By Level Chan and Shaniqwa Thomas

The Canadian Association of Pension Supervisory Authorities (CAPSA) has extended its deadline for submissions to October 14, 2022 on the following draft guidelines:

1. Approach to Risk Management Guideline;
2. Environmental, Social and Governance Considerations;
3. Leverage;
4. Cyber Risk.

Risk Management

In January 2022, CAPSA created a committee to develop a Risk Management Guideline. The purpose of the guideline is to help plan administrators fulfill their fiduciary obligations including, but not limited to, appropriate consideration of their standard of care.

The intention was to develop a stand-alone guideline. However, CAPSA since decided to consider incorporating other guidelines to improve effectiveness and avoid duplication. CAPSA is seeking stakeholder feedback on issuing an inclusive guideline on risk management that would encompass a broad range of common risks.

Based on stakeholder input on the approach, CAPSA may:

1. Develop an inclusive Risk Management Guideline that will contain sections on ESG, leverage and cyber risk; or
2. Publish three stand-alone guidelines, plus a separate principles-based guideline relating to risk management practices.

Environmental, Social and Governance Considerations

CAPSA released a draft CAPSA Guideline: Environmental, Social and Governance Considerations in Pension Plan Management for consultation. The draft guideline outlines how pension administrators may consider some environmental, social, and governance (ESG) factors when making investment decisions, while still meeting their fiduciary obligation to plan beneficiaries. The draft notes that our understanding of climate change has been re-envisioned and, to no surprise, climate change affects the financial system as a whole as well as individual companies and industries, and thus pension plans.

The draft guideline points out that administrators should consider whether any ESG factors are relevant to investment performance and take appropriate action based on that determination. The implementation of ESG factors is consistently changing. Plan activities should be adaptive, responsive and reviewed regularly to reduce risk.

Examples of ways that an administrator could incorporate ESG factors include:

• Portfolio limits on exposure to greenhouse gas emissions;
• Setting investment targets for the portion of green assets in a portfolio;
• Setting standards related to executive compensation, diversity, labour, or cybersecurity practices in target companies.

The draft guideline affirms that how ESG considerations are incorporated into investment decision-making will depend on the unique characteristics of each pension plan. It provides that administrators may determine to use ESG considerations in two instances:

1. Use as a deciding factor when choosing between two equivalent investment options (options that provide equivalent expected risk-return results);
2. When allowing plan members choice in selecting investments as part of a defined contribution plan, administrators may choose to include an ESG-mandated fund option. Such a fund and its investments must remain consistent with the goal of providing retirement income.

While the draft guideline does not state that the consideration of ESG factors is mandatory, it says that ignoring or failing to consider ESG factors that may be potentially material to the fund’s financial performance could be a breach of fiduciary duty. ESG factors may be relevant to assessing the risk adjusted performance of assets, and may have material financial impacts on investments.

Further, as part of their standard of care, administrators should assess whether their plan, governance, risk management, and investment decision-making practices are sufficient to identify and respond to material ESG information in a manner proportionate to their plans and appropriate for their investment beliefs.

The draft guideline also lists several key considerations for stewardship activities, recommending that administrators consider collective stewardship options like industry organizations, or third party ESG rating and shareholder services.

Additionally, administrators should evaluate and update the performance of their ESG periodically. If administrators rely on a third-party investment manager or are investing in a third-party fund, they also need to monitor the ESG considerations of that outside third party.

The draft guideline also notes that a plan’s Statement of Investment Policies and Procedures (SIPP) requires a description of factors relevant to the plan’s investment approach. If ESG factors are considered for risk management and investment purposes, it is a best practice to disclose how ESG factors are considered.

Leverage

The draft Leverage Guideline provides guidance on practices for managing risks associated with the use of leverage in pension plan investments. As stated in the guideline, “leverage exists when any technique or strategy is used to adjust a pension plan’s economic exposure to investment assets. That is different from what the plan could achieve by simply investing its capital (or net assets) in securities or other financial assets”. In other words, leverage is a means of achieving economic exposure greater or lesser than the capital invested.

This guideline reviews:

• Types of leverage;
• Impact of leverage on risk;
• Implications of leverage for risk management;
• Types of risks associated with leverage, including market, liquidity, counter-party and other risks;
• Leverage risk management including, ensuring consistency with fiduciary duties and the prudent person rule, documenting leverage in the SIPP, monitoring and mitigating risk, and using stress testing and scenario analysis.

The draft guideline also includes metrics for measuring leverage and considerations when developing and validating leverage measurement capabilities.

Cyber Risk

Cyber risk is the risk of financial loss, operational disruption or reputational damage from the unauthorized access, malicious and non-malicious use, failure, disclosure, disruption, modification, or destruction of information technology systems and/or the data contained therein.

The draft Cyber Risk for Pension Plans Guideline reviews:

• Integrating cyber risk into a plan’s general governance and risk management framework;
• Delegating to third-party service providers;
• Developing incident reporting and response procedures.

It also includes a list of questions for plan administrators to consider when integrating cyber risk into their governance and risk management protocols.

Submitting feedback

CAPSA is seeking feedback on the proposed guidelines by October 14, 2022. Please contact a member of our Pensions and Benefits team for any assistance with a submission.

This client update is provided for general information only and does not constitute legal advice. If you have any questions about the above, please contact a member of our Pensions & Benefits group.