Time to scrap the 30% rule?

The rule, according to the ACPM, was established on the presumption that pension funds should only be passive investors, and that they needed to be insulated from potential losses should a business fail. “However, that logic now appears tenuous, and its results for Canadian pension fund investors suboptimal,” wrote the ACPM.

The reasons the association sets out for this includes:

• The assumption that pension administrators would take an active, day-to-day interest in the running of an acquired business as opposed to appointing qualified directors to run it on their behalf is dubious;
• A 2008 study co-authored by researchers from Brunel University and the Organisation for Economic Co-operation and Development argued that the data supports removal of quantitative restrictions such as the 30-per-cent rule and replacement solely with the prudent investment standard;
• A permissible investment of 10 per cent of a pension fund in one passive investment may create a greater risk of financial loss than another investment with greater than 30 per cent voting interest, thus the risk of exposure to business failure is more likely to be better managed where the investor has the ability to exert direct control in appropriate circumstances to protect its investment;
• A significant number of pension fund investors in Canada have grown to become large, sophisticated investment organizations. To assume such organizations need to be “protected” from investment losses by imposition of the 30-per-cent rule is outdated, not evidence based and paternalistic; and
• A presumption that pension fund investors should only be passive investors doesn’t acknowledge the current reality of pension liability management and the returns necessary to meet those liabilities. If a pension administrator has determined an investment above the permitted 30-per-cent rule is prudent, the rule impairs the administrator’s ability to acquire investments that would otherwise be considered appropriate means by which to generate returns.

“The current low interest rate, low growth environment has now persisted to an extent that it can be characterized as the ‘new normal’ with which pension administrators must contend in the funding and investment of their plans,” wrote the ACPM. “Long-term expected rates of return are expected to persist at lower levels than seen in decades for many years to come.

“As a result, pension administrators need the ability to seek active investments in order to find higher return opportunities than may be available to passive investors, within the particular plan’s risk tolerances. Those opportunities are often available in private and alternative asset classes, such as private equity, infrastructure and the like, where an active approach and control in excess of that permitted by the [30-per-cent rule] might be most appropriate in managing the risk that such categories of investments carry …”

The consultations also sought views on the tax-policy issues associated with the growth of active investments by pension plans, including whether there are any tax-policy concerns relating to tax-exempt pension plans’ ability to acquire controlling positions in taxable corporations.

ACPM said there is no indication that the 30-per-cent rule was conceived as a means of implementing tax policy and queried whether it’s reasonable or appropriate to analyze the rule from a tax-policy perspective, noting that the rule is a very “imprecise” and “unreliable” means of addressing the potential tax-policy concerns identified in the consultation.

“While the [30-per-cent rule] may make it more difficult for a pension fund to extract earnings from a business if it prevents the pension fund from having legal control of the business entity, the fund may still obtain practical control through commercial agreements. As a result, removing the [30-per-cent rule] in and of itself is unlikely to have any material impact on the Canadian tax base.”

Read the ACPM’s full response to the consultation here.