As various media have reported in the past weeks, liquidity is at the core of the worldwide financial crisis. The crisis was initially rooted in irresponsible lending practices, particularly in the U.S. residential mortgage market, and triggered when financial institutions stopped providing credit on a worldwide basis both among themselves and to businesses and consumers. Since the beginning of the crisis, governments and central banks have been implementing measures to restore credit liquidity and confidence in the credit system.

The bad news of the repercussions in the financial market keeps piling up. Hardly a day goes by without reports of some financial calamity. Lehman Brothers, AIG, the Big Three, Madoff and other events are generating hundreds of news stories.

In the middle of December, another kind of liquidity story somewhat quietly surfaced in Canada. Great-West Life announced that it was placing a moratorium on redemptions from two of its segregated real estate funds, the Great-West Canadian Real Estate Fund No. 1 and the London Life Real Estate Fund. These funds hold commercial real estate, and the news is perhaps not too surprising for those who are familiar with such funds, given the nature of the assets they hold and the current state of financial markets. Other real estate and a couple of labour-sponsored venture capital funds have also frozen redemptions.

The freeze on redemptions in these funds represents an investment liquidity problem, rather than a credit liquidity issue. In the context of a capital accumulation plan (CAP), this development raises significant issues for both plan members and sponsors. Members who invest in market-based funds have already been hit hard by the loss in value of their funds arising from the financial crisis. Possibly the only thing that could be worse is if they can’t access their money at all. This is now the case for those investing in these two real estate funds, and possibly similar funds of other institutions.

Likely, most CAPs will not have exposure to this particular problem. Unfortunately, it seems inevitable that some plans will have exposure—the GWL Real Estate Fund made available to CAPs had more than $1.8 billion in assets as of Sept. 30, 2008. Whether or not your CAP is affected, there are lessons to be learned for all CAP sponsors.

The immediate response of CAP sponsors should be to prohibit any further contributions to these funds. Perhaps surprisingly, the Great-West and London Life real estate funds continue to accept contributions—plan members can continue to put money in, but they cannot get it back out until the funds allow redemptions again.

After the immediate response, CAP sponsors should re-evaluate the inclusion of these funds in their investment lineups. Questions to be considered could include the following:

  • Do plan members understand the liquidity issues?
  • Is it appropriate to include an investment option in your CAP that is, or may become, illiquid?
  • Does the fund provide value that offsets the liquidity risk (e.g., do returns reflect an adequate liquidity risk premium)?

A negative response to any of these questions would suggest that funds with liquidity risks should not be included in the investment lineup for your CAP. Invariably, 20/20 hindsight will lead to additional questions, particularly in relation to how funds are selected for your CAP, and whether there may be other funds offered to your members that could be problematic for similar, or even different, reasons.

The CAP Guidelines issued by the Joint Forum of Financial Market Regulators imposes an obligation on plan sponsors to select and monitor investment options made available to plan members. It is advisable for every CAP to have a well-constructed policy for selection and monitoring of funds offered under the CAP. Such a policy would fit naturally into a Statement of Investment Policies and Procedures (SIPP, or similarly a SIP&G–S Statement of Investment Policies & Goals), which is a statutory requirement for any CAP that is a registered pension plan. The SIPP should likely have provisions relating to assessing liquidity risk in investment options among other selection criteria.

Implementing or revising a SIPP with selection and monitoring criteria resulting from 20/20 hindsight may close the barn door, but it does not address the problem of the horses that have bolted. What of plan members who are adversely affected by a moratorium on withdrawals?

This question could be particularly difficult for CAPs that are registered pension plans, as there is potential for non-compliance with portability provisions of pension standards legislation. It may be appropriate for a CAP sponsor with a registered pension plan to seek guidance from the applicable regulator, particularly if an affected member dies, retires or otherwise terminates membership in the plan.

Sponsors of other types of CAPs may be well-advised to consider the potential for member complaints. There may be little that can be done before any moratorium on withdrawals is lifted, but an effective communications plan may be indicated, depending on the number of plan members affected.

Finally, adequacy of disclosure may become a significant issue for CAPs and plan members affected by a moratorium on redemptions. Discussion of this, though, will have to wait for another column.