Canadian Lawyer

w w w . C A N A D I A N L a w y e r m a g . c o m M A Y 2 0 1 6 45 investments in their pension plan portfoli- os. They only need state that they have given the matter consideration. And if investment funds with ESG elements are included in their portfolios, such choices must be con- sistent with the fiduciary duties owed to plan members by the plan sponsors. In other words, the choices in the pension fund must also be good investments. "So, there is this tension," notes Bush. "Members may not like certain investments, but what if cigarettes are a great investment?" The origin of the new ESG rules goes back to 2008, when an expert commission in Ontario was charged with reviewing the sometimes opposing goals of members' concerns over the choices of investments versus the need to produce returns for their retirement years. Bush, who advised the commission, notes that it eventually agreed on a relatively soft provision that simply stated: "Plan statements of invest- ment policies should reveal whether and if so how socially responsible investment practices are reflected in the plan's approach to investment decisions." From a practical point of view, the new rules create challenges for pension fund administrators and employers who spon- sor the funds. These range from trying to decide what constitutes an ESG factor, while trying to meet new filing deadlines; indeed, some experts suggest up to 130 issues may have to be considered, says Bush. Then there is the difficulty of ascertain- ing what investments are actually in a fund: This latter issue is particularly troublesome for medium- and smaller-sized employ- ers that contract out pension investment choices to professional fund managers, who manage pooled and segregated funds. Bush says, with many such funds now trading daily, the task of identifying what is in a fund becomes an ever-changing, even more difficult task. As a result, fund managers may also face new requirements to provide greater detail to plan sponsors about the types of investments they are choosing on behalf of plan members. Deciding what is an acceptable invest- ment and what isn't is not simple, she says. "Some people will say fossil fuels are good, some people will say they're not. What's the test? Is it pollution? Is it energy use? Is it sustainability?" In addition, negative screens for ESG factors will not be enough. Simply ruling out tobacco or companies active in Sudan is not appropriate. "You can't just say, 'I don't like people who wear blue shirts.' You can't make that judgment," says Bush. Instead, plan sponsors must be more specific about why a company or sector has not been cho- sen, especially if such an investment is likely to benefit plan members financially. There is help, however, for companies looking for guidance on making invest- ment choices that consider ESG factors. Picard notes that plan sponsors without the massive investing teams and buying power typical of very large pension funds are at somewhat of a disadvantage in this area; typically, they will use pooled funds and allow the fund manager to make the specific investment choices. "In that world, the plan sponsors have been a bit startled by this [ESG] requirement and bewildered as to what they are supposed to do," says Picard. She adds Ontario's pension regulator has been helpful by attending industry confer- ences and giving feedback on the new rules. It has also provided assistance on the web, such as FAQs designed to meet the con- cerns of firms that delegate investing strate- gies to others. In addition, for DC plans, the Ontario pension regulator has issued "Investment Guidance Note for Member Directed Defined Contribution Plans," which deals with their new, non-ESG mon- itoring and communication requirements. The guidance note includes information on the eight categories in which information should be included in a sponsor's SIPP. Picard also highlights another new doc- ument, "Form 14," which provides a road map through the SIPP process for DC plans. "It's a thing of beauty," Picard says, noting the form lays out in great detail the steps pension sponsors should be following when filling out and filing their SIPPs. This enhanced transparency is likely to be both an advantage and a risk for plan sponsors, says Picard. For instance, while regular monitoring of the fund will pro- vide greater protection for sponsors from member allegations that they have not paid enough attention to the fund's performance, sponsors will also risk liability if they fail to do what they said they would do; potential missteps include such issues as monitoring only semi-annually when they had formal- ly committed to quarterly reviews. Notes Picard: "I see this as being, finally, a true backbone to a regulator's efforts to impose good governance in the world of defined contribution plans." However, DC plan sponsors also need to ensure they don't promise too much when reporting to employees. For instance, Picard says there is a trend toward some DC plan sponsors including projected income streams on pension plan statements to employees. That follows recent recommen- dations from the Canadian Association of Pension Supervisory Authorities, a national group, suggesting that pension plan admin- istrators include projected account balances and income streams in their statements to employees. "I don't think employers realize how dangerous that is," Picard says, despite what appears to be airtight disclaimer lan- guage in such reports that aim to limit the employer's responsibility. "I wouldn't include projected income or account bal- ances. As an employer, I just wouldn't." Employees tend to trust their employers, she says, and if actual income flows fall sig- nificantly short of what has been projected — as they may well do — employers may face some degree of liability. Indeed, some firms have gone forward with such income stream estimates without the firm's senior executive being aware, says Picard. She notes human resources depart- ments have been known to move forward on their own initiative in this area with- out appreciating the associated downside, including reputational risks, that can arise when disgruntled, retired employees later complain. Some firms are not even properly informed about the level of investing fees that are appropriate for pension fund pools and may unwittingly be reducing employ- ees' returns by paying fees that are too high. For Picard, the detail and methodical approach of Form 14 and guidelines for DC plans, while voluntary, will at least help improve the oversight of employees' hard- earned dollars. And it is likely to go a long way to giving regulators some teeth, when it comes to pursuing the most egregious examples of hapless employers who have done very little to ensure a pension plan per- forms well for its members. "Good on the Ontario regulators," Picard says. "They're doing their best to regulate in a field where there is little legislation." The new regime, at the least, will greatly enhance what regula- tors know about the administration of DC plans, Picard notes, a vital step in moving to improve that administration in the future.

• Cover