PENSION INVESTMENT TRENDS OF ESG, DATA & CURRENCY

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1 PENSION INVESTMENT TRENDS OF ESG, DATA & CURRENCY A Special Industry Event held by: Benefits and Pensions MONITOR

2 Pension Investment Trends Of ESG, Data & Currency From left, Momtchil Pojarliev, Deputy Head of Currencies at BNP Paribas Asset Management; Tim Rourke, Vice President Segment Lead Pensions and Asset Owners at CIBC Mellon; and Michael Long, Senior Policy Consultant with the Financial Services Commission of Ontario; were the industry experts who examined a range of topics from currency to ESG (Environment, Social, and Governance) at the Benefits and Pensions Monitor Meetings & Events Pension Investment Trends' session. Michael Long, Senior Policy Consultant with the Financial Services Commission of Ontario; Tim Rourke, Vice President Segment Lead Pensions and Asset Owners at CIBC Mellon; and Momtchil Pojarliev, Deputy Head of Currencies at BNP Paribas Asset Management; provided a whirlwind tour of pension trends and issues facing every consultant and plan sponsor at the Benefits and Pensions Monitor Meetings & Events Pension Investment Trends session. Long started by discussing how the Financial Services Commission of Ontario is fine-tuning its statement of investment policies and procedures filing requirement and ESG disclosure statement. Then, Rourke explored how data is becoming an integral part in determining the right model for pension plans. Finally, Pojarliev shared his views on the need for plans to hedge their currency exposure and some of the approaches this could take. The Financial Services Commission of Ontario (FSCO) continues to fine-tune its guidance regarding the statement of investment policies and procedures (SIPP) filing requirement and the ESG (environment, social, and governance) disclosure statement that is part of the SIPP, said Michael Long, Senior Policy Consultant with FSCO. It helps first to deconstruct the ESG disclosure requirement. It s set out in Section 78(3) of the Ontario regulation and says the SIPP shall include information as to whether ESG factors are incorporated into the plan s investment policies and procedures special emphasis on plan and if so, how those factors are incorporated, said Long. The key points are whether a plan incorporates ESG and, if so, how it is incorporated into policies and procedures at what I like to refer to as at the plan level. Minor Correction A minor correction was made to FAQ 300, which asks, Does Section 78(3) of the regulation require our plan to adopt an ESG program? There was some confusion when this all first came out, he said, but the answer remains the same; Section 78 doesn t require the plan to incorporate ESG factors. It is the administrator s call whether or not the plan will incorporate ESG factors. FAQ 301 was a little more complicated, said Long. The question essentially speaks to what constitutes incorporating ESG factors in a plan s investment policies and procedures, that is, at the plan level. Many managers incorporate ESG, but that s different from the plan incorporating ESG factors. The FAQ specifically states, If the plan administrator leaves the decision as to incorporating ESG factors to its managers without any policy or procedure guidance, it is FSCO s view that this does not constitute the incorporation of ESG factors in the plan s investment policies and procedures. This has been our position all along. Carte blanche delegation to managers not making the decision yourself is not incorporating ESG, he said. However, the FAQ goes on to give examples of policy positions that the plan can take that would constitute incorporating ESG factors. An example already in the FAQ includes adopting the ESG policy of its investment managers or manager. As well, the policies or procedures of the plan could describe how the administrator incorporates ESG factors as part of the search, selection, and review process related to investment managers or funds. 1 BENEFITS AND PENSIONS MONITOR December 2017

3 BENEFITS AND PENSIONS MONITOR MEETINGS & EVENTS FSCO was told by PIAC that many pension plans are making the decision they want to incorporate ESG. We re going to require our managers to do that, but we re going to leave the details to our managers who know how to do this, he said. This prompted the tweak to the FAQ because this was such a common approach and there was confusion on this issue. We worked together with PIAC to develop an example. This example was incorporated into the new FAQ The approach in incorporating ESG factors, the technical approach which specific factors are going to be incorporated, which techniques we re going to use that can be delegated to the managers. Essentially it says it s okay to say we require our managers to incorporate ESG, but we leave it to them on how best to do this, he said. and Asset Owners at CIBC Mellon. The data is about your client experience, it s about confidence in your suppliers, it s about risk management, and it s also about helping you and your plans make decisions quickly. Suggested Content FSCO also revised Investment Guidance Note 4 on rules for the ESG disclosure statement. If the administrator incorporates ESG factors, the SIPP has to describe how ESG factors are incorporated. In the past, we had three very specific items that had to be included in the description. Some of these items were not applicable in all cases, so we have changed the guidance note so that these are now suggested content. What we re looking for is a clear statement on whether or not ESG factors are incorporated at the plan level and, if the factors are incorporated, we want the approach described at a high level in the SIPP. The disclosure should ultimately seek to accurately reflect the plan s approach to ESG incorporation, said Long. In a world where change is being discussed continually and there is disruption on many different fronts, we realize there are many possible right operating models and these operating models all tie back to the data, said Tim Rourke, Vice President Segment Lead Pensions December 2017 BENEFITS AND PENSIONS MONITOR Canadian Pension Model There is a Canadian pension model of creating and retaining talent and bringing expertise in-house that s recognized internationally. The good news here is that this leadership has also benefitted medium and smaller sized plans. They have been able to modify their investment strategies to be able to access the same type of investment opportunities. They re not investing directly through some of the alternatives, but go in through co-investments and co-funds that allow them to have the same types of returns as the larger plans, he said. As a result of this, asset managers are accelerating the pace of development and bringing new products to the market continually to benefit that particular segment of the market. In fact, the rapid rise of alternatives means they aren t necessarily alternatives anymore, said Rourke. They ve become so mainstream that perhaps we shouldn t classify them as such. From a plan sponsor, investment manager, and asset servicing perspective, once again, the data here is key. Clients demand access and flexibility as their alternative allocations grow. We know that you can select an OCIO program and outsource the responsibility, but you still are ultimately responsible, he said. This has put more emphasis on the need for transparency for governance and oversight and, more importantly, to free up your time and resources to focus on growing your business, said Rourke. And plan administrators are not the only ones who are struggling with the new complexities in the marketplace. Their boards and trustees have huge challenges trying to get the data that they need to make the right decisions, said Rourke. There s also a growing need to communicate more frequently than annually to plan members and to communicate through the different types of technologies. You need the timely data to support that, he said. Plans are also faced with FATCA, Common Reporting Standard, and various IRS rules that require new for- 2

4 mats of documentation. It s not just in completing the documents; often you have to explain it to senior executives in your company or the executives of the board before they ll sign the documents. Thought leadership here from your custodian is important, but you ll also need other subject matter experts to assist with this type of process to get the documentation right, he said. Since it s all about the data, custodians have a role to play by investing to create a space where plans, providers, third parties, and even Fintech start-ups can all build. Pension plans, asset servicing providers, and investment managers all face many of the same challenges. We need to understand how data is being consumed, how it s being manipulated, shared, and protected. Clients and counterparties are at very different levels of data maturity. Data Access However, it s really about exchanging data sets, how we transform the data to serve the next function, and passing it back and forth. Data access and client experience are closely linked to this, and will only become more important together, he said. The one conclusion that I d like to throw out here is we re all just getting started, so you re not alone in this journey. Pension plans of all types are working to build, refine, or redesign the right operating model, but everybody wants a different right approach. No two plans, as we know, share the same design, the same trustee structure or experience, or the same corporate DNA, he said. Currency is a very significant risk for institutional investors because they of- ten have sizable foreign currency exposures, said Momtchil Pojarliev, Deputy Head of Currencies at BNP Paribas Asset Management. It s probably one of the single largest risks in a portfolio. However, it s interesting that people haven t actually spent much time on designing currency policy. There are many plans that have a currency policy, but surprisingly there are also many plans that do not. No Single Solution The challenge in addressing currency policy is that there is no single solution which fits all; it all depends on the individual plan. There are a few different options that can be used to address foreign currency exposures. The first option, which is the easiest, is just to ignore currency. You can close your eyes and pretend that you don t have it, he said. However, in reality, every time you buy, for example, foreign stocks, you re also getting a portfolio which is long a foreign currency and short the Canadian dollar. It is dangerous to ignore the second portfolio because it can be quite volatile. The second choice tries to remove this risk by passively hedging a certain percentage of the foreign currency exposure. The word passive here is misleading because when people hear passive, they think that it means risk-free. There is still risk in doing this because while you don t really need a market view and you don t need to know where a dollar is going, there can be a negative cash flow when the Canadian dollar weakens, he said. There is also a big market timing risk due to the timing of the passive hedge implementation. For example, a plan that moves from no hedge to a strategic hedge ratio could face a Canadian dollar that is very expensive at that time. Putting the hedges on at the wrong time could result in substantial losses. Another solution to mitigate negative cash flows is to implement an active hedge. The difference between passive hedging and active hedging is that you try to time it and fluctuate the hedge ratio depending on your market views, he said. Also importantly, the same hedge ratio is not used for all currencies. With active hedging, every currency is treated differently because each currency has different diversification benefits to a portfolio. Finally, some investors are using currency alpha. Currency alpha tries to generate a positive return as an overlay to a portfolio. The difference between active hedging and currency alpha is that active hedging is dealing only with the actual foreign currency exposures of a certain portfolio, so it s unique for each client. Currency alpha, on the other hand, is able to trade anything in the currency universe and, because of this larger opportunity set, should result in the highest information ratio. While currency alpha can actually add volatility, it should be compensated for with higher returns. Market Views For those who find it difficult to have currency views, the preference may be to completely hedge it. However, completely hedging all foreign currency exposure is going to add volatility in portfolios for Canadian-based investors. While it depends on the particular portfolio, usually what we suggest is to run simulations based on the assets that you have to see what strategic hedge ratio would have given you the least volatility over certain time periods, said Pojarliev. BPM BENEFITS AND PENSIONS MONITOR WOULD LIKE TO THANK THE SPONSORS OF THIS EVENT 3 BENEFITS AND PENSIONS MONITOR December 2017

5 SPECIAL EVENT TOPICS Pension / Investment Events: Pension Investment Strategies April 24, 2018, Vantage Venues Toronto. Today s pension plans face paying out retirement benefits to their youngest employees up to 50 years from now. This session will examine how investment strategies can meet these future liabilities in a changing environment. Pension Risk Strategies September 25, 2018, InterContinental Toronto Centre Toronto. Major trends are reshaping Canada s pension plans and their risk strategies as employers look to share or off-load pension risk and focus on de-risking. How these work and what risk strategies are on the horizon will be the focus of this session. Pension Investment Trends November 13, 2018, Vantage Venues Toronto. The continuing low interest rate environment is prompting pension plans to seek new investment opportunities to generate the returns they need to match their liabilities. Industry experts will provide their insights on how pension funds are investing their money now and what they will be considering in the future. Benefits Events: Benefits 2018 March 20, 2018, Vantage Venues Toronto. In 2018, cost will again be the primary challenge facing plan sponsors. How this challenge will be addressed in the coming year will be the focus of this event. Benefit Trends & Insights May 8, 2018, Vantage Venues Toronto. The one constant when it comes to benefits is change. This session will examine areas such as the impact an increasingly global workforce is having and will have on benefit plans and how new approaches to providing benefits can be used to meet the needs of employers and employees. The Future of Benefits October 18, 2018, InterContinental Toronto Centre Toronto. What will the benefits plan of tomorrow look like? Our speakers will gaze into their crystal balls and share their thoughts on the future of areas such as paramedical coverage in benefits plans and managing the soaring cost of drugs. FOR MORE INFORMATION or additional sponsorship opportunities, please contact Joelle Glasroth at joelle@powershift.ca or ext 11 Benefits and Pensions MONITOR Mee tings & Events Benefits and Pensions Monitor, A Publication of Powershift Communications Inc. 245 Fairview Mall Drive, 5 th Floor, Toronto, ON M2J 4T1