an increasingly complex investment universe. The first component of this type of outsourcing is the selection of what is known as an “oversight” or “fiduciary” manager (Manager).
Origins and Nature of Investment Outsourcing
Investment outsourcing first began in the Netherlands and the UK a few years ago. It has since spread to the US, and now to Canada.
The concept involves the appointment of a Manager, a third party who manages the totality of the RPP’s assets in accordance with the RPP’s statement of investment policies and procedures (SIPP). Where the RPP assets are aggregated and invested through a master trust, the Manager manages the master trust’s assets in accordance with the master trust’s version of the SIPP (which should accord with the SIPPs of the RPPs investing in the master trust.)1
Typically, the Manager is responsible for selecting and monitoring the investment managers who are in turn responsible for investing the various asset portfolios within the RPP fund. It is the Manager who enters into the investment management contracts and to whom the investment managers report. The Manager may thus be referred to as a “manager of managers”.
Therefore, although some of what the Manager does will be advisory in nature, other services will be delegated to it by the RPP administrator (Administrator) and therefore provided as an agent of the Administrator. This blending of advisory and delegated investment services, some of which will be more “fiduciary” in nature than others, represents this type of relationship’s biggest challenge.
The main providers of fiduciary management services in Canada are mostly US-based asset managers, investment advisors and investment consultants.
The Standard of Care
It all goes back to the standard of care set out in pension standards legislation and to whom it applies. Although it is described in a variety of ways, the standard of care found in such legislation is fiduciary in nature.2 Because Canadian pension standards legislation does not constitute a complete code but is rather suppletive of the common law, the Administrator may not displace or rid itself of the obligation to act in accordance with its statutory standard of care. All that it can do is to discharge its fiduciary obligation by always acting in accordance with the standard. Although pension standards legislation tends to be less explicit about who else may be subject to the standard of care and under what circumstances it may apply to someone other than the Administrator, it is expected that the standard of care will apply to anyone who has discretionary authority or control over the administration or management of the RPP, including determining how its assets are to be invested. It clearly extends to agents of the Administrator, although determining when a relationship is one of agency is not always easy.
Because the legal underpinnings of the pension plan investment differ from jurisdiction to jurisdiction, what may work well in one jurisdiction may not work so well in another. For example, the concept of “named fiduciaries” in the US, pursuant to which an entity other than the sponsoring employer may be identified as being a fiduciary, means that the sponsoring employer may be shielded from obligations in respect of which it is not identified as the fiduciary. Such is not the case in Canada.
The Manager as a Fiduciary
The biggest challenges in an outsourcing situation consist of determining who is ultimately making a given decision, understanding the consequences of the decision-making process, and ensuring that the parties’ intentions are reflected in the outsourcing agreement. For example, the Manager may, at first blush, be responsible for selecting and overseeing the investment managers, but if the outsourcing agreement requires that the Administrator “bless” the selection of an investment manager, is it the Administrator or the Manager who has ultimately made the selection? Does it matter?
There are many things that the parties will have to consider in coming to an agreement and crafting a satisfactory outsourcing agreement. The following are some of those considerations:
- Who will select the investment managers?
- Will the same party select all of the investment managers or are there some who will or should be selected by one and not the other?
- Assuming that the investment managers report to the Manager, will or should they also report to the Administrator and when?
- Who will work on the SIPP and when?
- What other services will the Manager provide and how and where will these be described?
The Layering Effect
One of the trickier aspects of investment outsourcing occurs as a result of the Manager entering into the investment management agreements. The Administrator should require, in the outsourcing agreement, that the Manager, in the investment management contracts:
- subject the investment managers to the same standard of care as the one to which the Manager itself is subjected (which should be the same or equivalent to the statutory standard).
- require that the investment managers be liable for losses caused by their breach of their standard of care, not only to the other party to the investment management agreement (i.e., the Manager) but also to the Administrator and/or the RPP.
- require that the investment managers indemnify not only the Manager but also the Administrator and/or the RPP for such losses.
The reason for this is the layering of fiduciaries and the effect of a fiduciary’s discharge of its standard of care. Here is an example. Let’s say that:
- everyone, the Administrator, the Manager and the investment manager, are subject to the same standard of care (the Manager’s standard being set out in the outsourcing agreement, and the investment manager’s being set out in the investment management agreement).
- the Manager, in selecting and monitoring the investment manager, acted in accordance with its standard of care.
- the investment manager breached its standard of care, and the RPP suffered a loss as a consequence.
Given that the Manager has not breached its standard of care when selecting and monitoring the investment manager, the Administrator may not be able to successfully claim against the Manager. Since the Manager will therefore not have suffered any losses, there will be nothing against which the investment manager would be required to indemnify the Manager.
The Outsourcing Agreement
In addition to dealing with the issues discussed above, the outsourcing agreement should confirm that the Manager has obtained all applicable governmental and regulatory licences and approvals and is qualified to provide the services it has been engaged to provide. It should also oblige the Manager to make sure that it receives the same representations from the investment managers.
Like any other legal contract, an outsourcing agreement should be reviewed by legal counsel. In fact, given that such agreements tend to be complex and are too new for there to have developed any sort of “standard” agreement, it is imperative that the legal review be carried out by someone who is knowledgeable in the areas of pension and securities laws.