Investment managers who manage pension assets for Canadian registered plans should be aware of changes that will be introduced to the pension investment restriction rules contained in Schedule III to the Pension Benefits Standards Regulations, 1985 (Canada) (“Schedule III”), as these changes will impact how pension plans are permitted to invest their moneys.

As we reported to you in our previous Alert, on September 19, 2014, the Federal Department of Finance released draft regulations to amend and modernize Schedule III. The Federal Department of Finance will release these draft regulations in final form on March 25, 2015. The changes, long awaited since the Minister of Finance’s October 2009 announcement that the pension investment rules would be modernized, apply not only to federally regulated pension plans but also to those plans whose governing provincial legislation incorporates Schedule III.

Currently, Schedule III prohibits the administrator of a pension plan from directly or indirectly investing or lending more than 10% of the book value of the plan’s assets in or to any one person, two or more associated persons, or two or more affiliated corporations (the “10% concentration limit”). The changes will limit investments to 10% of the market value of the pension plan’s assets. The changes will also make clear that the 10% concentration limit is triggered when a loan or investment is made (i.e., the 10% concentration limit is not an “ever-green” requirement). This is a positive change, as confusion has long existed in the industry about whether this was an ongoing requirement or only one triggered when a transaction occurred.

A new exception will also be introduced to the 10% concentration limit with respect to investments that involve the purchase of a contract or agreement in respect of which the return is based on the performance of a widely recognized index of a broad class of securities traded at a “marketplace”. The term “marketplace” is replacing the current “public exchange” definition. This is another welcome change, as the term “public exchange” is outdated. The new “marketplace” definition is not a prescribed list of exchanges, but rather a principle-based definition that will capture changes as new exchanges are introduced and other exchanges cease to exist. It also reflects that pension plan investments may be bought and sold on public exchanges, as well as quotation and trade-reporting systems, or other platforms that are maintained to bring together the buyers of securities or derivatives.

The changes will also address the related party rules. Schedule III currently prohibits a plan administrator from directly or indirectly lending moneys of the pension fund to a “related party”, investing moneys of the pension fund in the securities of a related party, or entering into a “transaction” with a related party on behalf of the pension fund. The changes will remove the “public exchange” exception and introduce new exceptions, such as permitting the holding of an investment in the securities of a related party where the investment is made in an investment fund or segregated fund (in which the administrator of a pension plan and its affiliates may not invest). A new provision will also be introduced to give administrators a five year grace period to comply (from the date of non-compliance) with the related party rules in the event of non-compliance as a result of a transaction not in the administrators’ control (for example, a merger or acquisition of an entity that does not involve the administrator).

While these changes will prohibit the administrator from investing plan assets directly or indirectly in securities of the employer, the amendments now clarify that an administrator may engage the services of a related party for the administration of the plan, such as the hiring of a related party broker-dealer.

The September 19, 2014 draft regulations would have removed the nominal or immaterial transaction exception to the related party rules. The Federal Department of Finance, in responding to concerns raised by stakeholders, has decided to retain this exception in Schedule III.

Administrators of pension plans that currently hold securities of related parties will be given five years to divest their pension plans of these securities in order to comply with the related party rules. 

Finally, the changes clarify how Schedule III applies to “member choice accounts” (a newly defined term, which essentially means an account where a plan member is permitted to make investment choices under a plan), including modifying the application of certain exceptions to the 10% concentration limit and related party rules to investments of “member choice accounts”.

The final regulations will be published in the Canada Gazette on March 25, 2015. Investment managers, who manage pension assets for Canadian registered plans, and plan administrators, should be reviewing their investment mandates, including agreements and compliance monitoring systems, to ensure that they are ready to implement these changes.