Dante Manna and Hannah Brison

Background

The Office of the Superintendent of Financial Institutions (“OSFI”) is seeking feedback from stakeholders on its March 2022 Consultation Paper (“Consultation Paper”), which introduces proposed pension investment risk management practices for federally regulated pension plans. OSFI identified four areas where management practices and regulatory guidance could be enhanced, using the Consultation Paper to preview expectations in these four areas prior to issuing draft guidance.

The Consultation Paper solicits feedback from plan administrators and other industry stakeholders on its proposed expectations and how they may work in practice. As the Consultation Paper was based on a survey of plans holding a greater than average amount of assets, and a higher than average proportion of non-traditional assets, OSFI indicates that feedback from smaller plans with less complex investment strategies will be needed to develop practical guidance. OSFI is also seeking views on how the principles would apply to defined contribution pension plans.

The four areas

OSFI identified the following four areas as the subject for future investment risk guidance, as further described below:

(1) Independent risk oversight function;
(2) Risk appetite and risk limits;
(3) Comprehensive portfolio and risk reporting; and
(4) Enhanced valuation policies and processes.

Feedback questions are posed under each area, some of which are reproduced below.

1. Independent risk oversight function

OSFI proposes that plan administrators have in place an independent risk oversight function, separate from the plan’s “operational management”¹, to provide oversight of the plan’s risk management practices. The independent risk oversight function would report directly to the plan administrator and its key responsibilities could include establishing frameworks and policies; developing approaches to identify and assess pension risks; setting and reviewing risk limits; and establishing risk monitoring and reporting requirements.

Key questions include:

• How do pension plans anticipate implementing an independent risk oversight function?
• How should plans with less complex investment strategies, that do not merit a dedicated independent pension risk expert, achieve the benefits of the “independent risk oversight function” principle in an effective way?

2. Risk appetite and risk limits

The Consultation Paper sets out expectations that:

• A plan administrator would define the plan’s “risk appetite” (the acceptable amount and type of investment risk) in a formal “risk appetite statement”, to be reviewed regularly.
• A plan’s independent risk oversight function would develop “risk limits” (concrete, measurable thresholds that should not be exceeded), in accordance with the risk appetite statement. Such risk limits would include volatility thresholds determined through the use of statistical modelling techniques.
• Operational management would manage the investment portfolio in accordance with the risk limits.
• Independent risk oversight function would monitor the investment activities and verify compliance.

Key questions include:

• How do pension plans anticipate implementing risk limits?
• What are key tasks that a plan administrator should carry out to identify what risk limits should be in place and how often they should be monitored?

3. Comprehensive portfolio and risk reporting

OSFI proposes that plan administrators be provided timely and comprehensive risk reporting, including market, credit and liquidity risks. It is contemplated that such reporting would provide “sufficient look-though to the underlying holdings of investment funds” to understand the plan’s risk exposures, including leverage, derivative, and foreign exchange exposures. This may in turn effectively require a plan administrator to procure enhanced reporting from third-party service providers.

Key questions include:

• What controls do plan administrators have in place to ensure that portfolio and risk reporting is comprehensive?
• How do plan administrators manage data limitations relating to investment funds?

4. Enhanced valuation policies and processes

The Consultation Paper proposes that plans enhance their documentation of valuation policies and processes. This includes not only periodic “due diligence” of valuation policies and processes of third-party service providers, but also interim valuations of alternative assets during periods of market stress to ensure sufficient accuracy of the valuation.

Key questions include:

• How do plan administrators evaluate third-party valuation processes and procedures?
• During periods of market stress, how do plan administrators ensure that third-party valuations (e.g., investment funds) reflect fair market value?

Proportionality considerations

OSFI stated that one priority of the Consultation Paper is to ensure that the principles outlined above are adaptable to smaller and less complex pension plans. For example, the Consultation Paper states that for a smaller plan, the independent risk oversight function may reside within the operational management functional structure, subject to “controls” (e.g. separating responsibility for oversight of operational management and risk oversight to different members of a Board or Committee).

Key questions include:

• How should smaller plans that pursue less complex investment strategies implement the risk management principles described in the Consultation Paper?
• What controls or practices can be put in place to ensure that plan administrators of smaller and less complex pension plans are kept informed when their pension plan is approaching levels that are outside of their risk tolerance?
• What are examples of risk management strategies implemented for defined contribution plans that address the principles described in the Consultation Paper?

Submitting feedback

Federally-regulated plan administrators, particularly those that did not participate in the OSFI survey, are encouraged to respond to the Consultation Paper to ensure their circumstances are considered in the draft guidance. Such feedback is requested on or before May 13, 2022. Please contact us for more information or assistance with the submission process.

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 and Benefits group.

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¹ OSFI defines “operational management” to be investment managers, including investment fund managers or other independent service providers that are investing the pension plan’s assets and internal senior management that makes decisions related to the plan’s investments.