Module 9: Developing the Statement of Investment Policy Flashcards
Describe the purpose of an investment policy statement (SIPP) as outlined by the Office of the Superintendent of Financial Institutions Guideline for the Development of Investment Policies and Procedures for Federally Regulated Pension Plans (OSFI SIPP Guideline).
According to the OSFI SIPP Guideline, the purposes of a SIPP are to:
(a) Communicate the investment philosophy of the plan administrator to the pension fund managers
(b) Describe objectives for the investment and lending programs and the overall risk philosophy for the pension plan
(c) Document how investment managers will be chosen, compensated and replaced in a manner that encourages compliance with the policy’s goals and procedures
(d) Communicate the investment strategy to those who evaluate the financial condition of the plan and to those who recommend contributions to the fund. These groups may include the plan actuary, a pension council and the Office of the Superintendent of Financial Institutions (OSFI), as well as members of the plan and other beneficiaries who want to assess the amount and security of their stake in the fund.
(e) Identify roles of those involved in the investment process and what is expected of them.
Explain the purposes of quantitative and qualitative constraints within a pension plan SIPP that are required by federal and provincial pension legislation and provide an example of each type of constraint.
Quantitative and qualitative constraints are intended to control the investment risk to which the pension fund may be exposed.
Quantitative constraints establish minimum and maximum percentages that can be invested in any one asset category or particular security. The resulting diversification provides diversification and limits risk exposure. For example, a SIPP may limit investment in Canadian equities to an amount that falls between 30% and 50% of the overall pension fund.
In the context of a member-choice defined contribution pension plan, an example of a quantitative constraint is the definition of the number of available investment options (e.g., the SIPP made state that the plan will offer members a choice among 15 and 25 available investment options).
Qualitative constraints impose other conditions on the investment of the plan monies. They often relate to requirements that investment managers exhibit certain “high-quality” characteristics. For example, the SIPP may state that it is expected that selected investment managers exhibit stability in portfolio management personnel or have an established succession process to deal with normal personnel turnover. Responsible investing (RI) policies would also typically include qualitative constraints that result in the selection of securities that meet the particular RI objectives.
Explain who is responsible for a pension plan’s SIPP and outline the approval process under federal pension standards legislation.
Under federal pension standards legislation, the SIPP is the responsibility of the plan administrator.
Although the plan administrator is not required to have the SIPP approved by the actuary or OSFI, the plan administrator must submit the SIPP to the actuary and the pension council (if one exists). Plan administrators are not required to file the SIPP with OSFI on a regular basis; however, the SIPP must be available for OSFI review on request.
Describe the investment responsibilities of pension plan administrators outlined within the terms of the federal pension standards legislation.
Federal pension standards legislation requires that pension plan administrators:
(a) Administer the pension fund in accordance with Pension Benefits Standards Act (the Act) and its Regulations
(b) Act as trustees for plan stakeholders (employers, members and beneficiaries) and exercise the degree of care that a person of ordinary prudence would exercise in dealing with the property of another person
(c) Invest assets of a pension fund in accordance with the Act and in a way that a reasonable and prudent person would apply to the investment portfolio of a pension fund—that is, the prudent person portfolio approach
(d) Invest the plan assets in accordance with Schedule III of the Act’s Regulations, which sets out the prescribed investment and lending limits for a pension fund
(e) Hold the assets in trust or with a custodian
(f) Establish a written SIPP that includes the prescribed elements.
Outline information that the federal pension standards legislation requires to be included in a SIPP.
The federal PBSA identifies that a SIPP must include the following content:
(a) Categories of investments and loans, including derivatives, options and futures
(b) Diversification of the investment portfolio
(c) Asset mix and rate-of-return expectations
(d) Liquidity of investments
(e) Lending of cash or securities
(f) Retention or delegation of voting rights acquired through plan investments
(g) Method of, and the basis for, the valuation of investments that are not regularly traded at a public exchange
(h) Related party transactions permitted and the criteria to be used to establish whether a transaction is nominal or immaterial to the plan.
Describe “ESG factors” that sponsors of pension plans registered in Ontario must reference within the SIPPs for their plans.
“ESG factors” is not defined in the Ontario pension legislation but can be described as a broad term that encompasses a wide range of environmental, social and governance factors. Their nature can be summarized as:
(a) Environmental factors that relate to a company or industry’s interactions with the physical environment
(b) Social factors that concern the social impact of a company and/or industry on a community or society
(c) Governance factors that typically relate to how companies and/or countries are governed.
Outline the ways that ESG factors can be disclosed in the SIPP for an Ontario pension plan
When the plan administrator has decided not to incorporate ESG factors into its investment policies, a statement to that effect must be included in the SIPP including, if desired, a brief explanation of the rationale used to make that decision.
When the plan administrator has decided to incorporate ESG factors into its investment policies, a statement to that effect must be included in the SIPP, as well as information on how those factors have been incorporated. Details of how ESG factors may be incorporated are not provided within Ontario pension legislation.
Identify the parties whose roles should be clearly outlined in the investment policy statement when a pension plan sponsor (or Quebec pension committee) has delegated the responsibility for managing pension funds to third parties.
When the plan sponsor or pension committee has delegated responsibilities for managing pension funds to third parties, the investment policy statement should include a description of the roles of:
(a) The plan administrator (or in Quebec, the pension committee) itself
(b) In trusteed situations, the respective roles of management and the board of trustees
(c) Investment managers
(d) Custodian/trustees
(e) Pension/actuarial consultants
(f) Investment consultants
(g) Employees, where they are involved in investment decisions.
Describe the general SIPP governance activities required by pension standards legislation after the initial investment policy statement has been developed
Once a SIPP has been written and adopted by the plan administrator/pension committee, the various Canadian pension regulators have different requirements relating SIPP governance activities, including the following.
(a) Most jurisdictions require an annual review of the SIPP (in New Brunswick, only a triennial review is required) with confirmation provided to the regulator, sometimes using the mechanism of the Annual Information Return filing.
(b) Most jurisdictions require that the SIPP for a defined benefit pension plan be provided to the plan actuary.
(c) For federally registered pension plans, the SIPP must be made available for review by the Office of the Superintendent of Financial Institutions (OSFI) upon request, and OSFI suggests that investment information be maintained in a manner that facilitates analyses relating to asset quality and concentration, interest rate and maturity mismatch, the diversification of income sources. It should also allow comparison of current pension assets against the limits included in the SIPP.
(d) The federal pension regulator suggests that the plan administrator consider disclosing the investment policy, investment manager mandates and performance information to plan members.
(e) Only New Brunswick and Ontario require that the plan sponsor file the SIPP and its amendments with the regulator.
(f) Ontario requires that certain SIPP information be disclosed to plan members on their annual disclosure statements.
Explain the intent and scope of the SIPP Guideline issued by the Office of the Superintendent of Financial Institutions (OSFI).
The guideline outlines factors that OSFI expects plan administrators to consider in establishing, implementing and monitoring a SIPP for a pension fund. It is meant to serve as a guide to assist plan administrators in developing investment policies and procedures suitable to their pension plan without limiting the care plan administrators take in their duties.
It is intended that the OSFI SIPP Guideline be adapted by each plan administrator to reflect the obligations of the plan (including regulatory requirements), objectives of the pension fund and all other factors that may affect the ongoing funding and solvency of the plan and the ability of the plan to meet its financial obligations. The administrator should be prepared to explain any deviation from the guideline.
Appendices to the Guideline provide certain information, including:
(a) Issues that need to be considered in establishing an investment policy
(b) A summary of investment and lending limits prescribed by the federal pension standards legislation
(c) Identification of other OSFI guidelines and best practice papers relevant to investment policy making.
Describe the procedures for pension fund investment activities that the OSFI SIPP Guideline recommends be documented in a SIPP.
Procedures OSFI recommends be documented in the SIPP include:
(a) Identification of responsibilities and accountabilities
(b) Processes for recommending, approving and implementing decisions
(c) Identification of the frequency and format of reporting and of performance measures
(d) Description of how investment and lending policies are to be implemented and monitored
(e) Description of how loans and investments are classified
(f) Description of how loans and investments are valued if they are not regularly traded
(g) Description of the custodial arrangements for plan loans and assets
(h) Monitoring and controlling of the plan’s exposure to changes in interest rates, foreign exchange rates and market prices
(i) Identification of potential conflicts of interest, how they may arise and how they should be addressed.
Describe the factors that the OSFI SIPP Guideline expects a plan administrator to consider when preparing a SIPP.
A plan administrator is expected to consider all the following factors when preparing a SIPP:
(a) Current investments in place
(b) Rate of future contributions
(c) Amount and structure of current and accruing liabilities
(d) How liabilities and the various investments being contemplated would respond to plausible economic events (“what if?” scenarios)
(e) Financial situation of the plan
(f) Tolerance for risk
(g) Maturity of the pension plan
(h) Estimated cash flow requirements
(i) Financial risks the plan sponsor may face regarding funding the pension plan.
Identify factors that the OSFI SIPP Guideline recommends a DB pension plan administrator address in order to understand the plan’s obligations.
To understand the obligations of a DB pension plan, the administrator of such a plan should consider the following:
(a) Whether pensions in payment are increased to keep pace with the cost of living
(b) Whether the pension formula adjusts to increases in salaries over time
(c) How obligations are distributed among the categories of members and former members
(d) Whether changes in employment levels or conditions are likely to change patterns of retirement
(e) Whether ancillary benefits are contingent on full or partial termination
(f) Whether any plan changes are anticipated (e.g., conversions).
Describe the investment risks outlined in the OSFI SIPP Guideline.
Credit risk: This is the risk that a counterparty will not pay an amount due as called for in the original agreement and may eventually default on its obligation.
Mismatch risk: This is the risk that a solvency deficiency will develop because an increase or decrease in the market value of plan assets is not matched by a corresponding increase or decrease in the liabilities.
Currency risk: This is the risk that the market value of a financial instrument will fluctuate due to changes in exchange rates.
Price risk: This is the risk that the market value of an investment or of a financial instrument based on investments will fluctuate.
Interest rate risk: This is the risk that the market value of a security will fluctuate due to changes in market interest rates.
Describe how the OSFI SIPP Guideline recommends that credit risk should be addressed.
A SIPP should identify credit risk where it is material and describe how it will be managed. If the exposure to credit risk covers a long time period, the SIPP should provide for a regular credit review. Credit risk can be controlled through diversification and through careful underwriting, holding collateral and obtaining guarantees from third parties.
Describe the objectives that the range of authorized investments and loans of a pension plan should address as outlined in the OSFI SIPP Guideline, and the recommended minimum descriptions to include in the SIPP.
Within certain limits needed to protect the plan from arbitrary action in the decision-making investment process, the range of authorized investments and loans should:
(a) Facilitate the building of an investment portfolio that can serve the needs of the plan efficiently
(b) Consider potential changes in circumstances in the short-term future
(c) Avoid the concentration in any one investment market.
At a minimum, the description of each authorized investment category should include:
(a) The quality of the assets to be included in the category
(b) The impact of changes in equity markets, interest rates and inflation upon the investment
(c) The priority in claims to assets upon liquidation
(d) Cash flow characteristics
Identify SIPP content recommendations made by the OSFI SIPP Guideline when a SIPP authorizes the use of derivatives.
If the use of derivatives is authorized, a SIPP should:
(a) List the acceptable derivatives instruments
(b) State the proportion of asset portfolio that may be so allocated
(c) Indicate the purpose—for example, hedging or index replication—for which they are to be used
(d) Identify which managers are authorized to use derivatives and set trading limits
(e) Indicate where the products can be obtained
(f) Describe how over-the-counter products are to be managed.
Identify SIPP content required by the OSFI SIPP Guideline regarding asset mix and rate of return expectations.
In terms of asset mix and rate-of-return expectations, a SIPP should specify:
(a) The expected rate of return of the portfolio, e.g., a real rate of return of a specified percent over a period of years, or a nominal rate of return, or a rate of return over some benchmark portfolio
(b) The expected volatility of the rate of return of the portfolio
(c) The types of return expectations
(d) Over what time frame return expectations are expected to be achieved
(e) How return expectations are to be used to monitor the investment manager’s performance.
Describe the guidance offered by the OSFI SIPP Guidelines around the pledging and borrowing of pension plan assets.
Pledging assets is necessary for some activities, such as engaging in futures contracts. Borrowing can result in a pattern of cash flow that is more suitable to the needs of the pension and reduces its vulnerability to changes in interest rates. However, pension plan administrators that pledge or borrow assets are expected to examine the risks of these activities and ensure they are addressed in the investment policy.
The plan administrator should examine the risks of these activities and ensure that pledging or borrowing is permitted by the trust agreement and ensure that the risks are addressed in the SIPP.
Describe why the OSFI SIPP Guideline states that it is important to define the roles and responsibilities of fund managers and professionals and identify its recommendations for this process.
The OSFI SIPP Guideline states that those involved in the investment process must have clearly defined roles and responsibilities and that accountability both for action and inaction is important. The assignment of responsibilities should protect the pension plan from conflicts of interest.
The OSFI SIPP Guideline states the following.
(a) The investment policy should identify the tasks that need to be done and which officer or agent should perform them, together with appropriate authority for actions.
(b) The assignment of responsibilities should include adequate checks and balances to protect the investment of the pension plan. Material transactions or shifts in allocation should be approved by the plan administrator or the party it has empowered to make these decisions, particularly if it involves underwriting or investment in illiquid assets.
(c) Where the custodian provides monitoring and reporting services to the administrator, the former should be provided with a copy of the investment policy and adequate supporting material so that they may question improper activities.
(d) The valuation of plan assets should be performed by people independent of the investment and lending function and should be sufficiently frequent to alert the plan administrator of significant losses or deviation from authorized activities.
(e) All compensation should be consistent with investment policies and goals. Any system of rewards must not encourage deviation from the ethical behaviour or the mandate assigned to the investment manager.
Describe the requirements of pension standards legislation in the area of investment policies for member choice DC pension plans.
Most pension standards legislation in Canada exempts member-choice DC pension plans from the requirement of preparing a SIPP for the plan. Effective 2022, only New Brunswick pension standards legislation requires that sponsors of member choice DC pension plans prepare and register a SIPP with the provincial pension regulator.
Identify recommendations of the CAPSA Guideline No. 3, Guidelines for Capital Accumulation Plans (CAP Guidelines) that a CAP sponsor can use when selecting investment options and investment funds for the plan.
When choosing investment options for a CAP, the CAP Guidelines recommend that:
(a) The sponsor complies with all applicable legislative requirements
(b) The sponsor should ensure a range of investment options is made available, taking into consideration the purpose of the CAP
(c) Consideration be given by the sponsor to the number of investment options to make available, the degree of diversification among the options, their liquidity, risk levels and their associated fees
(d) Consideration be given to the CAP sponsor’s ability to periodically review the options
(e) When the chosen investment options include investment funds, their attributes such as investment objectives, strategies, risks, manager(s), historical performance and fees should be considered. In addition, consideration should be given to whether the selected investment funds provide CAP members with diversification within their styles and objectives.
Identify factors that CAPSA Guideline No. 3, Guidelines for Capital Accumulation Plans (CAP Guidelines) recommends a CAP plan sponsor consider if an investment option no longer meets its selection criteria.
In the event an investment review reveals the investment option no longer meets the selection criteria, the type of action a plan sponsor can take is based on a number of factors, including:
(a) The length of time the criteria have not been met
(b) Any other deficiencies in how the investment option operates
(c) Any complaints expressed by plan members
(d) The impact on plan members of any action taken relating to the investment option
(e) The availability of equivalent investment options
(f) The investment options that will remain available in the plan should an option be removed.
Provide an example of each of the two types of investment beliefs that may exist.
Investment beliefs may be demonstrable (e.g., a belief that an equity risk premium exists) or asserted (e.g., a belief that unrewarded risks should be removed from portfolios as cost-effectively as possible).
Identify the types of investment or pension/retirement plan committee decisions that can be influenced by the committee’s underlying investment beliefs.
Investment or pension committee decisions in respect of the following can be based on underlying beliefs about the investment environment:
DB plan committees address:
(a) Investment objectives and constraints
(b) Long-term investment strategy
(c) Investment manager structure and roles and manager selection
(d) Monitoring investment results against objectives.
CAP committees address:
(a) Investment objectives and constraints
(b) Service provider structure and provider selection
(c) Specific investment alternatives
(d) Investment information provided to plan members
(e) Monitoring investment results against objectives.
Describe the challenges that an investment or pension committee can face when reviewing investment decisions and how those challenges may be effectively handled.
Decisions can be made based on investment beliefs at a particular point in time. However, a plan’s context will likely change over time and/or the committee may change its membership to include individuals who do not share the original investment beliefs that resulted in a particular decision.
Key takeaways for investment or pension/retirement plan committees are that they should:
1) Work to ensure that the beliefs underpinning their decision making are demonstrable
2) Document beliefs
3) Review beliefs for continued relevance and acceptance by committee members.
