Spotlight On Compliance
By: Christian Lachaussée
Thanks to innovations in the financial markets, along with the lifting of foreign content restrictions, pension portfolios comprised exclusively of low turnover, blue chip equities have become a distant memory. The competition for value-add has spawned a dizzying array of sophisticated investment instruments that involve niche strategies and specialized management.
This evolution of the investment landscape has given birth to new sources of risk, as well as a host of new metrics to monitor those risks. These changes translate into unprecedented pressures on pension fiduciaries. Supervision is more demanding because of the size and complexity of the holdings. This, in turn, places additional pressures on manual tracking procedures, resulting in a net increase in fiduciary risk. This is particularly disconcerting when you consider that a whopping 60 per cent of pension funds in Canada utilize manual tracking for mandate monitoring, says a recent RBC survey.
It also found that approximately 28 per cent of plan sponsors delegate monitoring responsibilities to their investment managers1, meaning more than a quarter of plan sponsors actually have no formal monitoring method in place. For the plan to realize the intentions of the investment policy, diligent supervision, and monitoring mechanisms are absolutely essential.
Another issue is the frequency with which some elements of the investment process could have been questioned by an institutional investor. By comparing a large number of portfolios over the past year against their investment rules, elements were found that could have been subject to inspection/validation in approximately 70 per cent of cases. Admittedly, not all breaches are necessarily subjects of urgent concern, but it goes without saying that a well-informed fiduciary is better prepared to have meaningful dialogue and thereby improve the supervision of his/her investment managers.
The Canadian Association of Pension Supervisory Authorities (CAPSA) guidelines place governance responsibility squarely on the shoulders of plan administrators. One needn’t look further than recent business headlines throughout the country to find examples of poor investment processes, demonstrating the validity of CAPSA’s recommendations. Increasingly, there are examples on both sides of the border where administrators assumed rules and laws were being respected, while judgment errors and fraudulent activity were taking place.
Unfortunately, absolute trust can lead to unpleasant surprises in the investment world. And if recent occurrences are any indication, the spotlight on compliance will only grow brighter and more unforgiving in the months and years to come.
However, there are actions pension plans can take to empower themselves with respect to prudent compliance. One of the first steps would be to identify the various factors that should be taken into account to help ensure protection of the pension plan’s members, including:
- Demonstrating due diligence (with written records)
- Specifying policies and rules that can be tracked
- Carefully reviewing content of investment policy
- Ensuring proper application of investment policy
- Facilitating a comprehensive audit
- Ensuring legal supervision
- Implementing sophisticated investment tracking and manager monitoring
Thanks to advances in technology, pension plans can choose from a wide range of powerful monitoring tools, designed to provide objectivity and to assist in lightening the burden of mandate oversight. And considering the growing sophistication of investment vehicles today, the need for powerful, computerized monitoring processes will only increase in the future.
Looking ahead, mandate compliance will surely continue to grow more complex in Canada. In the plan sponsor survey referenced earlier, 40 per cent of respondents said they expect non-traditional asset classes such as hedge funds and private placements to lead the charge in requiring more sophisticated compliance reporting. As one respondent commented, “We’re going to be relying more on service providers … because things are getting too complicated and because companies are looking for ways to outsource in order to do more with less.”
Christian Lachaussée is with BENCHMARK, the investment analytics arm of RBC Global Services in Montreal.
1. An in-depth telephone survey conducted by Carolyn Vose & Associates on behalf of RBC’s BENCHMARK unit. Twenty-five pension funds were randomly selected and the person responsible for mandate compliance was interviewed. The funds surveyed range in size from $140 million to $6.8 billion in assets under management.
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