Proceedings of the Standing Senate Committee on
Banking, Trade and
Commerce
Issue 17 - Evidence- May 5, 1998
OTTAWA, Tuesday, May 5, 1998
The Standing Senate Committee on Banking, Trade and Commerce met this day at 9:30 a.m. to examine the state of the financial system in Canada (The Role of Institutional Investors).
Senator Michael Kirby (Chairman) in the Chair.
[English]
The Chairman: Senators, welcome to our continuing study of the role of institutional investors, how they are managed, and why the managing needs to be adjusted with respect to the legislation and regulations governing institutional investors. These hearings will be held over a three week period -- this week and next week and we will continue after the parliamentary break.
We will meet tomorrow evening at six o'clock and on Tuesday and Wednesday night next week. However, at our Tuesday night meeting we will deal with our other studies. At that time we will hold a teleconference with government officials from New Zealand.
Our first witness this morning is Mr. Malcolm Hamilton who appeared before us when we met in Toronto. Thank you very much Mr. Hamilton for coming to assist us again.
Mr. Malcolm Hamilton, Principal, William M. Mercer Limited: I am an actuary who, for the last 20 years, has consulted to many of the largest pension plans in Canada, public-sector plans such as the Ontario Teachers' Pension Plan and Ontario Hydro's Pension Plan, as well as private-sector plans such as those covering the employees of the Bank of Montreal and Abitibi Consolidated.
I have spent relatively little time working with institutional investors, but a great deal of time working with the pension funds who retain institutional investors to manage their money. My remarks will address the governance of pension plans in Canada, and the extent to which pension plans are well served by current practice.
It has been my experience that pension funds are administered by well-meaning, capable people who bend over backwards to do the right thing. In 20 years as a consultant, I have never seen a single instance where a board or a pension committee knowingly acted against the interests of plan beneficiaries.
That having been said, there is a great deal of confusion about what decisions get made in what capacity, about who is affected by these decisions, about what constitutes prudence, and about what the mission of a pension fund is in the first place.
Pension plans have assets and liabilities. The liabilities arise from an obligation to pay the pensions that plan sponsors promise to plan members. Assets are set aside in trust to secure these obligations. However, who owns the assets? In a sense, the plan members own the assets which, after all, have been set aside for one and only one purpose, to secure the pensions that the members have been promised.
In another sense, the plan sponsor owns the assets because favourable investment returns reduce the contributions that the sponsor will make in the future, while unfavourable investment returns increase these contributions. Members are typically not affected by investment performance. Good performance does not improve their pensions; bad performance does not increase their contributions. In short, the money is set aside to secure a promise, but the money and the promise are distinct.
There is only one circumstance where the money and the promise become the same thing. If a pension plan is wound up by an insolvent plan sponsor, and if the fund does not have enough money to cover its wind-up obligations, then the members' pensions are rolled back to what it can afford.
This puts the plan administrator in an awkward situation. The administrator is to act as a fiduciary in the interest of plan members, yet the members are, in most circumstances, unaffected by the investment policies the administrator adopts. I do not know if any of you have tried to serve the interests of a party unaffected by your decisions, but it is not easy.
In the real world, one of two things happens, either the administrator adopts a me-too policy, the objective of which is to look as much like other pension funds as possible in the belief that, if anything goes wrong, a judge will not find fault with a fund that did what everyone else did; or, alternatively, the administrator adopts a policy that serves the interests of the plan sponsor, recognizing that in most circumstances it is the plan sponsor who is affected by, and therefore has an interest in, fund performance.
A few years ago, two American anthropologists wrote a book called, Fortune and Folly after studying the behaviour of large American pension funds. When the authors looked for the reasons behind the most fundamental investment decisions, they expected answers that were firmly rooted in financial theories and the nature of the plan's obligations. Instead, they heard explanations that they likened to the creation fables of primitive societies, stories about the clash of great forces in times gone by, of heroic decisions by heroic figures now almost forgotten.
Emulating the practices of other pension funds is for most plans at most times harmless. The members are well protected by funding conventions that require the plan sponsor to set enough money to secure the plan's obligations in most foreseeable circumstances.
The investment policies adopted by most plans are, on the whole, quite sensible and quite similar, emphasizing a balance between equities and bonds and broad diversification within asset classes. The most significant departure from sensible investment policy is the one imposed by the Government of Canada, the 20-per-cent limit on foreign diversification, a limit that increases both the cost and risk of planned sponsorship.
However, while most pension funds are well served by copying the practices of others, it is dangerous for plans that are truly different to ignore this fact. Plans that are not as well-funded as other plans, plans that are sponsored by financially weak employers, plans that are inordinately large relative to the flagging prospects of a declining industry, plans with two or three retired members for every member still on the job, plans such as these cannot afford to adopt policies that are appropriate for younger, better funded plans. If they do, there will inevitably be a day of reckoning.
The pension industry has enjoyed 20 good years. We have seen returns that none predicted and that few thought possible. Even the weakest and most vulnerable of plans has prospered. Members have been well-protected, and plan sponsors have enjoyed low costs. However, the test of the system is not how well it endures prosperity, but how well it endures adversity and, as night follows day, the adversity will come. Then and only then will we know whether our pension system and our government structures have effectively served the interest of both planned sponsors and planned member.
The Chairman: I know you have read the paper that was prepared for this committee by Professor MacIntosh of the University of Toronto and, because I am not a lawyer, I will not get into some of the issues that he raises about the legal restraints on the ability of institutional investors to effectively monitor and, indeed, discipline managers.
In the market-place, it is assumed that there is pressure on managers to perform, and the measure of whether or not they are performing is clear, the measure is either the profitability or lack thereof of the company. It is what happens to the stock price. There are clear, quantitative and public signals that put pressure on managers of public companies to perform.
There seems to be no corresponding element of pressure, which I think is a key element of the accountability process, on managers of public pension funds. I, in my lifetime, cannot think of public pension fund managers who have been dumped from their job, roundly criticized by their members, or whatever for underperformance, and yet it is hard to believe that there has been a 100-per-cent effective performance measure over the last 30 years.
Is my perception correct that there does not seem to be much of an accountability process in the sense of the disciplining of underperforming managers? If my perception is correct, what changes could be made, either legislatively or in regulations or public policy of some form, to address that problem?
Mr. Hamilton: Your perception is pretty accurate. There are many different kinds of pension plans in Canada. The one I am most familiar with, the one most people think of as being a pension plan, would be a defined-benefit arrangement covering the employees of a corporation.
Unless the corporation is very large, the people who manage the pension fund from the employer's perspective do not do so full-time. Only the largest company can afford to hire an individual whose sole mission in life is to direct the investment of its pension fund. Typically, it is done as a part-time function by a treasurer or somebody in the organization who has an interest in pension matters. It is not central to the way the corporation measures its own progress. The corporate focus is on earnings, on the business, and on sales. The pension fund tends to be a sideline, and it does not attract the same level of attention.
If people wanted to change that -- and I am not sure changing that will make a big difference to the way pension funds are invested -- what is required is a clear measure of the value added of the people who direct the investments of the pension fund.
I will explain so that you understand what I mean by that. The person in the corporation who retains investment managers is not the person who is managing the money. Every investment manager is evaluated relative to market benchmarks and the performance of other investment managers.The person who actually picks the investment manager will be monitored on some basis, but it is not clear what that basis should be. What most pension funds do is compare the performance of our pension fund to the performance of everyone else's pension fund. The presumption is that everyone's pension fund is the same, but that is often not the case. You can have a pension fund that is rapidly growing, well funded, with a financially strong employer that can afford to take all the risk in the world without exposing the members of that plan to any risk of loss at all. At the other extreme, you can have a large pension fund in a declining industry that is not very well funded, where there is no certainty that the employer will continue in business, and if the people running that pension fund took the same risks as the first pension fund, they would be behaving quite imprudently. This is not clear yet -- and I think it will be some time before it is clear -- just how we can get a measure of the value added by the people who direct on behalf of the corporation the investment of the pension fund. It will be a while before we have a good measure of how they have added value, a measure that takes into account the differences between their plan and other plans.
The Chairman: I understand what you say. One could go from that conclusion to the conclusion that, therefore, we should do nothing in the meantime. I have difficulty with that.
Even recognizing that there are significant differences in the types of plans, between the mature, declining industry or the declining industry and the rapidly growing one which is adding employees all the time, nevertheless, one ought to be able to measure the performance of plan managers on some year-over-year basis, for example, not counting new contributions in any given year, so you know how much money was in the fund at the beginning of the year.
Clearly, one could develop even relatively simple-minded tests, which would be one step above doing nothing.
Mr. Hamilton: Simple-minded tests might do more harm than good. You can design measures. However, the measures that exist are not widely used right now.
If you have a plan that is very well funded and a corporation with very deep pockets, the mandate of that pension committee might be to go out and maximize return. They are not worried about risk. The pension fund is small relative to the business, but the members are well protected by the size of the fund. In that situation they would try to maximize return. They will buy lots of stocks, as they should.
If we have another pension fund where the assets barely cover the liabilities of the plan, where the plan sponsor is not financially strong, may not be around in two or three years, the people managing that pension fund cannot pursue the highest return. It would be irresponsible. They must step back and accept that the obligations of this plan are such that they would invest in a lot of annuities and that safe assets for the plan would be bonds. They will be forced or should be forced by their fiduciary obligations to pick an investment strategy which emphasizes safer investments.
If you adopt a simple measure, and compare the returns of both of those pension funds, you will create a lot of pressure for the not well-funded plans to pile on the equities so that their performance compares favourably to plans that are not in the same situation. There are ways to do that, but the simple ways, I think, will be counter-productive.
The Chairman: Your said that it would be some time before one knew enough to be able to come up with those complicated measures. Does that mean that you would recommend doing nothing?
Mr. Hamilton: No. We are evolving towards something better, but we do not have the answers yet. People may like to think this is a field where all the answers are known. It is not so. Even articulating whose interest you are considering when you are investing pension money is not easy to do, and not all organizations do it in the same way. This is an evolutionary process. Things are getting better, but there is a way to go yet. I do not think there is anything anyone can do to fix it overnight.
Even have about 10 different regulatory authorities in Canada, some are provincial and some are federal. You could line up all 10 of them, ask each one how they can tell whether a pension fund is appropriately invested, and you will get 10 different answers. We have not figured it out yet.
The Chairman: Is there anything that we should do in the meantime to accelerate the process of working it out?
Mr. Hamilton: I do not know enough about your function or your mission to be able to tell you that. If you develop an understanding of this, and if you spot things that trouble you, you should say so in as loud a voice as you can. I think people will be influenced by that. There is no magic bullet whereby a government can pass a regulation and everything will be fixed the next day.
Senator Oliver: Why do you think you were asked to come before the committee today? What specific issues were you addressing? Were you asked to address the whole concept of corporate governance with respect to institutional investors, that is pension funds and investment groups? What types of principles should be in place to ensure the viability of these funds? Is that not why you are here?
Mr. Hamilton: I told people when I was asked to come here that the governance of corporations is something I know little about. What I do understand, however, is pension plans and pension funds, so I can speak for the ultimate beneficiaries of the performance of these institutional investors and, on that basis, I was invited to appear. I will not address corporate governance because you know more about it than I do. I will speak to pension fund governance.
Senator Oliver: On the basis of your experience with Ontario Hydro and Abitibi and so on, what can you tell us about investor activism like CalPERS? Is that something we should have in Canada, and is that something which you advocate?
Mr. Hamilton: It is not something I advocate, but I do not object to it. In the private sector, I do not think the pension funds are very active in trying to influence the behaviour of corporations. In the public sector, it would be a little more so, but Ontario Hydro I do not think is incredibly active in that area. The Ontario Teachers' Pension Plan is more active. Certainly it does no harm, but I do not know whether much good flows from that kind of activity or not.
Senator Meighen: To be able to talk about the performance of pension fund investors, we must talk about what they are investing in. As you pointed out, by law, they are investing up to 80 per cent of their assets in the Canadian market. The Canadian market is a limited market. This committee has called three times for modification, if not elimination, of the 20-per-cent foreign rule. Other organizations have made similar calls.
According to the Minister of Finance, as I understand his position, it is not a question of "if," it is a question of "when." He feels that, if we were to proceed with it now, we might risk putting further pressure on the Canadian dollar. I have not heard anybody else espouse that view. I am interested in your comments, if you would care to make any.
You have been critical of the foreign content rule and, given the fact that the Canada Pension Plan, as it is now constituted, will be injecting huge new sums of money into the Canadian market, can you add anything to your already critical assessment of the foreign content rule in terms of the constraint on the investor?
Mr. Hamilton: I do not know of any good argument for the 20-per-cent foreign content limit. Five to 10 years ago, when the Canadian public sector was borrowing huge amounts of money, you could understand why people wanted to try to prevent investors from investing abroad. We were large foreign borrowers. I maintain that it is a policy that does nobody any good, but I can understand the reasoning for it.
As we all know, the situation has changed quite dramatically. Public sector borrowing requirements are well in hand. We have a population with a demographic profile where retirement savings are piling up. The investment opportunities of the world are something that people really should be able to exploit. It is not a matter of capital vacating Canada. I have every confidence that, if Canadian investors hold more foreign investments, foreign investors will hold more Canadian investments. All of the investors will end up better diversified. They will all end up with better investment portfolios and better results as a consequence. This is a straight win-win proposition, and I eagerly await the time when people can get around to changing the rule.
Senator Meighen: Taking the market as it is with that rule for the moment, there are, in addition to the 20-per-cent rule, other constraints, for better or worse, on institutional investment activity. I am thinking of things like early-warning-system rules, insider-reporting rules, secondary-distribution rules, and takeover-bid rules. In your experience, do any one of these jump out as being an unnecessary constraint upon investment managers achieving better returns?
Mr. Hamilton: Not in any material sense. I am sure some of them are irritants, and I am sure they annoy people, but if you stand back at the end-users level, if you are the member of the pension fund or the sponsor of a pension fund, those kinds of things are not materially adverse to the performance of the pension fund.
Senator Meighen: What about solicitation rules? I have always found it somewhat difficult to understand why you must file a dissidence proxy circular if you talk to other shareholders. Could it not be argued that, in the interest of shareholder activism and better pension fund management, this rule operates as a constraint to gathering or marshalling opinion to present to management of a company so that the company will be better managed? If you cannot talk to your fellow shareholders, you are acting in a vacuum, and it might be an inhibition.
Mr. Hamilton: You are probably right, but I cannot comment on it because for most pension funds in Canada that is not an issue they deal with themselves. The pension fund is divided up amongst a bunch of professional investment managers. They are the ones who hold the assets. They make the management decisions. They would feel constrained by that. It is not something the people choosing the investment managers, the people representing the sponsors and the members are, frankly, even aware of.
Senator Meighen: It is, in your view, almost total hands off?
Mr. Hamilton: It is total hands off.
Senator Meighen: By law, or by practice?
Mr. Hamilton: It is not by law. By and large, those who direct the investment of pension funds are not professional investors. They are not people with a long history of managing money. They are drawn from the sponsoring corporation. They may be appointed by unions representing members. They are lay people, and they do not try to manage the money. They do not even try to interfere very much with the managers who are retained to manage the money.
What they do is more or less what Canadians do when they pick mutual funds. They choose an investment manager. They retain a firm like my own or any number of other firms to help them select one or more of those managers to manage the money. They give them the money, and then they hold them accountable for their performance. When they give them the money, they will say: "We will measure you relative to the TSE 300, the Scotia McLeod Bond Index, or relative to a universe of pension funds, and we expect you to do better than average. If you are better than average, we will be delighted and not ask you many questions. If you are not better than average, we will be upset and probably replace you." It is that simple.
Senator Meighen: Would I be fair to conclude then, in terms of finding out how the market-place could be improved in the interests of those who have pensions, we should talk to the managers of the funds to determine what, if any, constraints cause them to have poorer performances than they would otherwise have?
Mr. Hamilton: If that is the question, you should speak to the people who make the investment decisions, which, for most pension funds, will be professional managers. The odd, large corporate or public sector fund manages its own money, for example, the Ontario Teacher's Pension Plan. Most of the money is managed internally. They would give you pertinent answers to that question.
If you go to a mid-size Canadian company with a pension covering the members of its union, they will have no idea of how to answer that question.
Senator Meighen: The distinction between self-managed pension funds and delegated management funds is a question of size in the main, would that be your experience?
Mr. Hamilton: Yes. Even the large funds will delegate some of the investment management functions. They might manage the Canadian equities themselves and delegate the foreign. Even the very large funds will usually delegate some of the investment management to professional investors. However, the mid-to-small funds are usually delegated.
Senator Callbeck: I want to ask a question about institutional activism and corporate governance which has already been referred to by Senator Oliver. You said you do not advocate it or you do not object to it, but you must give your clients some advice on this.
Mr. Hamilton: They would not turn to me for advice on that matter. I advise on matters such as how their assets should be divided up by asset class, how much equity they should have, how much bond, how much foreign, how much Canadian. I advise them on those types of questions. I advise them on how the plan should be designed, how much needs to be contributed, whether the pension fund is at an appropriate level given the obligations of the pension plan, and how rumoured legislation will affect the members of the plan.
They would not ask me for advice about whether activism would improve the performance of their pension funds.
Senator Callbeck: Do you think that activism has increased or decreased in the past 10 years? What do you think about the future?
Mr. Hamilton: It started from non-existence, so if there is any activism, it must have increased. You read a great deal about it. Some pension funds are quite active. If you are a small pension fund, there is little point. If you are a small pension fund and you have given the money to someone to manage and they have pooled it with a number of other small pension funds, you just do not have the time to think about influencing the behaviour of the corporations in which they have chosen to invest. If you have $50 billion or $10 billion, however, that might be a worthwhile activity.
Senator Callbeck: Do you think this type of activity will increase in Canada?
Mr. Hamilton: I suspect it will. Most things that go up keep going up, and this is probably not the exception to that rule.
Ultimately, the real question is: Does it improve the way companies perform, and does it produce a benefit at the end of the day? I am sure some activism does, and I am sure if it were taken to excess, it would not. No one will ever know exactly what the right balance is. I could not speculate on whether we are that point or past it.
Senator Angus: Are you familiar with the PIAC, the Pension Investment Association of Canada?
Mr. Hamilton: I know it exists. Some of my clients are members of it, but I do not attend their meetings, nor am I a member.
Senator Angus: Their representatives appeared before our committee earlier in the year, and indicated that some 78 corporate pension funds are members. I understand that your own expertise and knowledge is in that area as opposed to the big public funds, is that right? I think you said the private funds are the ones you know more about.
Mr. Hamilton: I have a pretty even mixture of public and private in my clientele. What I know about is how pension funds are governed. What I know little about is how corporations are governed or how institutional investors affect that.
Senator Angus: PIAC has 47 public funds as well as some private funds that belong to them. They have developed since 1991, when they set up a special governance committee for these funds, a fairly elaborate model of rules with respect to corporate governance matters, and proxy solicitation to which Senator Meighen referried. Are you familiar with their guidelines and the PIAC model?
Mr. Hamilton: I know they have them, but I have not studied them.
Senator Angus: One of the points you made was that with the private plans it is often difficult to have full-time people working on them, just by the nature of the critical mass of the small company. Is it correct to assume, though, that in your view it is desirable that the people running these funds for the beneficiaries should be focused on their task on a full-time basis?
Mr. Hamilton: I am not sure it is desirable. You probably do not hear a lot of testimony on the test the end user would like to see, which is: Do these larger, more active funds get better performance?
The answer to that is, maybe they do, sometimes they do, sometimes they do not, and if they do, not much. I can remember reading Pension & Investment Age, which had two stories on the front page. The first one was about somebody creating a pooled fund so all the small pension funds could funnel their money into one big pool fund and get all the benefits associated with being a large fund. The other story was about the Ford Motor Company fund, a large fund. It was partitioned into a whole bunch of different pieces and the pieces given to different managers so it would have all the benefits of being a small and agile fund. I have seen very little evidence that any of these things materially affect the bottom line performance of a pension fund.
For the large funds, it is feasible to think of specialists trying to add value, but it is not easy to do. No one should think that, because you have a well-educated specialist who is trying to add value, that any value will be added. It is tough to go out into the capital markets and beat the performance of other investors, because they are well educated, focused and dedicated. The small investors -- to the extent that they can get an investment manager to manage their money at a reasonably low fee -- will probably do every bit as well as these large institutions.
That is not to say that institutional managers should not be active in governance, but if some of them are, that will benefit the ones who are not. I suspect that, if the big funds take that on and do a good job of it, the benefits will not be restricted to large pension funds, they will be enjoyed by pension funds of any size.
Senator Angus: I follow your reasoning. Let me develop it in a different way. We have been conducting a fact-finding study on institutional investors generally. The first thing we discovered -- I think it was pretty obvious to us -- was that institutional investors are, by and large, the major players in the Canadian capital markets today, and that by a very significant percentage. Second, we found that amongst the institutional investors, by far the most active in terms of getting close to the management of the companies in which they invest, are pension funds, as opposed to, for example, banks and insurance companies who are conscious of the client relationship. Would you agree?
Mr. Hamilton: I would agree with the observation. I am not sure that is necessarily the reason for it, but that does not surprise me.
Senator Angus: One of the reasons that was suggested to us, certainly in the case of the banks, is that they are sometimes, as an institutional investor, reluctant to get too close to their major customers.
We have determined that the major investing public in Canada is the institutional investor, and we have completed a study of corporate governance of the public companies listed in Canada. We have also determined that there has been a measure of corporate governance improvement following the TSE guidelines and the Day report. There was a significant and measurable improvement in the orderliness, in the management, and in the overall accountability of public corporations to their shareholders.
That has led us to question, if institutional investors are so significant and there is no set of guidelines which governs them, whether there should be some governance of the institutional investors themselves. Do you think there is a valid role for public policy discussion of that aspect?
Mr. Hamilton: There is a lot of merit to a discussion, but I would leave you with one message: Trace that back and see where it ends up. What you will find is a much more complicated story than you would have expected to find. For example, a good chunk of the pension money is defined-benefit pension plans. That is the biggest single piece of the pension money.
As I said in my statement, it is not clear on whose behalf that money is invested. The people think that because the money is set aside, in trust, to secure the pension promise, the money is therefore invested on behalf of the members. The only problem is that nobody can find any link between how the fund performs and what the members will receive.
If you are in a corporate defined-benefit plan in Canada, and your pension fund shoots the lights out for 10 years like it did the last 10 years, none of that necessarily goes into the pensions. It goes into contribution reduction, and it does so for a good reason and that is, when you look back to the period of 1965 to 1975 when the reverse happened, everybody who invested did horribly, it did not come out of the pensions. It went to the contributions of the plan sponsors, so the beneficiaries of the investment performance of those funds, in most circumstances, is not the members of the plan. It is the corporation. Now you have this sort of incestuous situation where the corporation is the beneficiary of the performance, and the money is invested in the corporations. Corporate Canada, to some extent, owns itself. Resolving that is not an easy matter.
In pursuing that, the first question you must ask is: On whose behalf is all this money invested? Then you must ask: How does it affect them; and how do we make sense of it? We do not have the answers to those questions yet, that is, who is affected, how it affects them and how we make sense of it. That work needs to be done.
Senator Angus: We felt that a public policy debate on that subject might develop some of the answers. Do you have some suggestions?
Let us deal with a specific question. Presently, we are riding the crest of a bull market. Everybody is worrying about asset over-valuation, and asking, when will the bubble burst? The actuarial report of these se major clients of yours could be showing a large deficit and then, suddenly, the valuation on paper could be a substantial surplus. The question is, who is in charge? What will a fiduciary do? How will they handle this surplus, and what will they say to the unions or the representatives of the beneficiaries who want the benefit of that huge surplus?
Mr. Hamilton: That struggle goes on every day. The plans go into a surplus position and then the question is who should benefit from that? From my perspective, most pension plans in Canada would benefit from a clearer understanding on the part of the members and the sponsor as to who is responsible for what.
The answer is not the same from plan to plan. The Ontario Teachers' Pension Plan runs as a partnership. That is one of the few instances in Canada where the members do have a direct interest in the performance of that pension fund. Ontario Hydro's plan is a completely different arrangement. If you go into the private sector, you will find that those arrangements are completely different again.
To have a system that serves the end user, we need to start with a better understanding of who the end user is, and what the deal is. I am not saying that members should or should not be affected, but they should know what is going on.
If the deal is that the sponsor promises you a pension and sets money aside to secure it, but the investment performance, for good or bad, goes to the sponsor not to the member, that should be understood. Then, within that context, this activism issue ends up with corporations having funds that own corporations, and the benefit, for good or bad, of activism, governance and investment performance, accrues back to the corporations. I do not know how you break that because it is quite circular.
Senator Angus: I understand exactly what you are saying. It seems to me, in most of the private plans at least, the administrators of the plan consist of a committee of the board, who are part-time people with, perhaps, one or two senior management employees. Taking that basic example, could you suggest how you would do it differently today to achieve the improvement?
Mr. Hamilton: In the situation you have described, it would be helpful if it were clear to everybody in what capacity that group is making their decisions. For example, in those committees that you describe, the people wear a large number of hats. Some of them are members, some of them are managers and officers of the corporation representing the employer, and some of them are on the board of directors representing the shareholder. They can wear two or three different hats.
The decisions comes down as to, for instance, how much money is to be put into the pension fund. Are they wearing the same hat when they make that decision as they are when the question is asked: How much of the fund should be invested in equities? The answer is no, they are not. Usually, they have a corporate hat on when they are making a decision about how much money should go into the pension fund, and they switch to a fiduciary hat when they are asking the question: How much they should invest. If the law could do a little better job in trying to distinguish these roles, or if the institution could do a better job of distinguishing the roles, then you would get better decisions.
Having said that, in times like these, everything works. You do not need good governance when the market is going up 20 per cent a year and pension funds are doing well and members and sponsors are happy. As I said in my remarks, what this system has evolved into has not been tested. It cannot be tested until the markets head down for some period of time, and only then will we know whether things are working or not.
Senator Stewart: Reference has just now been made to a situation where the markets head down, and before that, the investment of pension funds in Canada was described as a kind of circular situation. Reference was made much earlier to the whole question of foreign content, and that is the area in which I am interested.
What has been the recent experience of Canadian pension funds investing in Southeast Asia?
Mr. Hamilton: The recent experience is they wish they had not. However, the experience just before that was very favourable. It is all a function of when they started.
Senator Stewart: Yet you are quite confident that we should go ahead and get rid of the 20-per-cent limit on foreign content?
Mr. Hamilton: Absolutely.
Senator Stewart: You can see the question that hovers there. Are you assuming a safe global financial market when you propose getting rid of the 20-per-cent rule? Would you go so far as to get rid of a 30-per-cent rule or a 35-per-cent rule? How far are you prepared to go in this situation?
Mr. Hamilton: I would get rid of the rule altogether because the rule does not compel people to invest abroad, it just permits them to invest abroad. Eliminating the rule does not mean everybody invests their money abroad. It means each person can decide what is appropriate.
Senator Stewart: Many people decided at one point that it was appropriate to investment in Southeast Asia. Is this done on the assumption that they are investing in a safe, global, financial market?
Mr. Hamilton: No. It is done on the assumption that diversification lessens risk. Nobody said, "I think Southeast Asia is a good place to invest, so I will put my whole pension fund in that." If unconstrained, individuals would have broadly diversified their money. If you were a global investor last year, you did not do badly. If you were an investor who invested only in Southeast Asia, then you did badly. Investors in Europe, you did phenomenally, as did investors in Latin America.
Senator Stewart: We have been talking about how the domestic market for these funds could be improved. Do you have any ideas as to how the international market, and of course obviously what I have chiefly in mind is the Southeast Asian segment of the market, could be improved? I am looking for your views on the role of institutions such as the IMF?
Mr. Hamilton: I am not competent to comment on that. From a market's perspective, I have every confidence that, if investors can invest globally, they will, over time, gravitate to the places that treat investors well. Those countries will attract foreign investment and, in my view, they will do well. In the long run, that will serve the interests of everybody.
As to whether the IMF is doing the right thing now in Southeast Asia or not, I really cannot say.
Senator Stewart: Is it your basic view that it should be left to the market?
Mr. Hamilton: It should be left to the investors. It is not a matter of leaving it to the market, per se.
Senator Stewart: The market is presumably the place where investors operate.
Mr. Hamilton: Each investor can then decide where he wants to invest.
Senator Stewart: It seems to me you are trying to have it both ways, probably not intentionally. On the one hand you are saying, let the investors make their decisions freely, yet the situation in which they will be investing may very well be somewhat tinkered with -- some might say corrupted -- by the operation of the IMF.
Mr. Hamilton: It may be, but if the investor is concerned about that, the investor can invest in places that are not corrupted by the IMF. Realistically, most Canadians will not sink 50 per cent of their investments in Southeast Asia.
Senator Stewart: I am interested in those who did sink in Southeast Asia.
As to our earlier discussion, what happens to the manager who does not do better than the average? I thought that was the most interesting question. Presumably everybody is expected to do better than the average.
Senator Angus: Or they do not get appointed to the Senate.
The Chairman: One of the greatest single lines that I ever heard at a First Minister's Conference was from G.I. Smith, the Premier of Nova Scotia. The subject at the conference was equalization, and G.I. Smith -- who subsequently became a Senator -- was in full flight in his closing remarks at the end of the conference. When he wanted to get across the concept that he really looked forward to the day that places like Nova Scotia did not have to receive equalization payments because their tax revenue was up to the national average, he finished his remarks with the statement that he really looked forward to the day when all provinces were above the national average, which to a mathematician like myself struck me as a fairly difficult objective to achieve.
Coming from a fellow Nova Scotian, I thought that we ought to at least remind people of that line.
Senator Stewart: It is a very useful line to remember. I am not an optimist the way G.I. Smith was. If this is territory into which you do not wish to venture, please tell us.
It is widely accepted that the greater the liberalization of trade in goods we can achieve, the better. I gathered from what you said earlier that you believed that the greater the liberalization of the international movement of investment money we can achieve, the better; is that a fair conclusion?
Mr. Hamilton: Yes.
Senator Stewart: Would this liberalized, global financial market, be independent, or would there be meddling by institutions such as the IMF?
Mr. Hamilton: I do not know if the IMF meddles in the markets. They meddle in the economy.
Senator Stewart: Surely they are pretty close, are they not? When you tell a country what they must do with regard to their interest rate, is that not pretty close to financial market meddling?
Mr. Hamilton: On T-bills it might be. However, you cannot really regulate bonds. The important thing is that the IMF deals with the borrowing of money and making loans and attaching strings to the making of those loans. To the best of my knowledge, it is not involved directly in the operation of the stock markets of these countries.
Senator Stewart: Surely it is very much into the governments' relationships with the economy. I believe that you would be told this emphatically by the people who run Indonesia or South Korea?
Mr. Hamilton: However, what is the link between that and Canadians who want to invest some of their retirement savings in Indonesia being able to do so or not?
Senator Stewart: You are telling us that you believe in greater liberalization of Canadian investment. I am trying to ascertain your vision of the situation, the market into which that Canadian money goes. I am trying to discover whether you are prepared to leave that unregulated. Are you assuming certain regulations for protection of property and prosecution of fraud and the like, or are you assuming that there will be international institutions -- and of course the IMF is the obvious one in here -- which will intervene in situations such as we had some years ago in Mexico and the situation which we had last year and which persists in Southeast Asia and as far north as South Korea? That is what I am trying to discover.
Mr. Hamilton: My views on liberalization are the same whether institutions like the IMF intervene or not. It would not affect it one way or the other. It might affect how I invest the money, but it would not affect my view that people should be allowed to make their own choices. Institutions should be allowed to make their own choices. If they choose to be influenced by those things, so be it, and if they choose to ignore them, that is fine too.
The Chairman: You have directed all of your comments to defined-benefit plans. You have talked about the fact that, if the plan performs, then the employer gets a pension surplus and so on. There is an evolutionary trend toward defined contribution plans where the employee and employer put money in and then the money is invested and, therefore, the risk is transferred from the employer to the beneficiary, the employee.
In your view, should that change the accountability mechanisms on pension fund managers in the sense that, now, if they perform badly, it is the individual employee who is left holding the can as opposed to the situation you described back in the mid-1960s and mid-1970s where, when pension funds performed badly and everybody was under a defined-benefit plan, the employer simply kicked in money to top up the fund? That does not happen in a defined contribution plan.
The responsibility on pension fund managers is greater because the social consequences of them under performing are much greater. What, if anything, in your view, does that do to change what the accountability rules ought to be?
Mr. Hamilton: What is clear in defined contribution plans or RRSPs is that it is the end user so to speak, the beneficiary ultimately, who wins or loses from investment performance. I do not know how that changes governance.
What I think will happen is the following: Suppose I ran a mutual fund. If I thought I could improve the performance of my mutual fund by being active in corporate governance, then I would do that, and if I succeeded, my fund would perform better than other funds. If my fund performed better than other funds, I would attract more investment money and I would succeed to a greater extent. As long as the end users are favouring funds that have performed well, they do not need to get all bound up in corporate governance.
The issue then turns to the people who manage the mutual funds. They must decide for themselves whether they can improve the performance of their mutual funds by being active in corporate governance.
I am not close to that business, but my gut feeling is that most of them would look at it and say one of the problems of doing a good job of corporate governance is the benefits of your work are not restricted to your fund. If I do a great job to improve the performance of a bunch of these companies, that may affect everybody else's funds as much as it affects my fund. I am not sure I would get a competitive advantage out of that.
There would be some that could. If you were small cap and you invested in a bunch of smaller organizations and other funds did not invest in those same companies, and you could improve their performance, then you would have an incentive to do so.
I am not uncomfortable with the process that leaves that up to the fund manager and says: make your own decision if you think you can improve things for your investors and yourself by being active in governance. Go for it. If you do not think you can, then you do not go for it. Ultimately, they will decide; and ultimately the market will decide whether that is something that adds value or not. I would not speculate now as to how it will turn out.
The Chairman: Are you suggesting that a reason for not doing it -- and thereby improving the performance of your own fund -- is because other people would get a free ride?
Mr. Hamilton: No, but if what you are after is relative return, the only investments that give you a competitive advantage are the investments that help you more than others.
The Chairman: I am asking a different question. If you could improve your return as opposed to your relative return, even though you would not improve your relative return and thereby gain the competitive advantage you are talking about, is that a reason for not doing something? Surely your focus ought to be, number one, on improving return and, number two, on improving relative return.
Mr. Hamilton: That is a good societal purpose, but in the real world, if you are managing a pension fund you are trying to do better than other pension fund managers. There are a whole bunch of things that compete for your time and energy, and given all these competing demands on your time and energy, if you can be a corporate crusader and help everybody, or you can work diligently doing other things that improve your returns and your market share, the market will reward the latter activity more than the former. However, that does not mean it is a greater social good, and I am not claiming that it is. The market pressure is to improve the relative performance of your fund, not to a make Canada a better place to live and work. That is something everybody should try to do, but the day-to-day pressure is not to do that.
The Chairman: The objective of the fund is clearly directed toward being better than your opponents, as opposed to being better overall, necessarily?
Mr. Hamilton: That is how the investors decide.
The Chairman: It seems to me that the distinction between the societal goal and the individual corporate manager is relevant.
Mr. Hamilton: If you back up from that, one observation that was made is that the corporate governance and the activism is coming out of the pension funds and, I would suggest, within that, more out of the public sector defined-benefit pension funds. For the reasons I just gave you, I do not think you will see much of it coming out of mutual funds. There is not a competitive advantage to be gained by doing so.
I think it comes out of public sector pension funds because of the kind of institutions they are. If I look at the Ontario Teachers' Pension Plan, it is a partnership between the teachers and the Province of Ontario. They have interests as investors that go beyond narrowly improving performance, and that is reflected in their behaviour. It is a public organization. They have an annual meeting where members discuss whether they approve of the way things are being done or not. That affects what they are.
Your original question was: Does defined contribution change that? I think it does, because it will push it, I think, into more of a relative-performance game.
The Chairman: You have also made a clear distinction between what might well be broader goals of public sector defined-benefit plans and private sector defined-benefit plans.
Mr. Hamilton: They are quite distinct.
The Chairman: Thank you very much for coming Mr. Hamilton.
Our next two witnesses are Mr. Roger Richard, Chairman of the Board, OMERS and Tom Gunn, Chief Investment Officer. Please proceed, Mr. Richard.
Mr. Roger Richard, Chairman of the Board, Ontario Municipal Employees Retirement System: On behalf of OMERS, I would like to thank you for allowing us to present our views on the role of the public pension fund in the Canadian economy.
A great deal of change is taking place in Canada and internationally which is dynamically altering the institution and processes governing business and financing. New technologies, rapid globalization of commerce and finance, and increasingly sophisticated consumers are forcing institutions to re-examine their roles.
OMERS supports the Senate's initiative to review governance, particularly as it relates to size. As the chair of the Senate committee himself stated, the Canadian public has an inherent distrust of large institutions, be it large business, unions or government institutions. Concentration of power in any area of our society is an issue that makes Canadians both uneasy and mistrustful.
I would like to apologize for Mr. Dale Richmond who had planned to be here today. At the very last minute he was requested to join a delegation of CIDA which is presently on their way to China to view the infrastructure of the city of Shanghai.
The Chairman: Mr. Richmond has been cooperative to the committee in the past. We appreciate your comment but fully understand why he is not here.
Mr. Richard: Mr. Tom Gunn will specifically address the committee's three key questions. I would like to make some general comments before he starts.
There is no question that OMERS is a sizable shareholder in the Canadian equities market. It is important to understand OMERS' investment philosophy. That is a key issue. The sole function of investing is a means to an end. That end is to meet the pension promise to its members. This is not the first time you have heard that from your presenters.
OMERS has no interest whatsoever in investing as a means to build an empire or to accumulate power. It has no interest in investing to build synergies or strategic alliances. Unlike mutual funds or other institutional investors, it has no interest in investing to attract customers, generate fees or generate short-term profits. We are driven by the need to meet our obligation to our members and by that obligation only.
As such, OMERS has a simple, straightforward philosophy regarding investment, alignment of interest and long-term performance.
One of the things we look at -- and I am sure it will be a question in the minds of the Senators today -- is the whole question of a lay board. This issue is often raised by the board.
The arrangement has worked well for 35 years, and I think our performance reflects that. Five areas justify the use of the lay board and why it has worked well for OMERS. The first is motivation. OMERS' board members are members of the pension plan and, as such, they are directly affected by how well they do their job. This represents a significant alignment of interest, if you will.
Second, there is a classic separation between the board representatives, that is shareholder representative, and management which is a powerful deterrent to conflicts of interest. The Chair and the CIO do not sit on the board. We are distinct from management, and we report to the board.
Third, while the board are not investment experts, they have expertise that is relevant to running a pension plan. OMERS' employees are investment professionals, so investment decisions are left in the hands of expert managers.
Fourth, the lay board is more committed to education than most experts or professional boards. We believe that experts often resist the educational process, while our board openly embraces the learning process. In fact, as an example, the board has instituted a series of information, education workshops which are delivered to the board each and every month as part of our board meetings.
Fifth, the OMERS board is more democratic than most executive boards. Executives are elected for a single term of one year only, and therefore no one person or group can consolidate power or rule autocratically. The OMERS' board is rightly compared to a concerned or committed jury that is asked to view the finding of experts and make intelligent decisions. It is fair for the Senate committee to ask how this is working. The OMERS' model, while not necessarily the perfect solution for every public pension institution, has a solid and responsive system of governance. OMERS' investment performance has been solid, and the plan is one of the few fully funded pension plans in Canada and, dare I say, around the world.
As an example, often during my visits in the U.S., as soon as I mention I am from OMERS they respond by mentioning that they know we are a fully funded plan. We are quite proud of that. We are a rare bird, indeed.
OMERS would like the committee to consider two points as you continue your investigations and draft your recommendations. One, it is possible to govern funds in different ways and achieve excellent results. There are many ideal models. OMERS is but one, we believe. OMERS would suggest that, whatever you recommend, it does not fundamentally undermine the features of those models that currently exist and are providing superior services to their members and the economy as a whole.
Two, it is worthwhile in your deliberations to keep in mind a need for flexibility among institutions that manage investments. Future regulation must take into consideration not only the requirements to respond and change quickly, but to respond to change that may be global in nature and beyond the scope of present regulatory powers.
Again, I would like to thank you for the opportunity to put forward our views. I would like to reaffirm our support for the work of this Senate committee.
Mr. G. Tom Gunn, Chief Investment Officer, Ontario Municipal Employees Retirement System: My purpose today is to provide the Senate committee with an overview of OMERS in relation to the three questions that have been directed to institutional investors.
The first of your questions as we have it, is about the size of OMERS' influence on Canada's largest companies and the economy.
By way of background, today OMERS manages more than $32 billion in assets. In 1997, OMERS invested approximately $3.4 billion of net new funds, roughly $13 million a day, on behalf of all its participants and pensioners.
The Chairman: Net new funds -- does that include rollovers plus new contributions?
Mr. Gunn:Yes. Approximately 80 per cent of the fund is invested in Canada and 20 per cent outside of the country. There is 46 per cent invested in shares and publicly traded companies. About 41 per cent of the fund is in debt instruments of various types, and 13 per cent is in other types of investments which are primarily shares of privately held companies, direct interest in real estate, and other things.
Of the 46 per cent held in shares of publicly traded companies, roughly 39 per cent, or about $9 billion, is invested in companies that make up the TSE 300 Index. These are companies with a market capitalization which exceeds $600 million. Approximately 7 per cent of the fund, the equity portion or $735 million, is invested in small- and medium-sized companies, which by today's definition is companies with a market capitalization of about $250 million.
OMERS' investment is also spread over all the industries represented by the TSE which further spreads our influence on an industry-wide basis and, in effect, dilutes our influence on any one industry.
On average, OMERS holds approximately 2 per cent of the market capitalization of the major companies in Canada. Our view is size itself is a relatively neutral influence. Size, however, is a relatively neutral influence on a known company. What matters is not the size of your ownership, but how your rights of ownership are exercised. That is what we view as the second of the three fundamental questions.
Our Chairman has mentioned our investment philosophy and our goals, but I would like to touch briefly on how the professional investment team in the process is used to achieve our goals.
The OMERS' board is empowered with overseeing the overall investment process. This involves an asset mix of the fund and improving the strategy that we follow to implement asset mix, but the actual strategy itself, when it comes to implementation and what is sometimes called the "tactical employment" of this, is in the hands of the professionals. This process is overseen by the board, but is put into place by professionals.
The professional managers in the OMERS fund are drawn from the same pool of investment professionals that exist elsewhere in the business. We all share the very high standards of accreditation, knowledge, ethics and other criteria that you would find in people in similar jobs in corporate Canada, and in the mutual funds business.
The rewards, incentives and general management of this business is much the same as it is in the major private sector financial services institutions.
Since OMERS does not seek to be a majority or controlling shareholder in Canadian companies, its main activities are to monitor information, vote its proxy as a fiduciary, and take other actions under special circumstances to ensure the long-term investment objectives of the fund are being met.
However, OMERS does believe it is a legitimate pursuit, and indeed more than a pursuit, it is an obligation of a fiduciary to seek all publicly available information and research on companies in which it owns its shares. This includes informal information gathering to assess the credibility and actual activity of the management of the companies in which it invests.
It is necessary that major investors do this because the current corporate disclosure laws in Canada do not go far enough. They require only certain amounts of information to be given out. Corporate lawyers in Canada and the U.S. are often reluctant to discuss concerns in any form until they are compelled to do so by law or by regulatory authorities.
This has created the option of a mission, which I think has been discussed in the press, particularly the United States. The mission is an internal bottleneck that prevents free flow of information critical to all shareholders and critical to information being disseminated in a timely fashion. It is generally said that information is freely available, but that is a theory and not necessarily practice.
As shareholders and as general shareholders, OMERS would like to see this practice changed to include provisions for much greater disclosure along the lines of recommendations made by both Canadian and American accounting organizations. In OMERS' view, such changes would create the level playing field between individual shareholders and institutional shareholders that many think would be valuable.
In addition to information gathering, OMERS actively votes all its proxies. We do so because, as a fiduciary, we regard our voting rights as property. Voting shares basically trade higher in the market-place than non-voting shares, and therefore, if you like, the voting value of these shares can be measured. We feel that, as a fiduciary, it is our obligation to exercise these property rights.
In March of this year, OMERS revised its proxy voting guidelines, and the updated 38-page book is attached as an appendix to the brief which is being circulated to you today. It contains a detailed breakdown of policy on five key areas which are: board of directors, executive compensation, takeover protection, shareholders' rights and social responsibilities.
Two points of the proxy voting guidelines are relevant to today's hearings. First, OMERS proxy voting guidelines are the primary and preferred means we use to manage our relationships in which we invest. Second, OMERS is asked to vote on approximately 1,200 proxies during the course of the year. We believe it is one of our primary requirements that we in fact view all the proxies and we judge how to vote them. We take this very seriously.
In addition, OMERS recognizes that each company in which it invests is unique, and they are all faced with very rapidly and pragmatically changing business conditions, and therefore it is necessary to judge how one should vote on a case-by-case basis.
Our policy is to look at the overall performance as the overriding criterion as to whether or not the interest of the pension funds and interest of the management of the companies in which we invest are aligned. The principle that we seek on this is not confrontation but alignment.
When OMERS believes that shareholder interests and investment have become seriously misaligned, OMERS has a very straightforward process to voice its dissatisfaction. We define serious misalignment at the point of which long-term shareholder value is threatened, not simply that management is doing something that is unusual or questionable, but there is a true threat to underlying value.
When OMERS makes a decision not to sell, the actions that the investment division may take include voicing dissatisfaction. Incidentally, these actions can be taken by anyone who owns shares. We may begin by writing to senior management and expressing our concerns. If nothing develops from that, OMERS may seek a private meeting with management or, under certain conditions, with members of the board. OMERS further may support other shareholders for voting for motions that others put on a ballot if no change is happening. If there still is no sign of progress, OMERS may put motions on a ballot itself.
From time to time OMERS may engage in legal action against companies where it is believed that management has not been acting in the interest of shareholders.
OMERS believes it is a perfectly legitimate role of an informed shareholder to ask managers what it is they are doing or not doing to generate value for shareholders, particularly when the company's performance has become misaligned from shareholder expectations. That is quite a different role from telling management how they should generate business objectives. The simple question is to ask people what they are doing, and how their plans will add to value. You ask if they are satisfied with their own results. In fact, you would begin by asking management where it is heading.
We believe that the most effective way to bring about change is to negotiate quietly with a company. Ultimately, when we do this, we are aware that all shareholders should be treated equally. The fact that we may ask first, does not mean that anyone else cannot or should not ask.
On balance, institutional investors, and OMERS in particular, have had a very positive value on the benefits to all shareholders in two ways. First, institutional investment professionals have early warning systems that may not have existed in a population of small shareholders. We closely examine what is happening with some companies and address any concerns. The first warning that a company has that something is not right is likely to come from an institutional shareholder, not necessarily from an individual.
Institutional investors have, likewise, demanded a great deal of information from public companies -- more than individuals are likely to demand. Frankly, everyone benefits from that increased information flow.
Conversely, except in those rare cases where illegal activities have taken place with regard to inside information, in reality the idea that institutional investors have an undue influence or have exercised undue influence over corporate Canada does seem anecdotal or more of a "what if" proposition. Both the investment goals and structures of OMERS make it one of the more responsible investors in Canada.
We believe the public in general should understand how we exercise the power we have. We try to ensure that all our practices are open to public scrutiny. We publish our proxy voting guidelines. We make them freely available. We have sent our guidelines to every company in which we invest, both in Canada and around the world. We hold public meetings twice a year in which we travel around the province and invite full representation of our membership. We will communicate with the local and provincial media on a proactive basis.
The Chairman: Thank you for your comprehensive statements. Mr. Richard, on your lay person board, I understand all the arguments you made, the motivation, the separation of management and shareholder, the democratic board and so on. How do you respond to the criticism that one hears which is that, fundamentally, given the highly technical nature of the management of a pension fund business, a pure lay person board ultimately -- and I was going to say ends up being "captured" by the professional staff -- ends up not in the position where they can argue with the technical investment decisions and recommendations of the staff because, fundamentally, the board does not have the expertise, and therefore to that extent, the investment decisions of any fund with a lay person board is fundamentally in the hands, exclusively, of the professional staff with no counterbalancing accountability. How do you respond to that criticism?
Mr. Richard: That is a fair and difficult question. This issue is often raised with the OMERS board. Superficially, it would seem that is apparent, but I would suggest it is a little more complicated than that. The education series I mentioned goes well beyond our board and what is happening locally in Toronto. One area of education relates to fiduciary responsibility, and we take that role very seriously. It is most important that we continue to upgrade our knowledge and information and, to that end, we attend sessions all over the U.S. and Canada.
Basically, you are right in what you say. We do rely on the advice of experts in relation to any specific investment. However, one of the most important things the board tries to achieve is to have the proper asset allocation mix. We have extensive training on that. Once that is set, then the experts help us to ensure those allocations are met. However, they only have a certain amount of influence in determining that. We, as a board, determine what the asset allocation will be, and that is based on risk and keeping the pension promise and where we are headed.
I think you would be surprised at the degree of sophistication of the questioning. I would submit that even with an expert board it would get into a discussion of whether the experts on the board are doing the appropriate investing. I can assure you that we are well informed. The questions we have to determine are of a critical nature and deal with high levels of risk and whatever. While we are not right up to scratch on technicalities on specific investments, we do know what we are doing and we do ask the questions. If those are not answered appropriately, then often the investment is put off until we are provided with more information.
The Chairman: For how long do your members serve on the board?
Mr. Richard: OMERS board members serve a maximum of two terms of three years. You are guaranteed six years on the board. Of course the first year is a learning process, but during last three years a member is very efficient. We try to ensure that there is rotation on a gradual basis so we do not lose a lot of our expertise.
The Chairman: Is it a 15-per-cent change or a 20-per-cent change every year?
Mr. Richard: That is the maximum.
The Chairman: My question is prompted by your comment on the asset allocation mix. There was a report about a case involving this in the newspapers. We will talk to Mr. Lambert about this, but I want to know if this could occur with you. The case arose some time ago when there was a strike at Maple Leaf Foods, and some members of the Ontario Teachers' Pension Plan demanded that their pension fund sell their shares in Maple Leaf Foods on the grounds that they wanted to be effectively sympathetic with the strikers.
The management of the teachers' pension funds said that they made decisions based on business criteria and not on social and political criteria and therefore they would not sell. Mr. Lambert made that public statement.
In the case of OMERS, do you try to achieve objectives other than, for example, simply maximizing return? To use my example, if a similar type of situation arose in Ontario where there was, say, a strike somewhere, or an environmental issue arose or whatever, what impact, if any, do those kinds of factors have on your asset allocation?
Mr. Richard: That is a good question. That question is often raised at the board level. Clearly the priority of the board is to ensure the pension promise. When we consider any investment, we look at the merits of the investment on its own. We do not get into social aspects. We have many debates on the board about social responsibility targeted investment. As you know, we are a multi-employee union. We have 1,100 employers. We represent a lot of unions. There is no question that it has been said that we should not invest in a certain company because they are pro-management and we are not. We have discussions, but in the end, every investment decision is based on the merits of the company and whether it allows us to generate the kinds of returns that will ensure that the pension promise is kept. We are very much aware of it, but I would have to agree we are not all about social investing.
The Chairman: You try very hard to resist that pressure.
Mr. Richard: That is correct.
Senator Angus: I must say I have been waiting -- and I think we all have -- with great anticipation to representatives of the mother of all institutional investments in Canada appearing before us. Your introductory statements obviously raise a plethora of questions and I would start by asking you, Mr. Richard, about conflict of interest.
We recently did a study on the proposed CPP Investment Board, and we recommended in our report that the conflict guidelines follow your model but, having heard your comments about one of your two principal philosophies, it seems to me that the first one, alignment of interest, is directly on that point. Perhaps you could elaborate on how your model works and what you consider to be the limits, if any, on dealing with conflicts of interest. As you know, you can go as far as preventing the people involved from owning any shares that you are investing in and so on.
Mr. Richard: The board members as well as the staff have very clear conflict guidelines to which we must adhere, especially in terms of reporting. Basically we are restricted from making any investment whatsoever because of information that we have gained either at the table or because the investment division has come forth with the list of investments. We are simply not allowed, under our conflict guidelines, to invest in those companies.
We must report monthly through our auditors and make full disclosure of any investments we make. Anyone on the board must make full disclosure each month through the board's auditors. If there are any irregularities, it comes back to the president and to the board member involved. Clearly, we have good guidelines in place and they cannot be broken.
Senator Angus: Have you had any instances with companies in which you invest where you have noticed conflicts in the governance structure and where you, as an institutional investor, have taken some steps to complain?
Mr. Gunn: We regularly will meet with major companies where there are concerns, and we will ask for further information about matters that may cause someone outside to raise questions. For example, one question that may create an issue of conflict relates to the attendance record of directors at meetings. A question could be put to a board about whether or not an individual, who does not attend very often, is truly representing the interest of shareholders. That person may have a whole host of conflicts. That is how we begin to explore this.
We are not attempting to tell someone what to do. If we are aware of something that raises a question in our minds, we would not hesitate to raise the matter, but there are no particular things which we would go forward and suggest that we would look for in a company.
There is one large public fund in the country -- or rather one that is now private -- that has approximately 15 guidelines which we are considering. They touch on issues on governance. We have a quiet set of rules by which we rate companies. We have not publicized that. There are more than 15 questions on that list.
Senator Angus: Are you referring to "the world according to Tullio Cedraschi" guidelines?
Mr. Gunn: Some may well think that Tullio's is a very good list, and indeed, it is. Frankly, we want to go beyond some of those features.
Senator Angus: You mentioned that, in your view, the disclosure rules, as they prevail today, do not go far enough. I found that statement to be fundamental. Could you elaborate and perhaps give some suggestions that we might cconsider?
Mr. Gunn: Yes. One of the concerns that has been generally expressed is this: Is a major investor privileged because that investor goes and talks to a company? Our position is that a major investor is not necessarily privileged. Our position is -- and this is one of the principles I make clear to all our staff -- that we neither desire nor seek inside information. We may seek greater clarity of information, and we may encourage companies to disclose information that we believe all investors should know.
Some of you may be aware that, in an earlier life, I was a senior regulatory officer and a chief financial officer of a public company where we practised what I preached as far as full disclosure is concerned. It is my experience that full and timely disclosure of information adds to shareholder value, and all companies ought to be encouraged to do that. It does not create an information advantage to any particular shareholder. Handling the information is what creates skills.
One of the points in the brief that was not in our oral presentation is the view that perhaps institutional investors gain additional expertise or additional insight because they get the information first, and that traditional investors, be they the widow or the orphan, do not have access to this information. I would point out that the trend of investment these days is such that more money is managed by institutional managers than one would expect. One of our economics departments has come up with a statistic which indicates that, at the present time, approximately 40 per cent of equities in Canada are managed by professional investment managers. All this information is readily available to any institutional investor. It is available on the public news wire and on the news services.
If a small investor chooses not to hire an investment manager, that is a commercial call that someone has made. It does not mean that they are disadvantaged in terms of the information available to them, but it does mean that they have elected not to hire a professional that will speed that information flow to them.
In general, making sure that information is disseminated in a rapidly timely fashion is important. This can be handled fairly easily. At the provincial level security commissions have staked out this territory and I think the formation of a national securities commission would help speed this information flow. I believe it can be done.
Senator Angus: Can you be a little more specific about the changes you would like to see? Canada has obviously lagged fairly far behind our friends to the south until recently. One striking example of games played over the years related to the disclosure of the remuneration of senior management in companies that were listed in New York or wherever. They had to file that with the SEC. We always knew what the bosses were being paid or what their stock options were, and so on. However, if companies were not listed, we did not have that information.
With the guidelines and the growth industry that is built up around corporate governance, we now know what the Canadian CEOs earn. The irony to me is, rather than lowering the threshold of the CEOs, it has increased it. The competition factor is there.
As to other aspects of disclosure, do you have some specific recommendations about changing rules, regulations, or laws?
Mr. Gunn: Yes, we do. In our brief we have listed a number of areas where information can be disseminated.
On the matter of disclosure, it is a written OMERS principle that companies should be fair in compensation but show moderation. That is a written policy and one which we have no trouble articulating.
Senator Angus: Does that apply to banks?
Mr. Gunn: Yes, or an oil company or in the automobile parts business where, I believe, the highest corporate salary in Canada was made.
Senator Angus: In regard to the disclosure, your statement was to the effect that, if these disclosure rules were enlarged and improved as you suggest, it would lead to a more level playing field between the retail and the institutional investor. Being trained as a trial lawyer, that was another way of saying to me that the playing field at the present time is not level. Notwithstanding the comments that you have made about that, there is no doubt that the perception, promulgated in part by the analysts, but by folklore as well, I appreciate, is that because of the restricted nature of the Canadian capital markets, the big players such as yourselves can make a phone call to the CEO, you will have an access that Joe Shareholder simply does not have, even if you are not getting insider information.It is the old wink and nod thing. Do you know where I am coming from? Could you comment on that, sir?
Mr. Gunn: First, let us remember, while we say the playing field may not necessarily be level, I do not think the objective should be that it be absolutely flat.
Second, there is a role for expertise and insight in this business. It is not so much a question of investment expertise requiring all information to be available equally at all times and all places, but rather someone who wishes to specialize in the field should be able to have equal access, should they ask. If you like, if I can put the trial analogy back to you, it is a pity you did not ask the witness the "deadly" question because he would have given you the answer that you needed to win the trial. That information was available. How you go about soliciting it is a separate matter. If someone else comes around and happens to ask that question, then yes, that information goes on the record. The advantage that person has is that, by reason of their insight, they solicited the question.
Once that answer has been solicited, the practice in the United States is that, if it is believed to be material, it is then publicly disseminated. That trend could be followed very readily in Canada, and I think everyone would benefit from it.
Senator Stewart: Mr. Richard, in your opening statement you talked about education of the board. You said something to the effect that professionals resist education, is that correct? Would you amplify on that?
Mr. Richard: That is not meant to be taken as a blanket statement. What we would say is that professional directors -- not necessarily experts outside the board -- because they are experts think they know it and, therefore, they are not perhaps as open-minded as a lay board might be. It was that vantage point I was coming from. We are definitely open to all information. We are seeking to learn. We want to know everything whereas, in some cases, we would argue that the expert views himself as an expert and is a little more close-minded. That is not to say that is always the case.
Senator Stewart: The position I am now going to state does not necessarily follow from what you have just said, but I will ask you if it does. One interpretation might be -- and it is not an exclusive interpretation -- that the expert is fully cognizant of the game and how it is played and, consequently, may be oblivious to changes in the environment which do not appear in the present rules of the game. Consequently, your lay person may very well -- if she or he has an opportunity -- have an enlightening effect upon the professional. Is that one of your points?
Mr. Richard: That is correct. I would say that is a very good point.
Senator Stewart: That is a very interesting observation. It is a warning to all of us -- as you become more and more cognizant of your field, you may very well be becoming more and more entrenched in the old truths.
We are told that the OMERS fund is invested about 80 per cent in Canada and about 20 per cent outside the country. In your brief, in respect of public policy, you state:
OMERS' efforts to find acceptable investments are further limited by the 20 per cent rule, which says, in effect, that Canadian pension funds can hold only 20 per cent of their portfolio in securities outside of Canada.
I believe you were here, gentlemen, when Mr. Hamilton was assisting the committee earlier this morning. As I understood him, he said that we should rely on the international market in which you are interested because of the limitation of the 20-per-cent rule. In other words, let the investor or the investors evaluate the situation -- for example, the situation in Indonesia, South Korea -- and make her or his decision.
Given the fact that you are a major investor, given the fact that presumably you find the Canadian market, which is relatively small, restrictive, have you given thought to the whole question of the globalization of the international money market? If you have, then I have two or three questions to follow. If you have not, then I will cease and desist.
Mr. Gunn: We are an active believer in international investment and an active believer that the 20-per-cent rule should be relaxed.
Senator Stewart: How far would you relax the rule?
Mr. Gunn: Somewhere between 30 per cent and 35 per cent would create a level of diversification which would work very well in the interest of most Canadians. It is a rule that has been found to work abroad.
There are other aspects of the 20-per-cent rule that are perhaps not broadly recognized. I would like to put them to you. There has always been an interest in companies buying other companies, particularly transborder between Canada and the United States. Under the free trade agreement, American companies are freely able to invest in Canadian companies and, because of the relative levels of markets, American shares are currently trading at a higher level than Canadian shares, creating a purchase advantage. That happens to create an interesting anomaly for all major pension funds, and that is, the market for Canadian securities can actually shrink. This has a job impact and quite the reverse of what one might expect.
Everyone will recognize that, if a Canadian company is bought by an American company, chances are that the next plant will not be constructed in Nova Scotia, New Brunswick or Ontario, it will probably be constructed in Ohio. However, if a Canadian company buys an American company, chances are that plant will be built here. Restricting the ownership level to 20 per cent can "de-create" jobs in Canada. We can actually create employment in allowing a freer flow of capital.
Senator Stewart: That is helpful.
I want to shift to another aspect of this internationalization of investment. Canadians have experienced, one way or another, what has happened in Southeast Asia. I do not know whether or not the Southeast Asia situation has had an "impact" <#0107> that is the word that is used nowadays -- on OMERS. Has the Southeast Asia situation impacted OMERS?
Mr. Gunn: Senator, major pension funds invest to diversify as much as look for opportunities around the world simply for return enhancement. Our policy has been to look for opportunities where there are good values, no matter where that country is located. If we are assured the assets of the pensioners can be protected, we will view it as a feasible market. Southeast Asia also includes Australia and New Zealand, both of which have generated very positive performance.
It has also been possible within Japan to produce reasonably strong results, even though the market has not been good. I can assure you that there are certain countries that the fund chose not to invest in, and we are quite pleased with our results.
Senator Stewart: Let us put aside the question of definition. I gather you are saying that you chose not to invest in Indonesia; is that correct? What about Thailand; what about South Korea? Were you there a year ago?
Mr. Gunn: Let me give the broad answer that we have given to all our membership when, publicly, I stood before our membership meetings. I can assure you, honourable senators, that no one is more accountable than the person who stands before a membership and explains that the fund lost $45 million.
Senator Stewart: Let me stop you there and ask you if you addressed the whole problem of the superintendents, or regulation of the international money market? It is a question that Mr. Martin, among others, has raised. Have you had occasion to address this problem?
Mr. Gunn: Yes. In effect, there are both regulators, who will meet from time to time to try to determine what "advice" not "orders" that they would give governments, as well as other bodies, such as the IMF, which is inclined to give very strict advice, almost to the level of orders. We are all aware that some governments around the world have resisted these orders on the grounds that it is a violation of national sovereignty.
Free market conditions suggest that market discipline does work in countries that adopt strict standards, although a number of consulting economists will have different views as to how readily these policies will work.
If you look at the reactions of the governments in Southeast Asia to the suggestions of the IMF and, for that matter, to the U.S. Treasury, you will see some mixed reactions, and there are real questions as to how successful these programs will be. There are continuing problems in Indonesia. There is more progress in Thailand and some progress in South Korea. There are some questions as to whether or not the government in Japan fully recognizes what is required. Again, this is an exercise that used to be referred to as "moral suasion." It takes time, generally, to determine whether or not the policies recommended by a national body are appropriate.
Senator Stewart: As a major investor, do you think that Mr. Martin should be pressing ahead with his initiative for a variation, a kind of international philosophy -- for example, the IMF or some such entity that would define what were good financial business practices -- and then have some competence to enforce those practices by saying, "If you do not accept the ground rules, then if you get into trouble, do not expect the IMF to come in and help you out"?
Mr. Gunn: That is an interesting question. Perhaps I should raise it directly with the minister. It could become a function of the Bank of International Settlements which, presently, does perform part of the role of the international bank regulator. Certainly the Department of Finance and the Bank of Canada will actively support that role.
Strong financial sector regulators are usually regarded as a source of strength throughout the world. For example, institutions such as ourselves, who go to invest in other countries as much as other banks, are often asked who our regulator is, and we are proud and pleased of the record of OSFI. I certainly applaud the minister's intention to try to reinforce this direction.
Senator Oliver: In your opening statement you talked about some of the ways in which you can and you do use your influence. In response to a question from Senator Angus, you gave an example of that. You said that, when you are engaged in informal information gathering with a company in which you have invested, you may say to them that you have noticed that a certain director has not had good attendance and you question whether this lack of good attendance is actually enhancing shareholder value. That is at the director level.
What about a person who is in management, a senior vice-president? If your research has shown you that there is a certain vice-president who seems to be holding back the company, would you raise that in your informal fact-gathering meetings with the companies in which you invest? How far would you go with that?
Mr. Gunn: Perhaps I could generalize a little bit. If we became aware that one division was not being well run to the extent that there was public information on it to suggest that there was a problem, we would wish to explore that. A legitimate question to ask executive management would be whether or not they were satisfied that they had adequate management within that unit. You would not put the focus on an individual, certainly not at a first meeting.
Senator Oliver: Have you had occasion to do this type of thing in your informal chats with a company in which you have made an investment -- looking at a division and asking them to have a look at certain management?
Mr. Gunn: Yes, to the first part, but hold my answer on the second. Let me give you an example of one company, which was a multinational, diversified, Canadian-based conglomerate that knew it was having trouble. It was a legitimate question of an institutional investor to ask whether or not progress was being made, whether or not they had drawn up plans to deal with this, what the options were, and when they expected to act. If action had not taken place, then one would have reason to ask follow-up questions such as: "Is there something new or have you just not moved? Is there a problem in the market-place?"
On one occasion we told the chairman of a major company that they had an awful lot of cash in the company. The company in question held in excess of $2 billion in cash. We expressed the opinion that the cash, frankly, belonged to us and that if they could not figure out how to invest it, then we could. We told them that, if they did not have serious business plans to invest this money in a new operation, we would like them to consider dividending it to us. We knew what rate of return to expect. These questions are legitimate. I would ask questions that any investor could and should ask.
Senator Oliver: My next question goes back to the very basis of corporate governance. You have covered most of the corporate governance principles. Your board consists of 13 members, made up, 50/50, of representatives and employees, but how is the chairman of the board chosen? How often does this board meet, for how long, and how are they compensated?
Mr. Richard: Your information is correct. We have 13 members. Six are employee representatives, six are employer representatives, and one is a government representative. There is a nomination process, followed by open elections, held annually in December.
Senator Oliver: That is by way of internal vote among the board?
Mr. Richard: Yes, only the board members vote. It has worked quite well. The remuneration package, as I think we outlined in the package, is half or a quarter of what members of many other boards receive. The chairman receives $12,000 annually; the other members receive $10,000.
Senator Oliver: How often do they meet?
Mr. Richard: Each and every month, for two days minimum. There are separate subcommittee meetings of investment and management, followed by a full board meeting the next day. In addition to the 24 days of meetings annually, there are other meetings; for example, education conferences. The commitment is large because, as you know, we all have our own duties back at the office.
Attendance is exceptional. Rarely does anyone miss a meeting, unless things are critical at work. In most instances, we have 100 per cent attendance.
Senator Oliver: I would like to add my congratulations on the excellence of your presentation. It really deals with the issues we are trying to address.
Senator Callbeck: You said that yours is a lay board and you spoke very positively about the membership. At the same time, you said it is not perfect. I realize it is very difficult to get the perfect board, but if you had the opportunity to make changes in the makeup of the board, what would you propose?
Mr. Gunn: Senator, as a person with some experience in governance, there are three points that I would make on that. First, one size does not fit all. There is not a perfect model for board governance. Second, while some might say lay boards are not effective, perhaps the model is boards to which people are broadly appointed without a particular interest in events. The board at OMERS is a participating board. Each person has an equal stake in the success of the plan. The board is made up of representatives of the organizations that are placing funds into the plan, and all of the people are beneficiaries.
The other key issue relates to the record of this board. OMERS was the first pension plan to reach a surplus. It has met and exceeded its targets for some time. The record speaks for itself. We have a model that does function, and that fact is often missed. Others may recommend boards of different composition, but frankly I would ask that their record also be public.
Mr. Richard: This year the major issue the board must deal with is a complete review of the governing structure, and we are now working through that. We are doing broad consultation with all our members, employer groups and employee groups. We had them in a couple of weeks ago. Obviously, it will remain a lay board, but we are looking at composition, numbers. We are reviewing that as any good board would do from time to time.
Senator Callbeck: The activities of the board would be subject to review from time to time. How often is that done now; and how is it done?
Mr. Richard: Each year we hold a strategic session for the board where they completely review what has been done. The priority this year is the question of board accountability. We believe we have some very good governance structures in terms of the overseer and in terms of management. The issues we have to deal with this year are: how well do we do our own jobs; how do we, critically, look at ourselves; and by what standards should we judge ourselves, our decision-making? This year, the second major issue that the board is reviewing relates to best practices in terms of board accountability, and whether they are found in the U.S. or in Canada. We will be studying that over the next year.
Mr. Gunn: We believe it would be very inappropriate for OMERS to recommend standards of corporate governance to corporate Canada which we would not follow ourselves.
Senator Callbeck: You mentioned that you used proxies. Who makes the decision as to how you vote on proxies? Is it the board? Is it the officers? Is it the investment managers?
Mr. Gunn: As we have said, we vote approximately 1,200 proxies in the course of a year, and most of the questions that are voted on are somewhat technical: support of auditors, approving financial statements, and matters of this sort which are voted on in a routine fashion by a staff member. The decisions are fairly straightforward. They are voted in accordance with the general guidelines.
If there is a particular matter of importance that we believe should be escalated, it is brought forward to the vice-president of the fund who monitors corporate governance, and if it is of sufficient importance, then it comes directly to my attention as the chief investment officer.
The board involvement is in the principles of governance. Certainly, if there were a particular action that we thought appropriate to take include in our application of these governance principles, I would not hesitate to bring the matter forward to the board for consultation. That is the approach I believe we should take. I would ask: Are you satisfied that we are on the correct course of action?
This year, given the nature of questions asked of bank boards, I personally had meetings with virtually all the major banks in the country and at some point I was accompanied by the president of the fund. Our policy was to follow our proxy voting guidelines. The board endorsed this and was well aware of what was going on.
Senator Di Nino: You suggested that a 30-per-cent to 35-per-cent foreign content limit would be appropriate. Would you maximize that limit, or do you think that there should be a limit at all?
Mr. Gunn: Ideally, there need not be a limit. Optimally, people like Mercer would recommend a limit no higher than 30 per cent, as would actuaries. Part of the reason for this is the liabilities of pension funds are in Canadian dollars, and mathematically there is a certain level at which it does not make sense to go beyond that figure.
As well, there is a trend in world investing by countries in which there are no limits, and if there is a limit, it rarely goes above 30 per cent. The main reason is that the liabilities of the fund are basically payable in Canadian dollars. Part of the reason to expand the limit is based on the running of the Toronto Stock Exchange, but its makeup does not necessarily reflect the makeup of the economy in Canada. To get broader participation in the Canadian economy is in everyone's interest. If it means that participation comes through companies incorporated outside Canada, well, after all, that was part of the purpose of free trade.
Senator Di Nino: You use as an example the purchase by an American company of a Canadian company, or the purchase by a Canadian company of an American company. A pension fund is really a pool of capital which is used in a number of ways to benefit the recipients of this capital. If there is no limit, or if the limit is very high, would not the spin-off benefits that the capital would give to the economy of that country be lost if, in effect, too much or -- and I agree it is an improbable scenario -- if all of the funds were invested outside of the country of origin?
Mr. Gunn: If the money were invested outside the country and then spent outside the country, that would be one thing. However, if we look back through the model of the last century, money invested in companies frequently, means that those companies are directed back to the parent country for their purposes.
If a Canadian company becomes a success by a world standard, typically it must invest abroad. However, let us remember that one of the advantages that comes by having large active Canadian companies with large international activities is that an enormous number of high value jobs are generated, jobs that remain in Canada. For example, with the technology jobs in the banking business, all the capital-markets jobs, in fact, are here. The fact that a major portion of the American banking system is controlled by Canadian financial institutions today is something which Canadians should take pride in, and that actually creates jobs and interest here.
Simply buying the controlling interest of a company incorporated in the State of Delaware or in Mexico for that matter will have economic effect in Canada. It should have an effect in other countries, but there will definitely be an effect in Canada.
Senator Di Nino: You can never control that?
Mr. Gunn: It is a question of: Do you want to control it or do you wish the market to allocate resources, in an appropriate fashion, by Canadians? I think we would all find that if we had our choice, we would opt for jobs in Canada rather than elsewhere.
Senator Meighen: Senator Di Nino mentioned that one of the features of the no-limit rule on foreign investment is that, in countries where there is no limit, it tends to settle the high 20s or low 30s per cent, which seems to reflect human nature. After all, you know your own market best, and various rationales contribute to that. I do not think the fear of some people that, if the rule were lifted immediately, the pension fund money would be invested abroad holds any water.
I would now like to deal with venture capital. During our CPP hearings in Vancouver, an eloquent plea was made to us that part of the CPP funds should be specifically allocated -- say 5 per cent -- to venture capital, very small cap operations, where obviously the risk-reward ratio is quite pronounced. Do you have any policy within OMERS in that area, stated or informal?
Mr. Gunn: OMERS has one unit within the investment division which is called the "Private Placement Merchant Banking Group." OMERS is of the view that we should promote the proper business enterprise in Canada. We have heard the discussion that has gone back and forth, concerning the flow and allocation of capital. Some interesting technical issues about this have been raised from time to time. One of those is that, on occasion, we have experienced too much money facing too few opportunities. Frankly, OMERS is very much of the firm belief that, if the economy of Canada does not prosper, the pension plan will not prosper.
We see our first role as a fiduciary for our beneficiaries. Social investment or any other form of investment or economic-directed activity must be subordinate to the long-term interest of the pension plan to the extent that we see opportunities that create other benefits. We do not see these as being necessarily contradictory, in fact we see then as being supportive. We look for opportunities where this can happen. We do not seek confrontation in this, but we look for profitable ventures. Our principle again is alignment of interest and a creation of value.
Senator Meighen: Given that and given what I presume would be the case, that you would probably hold shares in one of the four banks that are proposing to merge, what would be the process that you would go through to decide whether or not you would support those mergers or not?
Mr. Gunn: I expect that when those formal hearings are held we will be invited back to comment on that specifically.
Senator Meighen: You would certainly express your view to the management at the annual meeting of the Royal Bank or the Bank of Montreal, or TD or CIBC.
Mr. Gunn: Yes indeed, I have, and I have expressed some views in a public forum. They are basically this: I we look at the role of banking in Canada and we look at their role in the evolution of technology and the movement of banks around the world, I think we must be very careful that we take a broad view of what is, frankly, in the long-term best interest of Canada overall.
If we look at the experience in the United States, when the defence of local branches and local institutions took place, debates took place in two different areas. One was in Texas and the other was in the south eastern United States. The State of Texas chose to be extremely defensive of its banking system. As a result, there are no banks left in Texas. They are all headquartered in Atlanta.
If we look at the evolution of what happened in Europe, the Dutch said they would attempt to protect the banking system in Holland from being overwhelmed by large institutions from elsewhere. Instead, today, there are four large European-based banks based in Holland. Technology has changed the whole nature of banking significantly. That we must watch. The fact that there are alternate delivery systems out there is something that both the minister and the Senate must take into account.
While no one likes to miss or likes to lose the local presence of an institution, there are alternatives to that. It would be interesting to resolve the question of under what terms and conditions we want to maintain the local presence of a bank against the long-term interests of the country. I would encourage, and we will probably have, a healthy debate on this over the next several months.
Senator Meighen: I do not want to flog this to death, but will you have an internal debate within OMERS about this?
Mr. Gunn: I would encourage one.
Senator Meighen: Within the board or wider?
Mr. Gunn: I am not sure what you mean by "wider."
Senator Meighen: Would there be any role for senior management or for the beneficiaries?
Mr. Gunn: I think there would be an active discussion with the investment professionals and that would include the board. Our board quite openly and clearly reflects the views of all the beneficiaries and all the constituencies.
Senator Meighen: If I were a beneficiary of OMERS pension plan, would I have an opportunity to stand up and discuss this or any other issue at an annual meeting?
Mr. Gunn: At our regional meetings all questions are open for discussion. I would openly make the point that our president and all members of the board will answer any question put to them.
Senator Meighen: There was some discussion with Senator Angus about salary disclosure. Is there a downside to this at all? I was once associated with a small, domestically owned insurance operation, and the feeling there was -- and I believe it was communicated to the government of the province where it was headquartered successfully -- that disclosure would point out the difference in salary paid between this operation and the large American or international insurance operations. The CEO was, of course, very reluctant that that be done. Is that just a fact of life we must accept?
Mr. Gunn: I frankly think it is. There is no doubt that salary disclosure has led to salary increases, particularly in some industries. Again, it raises the question of what is fair and what is appropriate. These are legitimate questions for all organizations to work through.
Senator Meighen: Let us say that some of the salaries we have been seeing reported in the press, we feel, are unfairly reported, widely exaggerated. There is the danger is there not, that, if the salaries are within a certain level in a certain industry, raiding would take place and your best people would be lost?
Mr. Gunn: Do you mean the best people within OMERS would be lost, or in general?
Senator Meighen: Let us take OMERS as an example.
Mr. Gunn: Speaking of my own organization, I would proudly say that it is well run. Somebody once said to me that I should be happy if somebody came along to steal my staff because after all, they are well trained and very effective.
Certainly, you would not want a competing fund to go off and hire bad people, but that is a risk in all organizations. We believe in promoting our OMERS values within OMERS, and I believe all our corporations believe that people come to work for us for more than money. They believe and understand the culture and share the values of the organization for which they work. OMERS is a public sector corporation. It does not pretend or imply that it would pay the highest salaries on earth, nor would it be appropriate to do so. We have people who are dedicated to the goals of our membership and they are all happy to be there.
If I can deviate to the banking business for a moment, one question that came up was: What was the appropriate salary to pay the head of a brokerage operation within the banking business? I recall the numbers shown were $3 million, $8 million and $15 million. The question was put to all the banks and the response was that $3 million looks low and $15 million looks high. What is the right number? There was not a very strong explanation for this, but it is legitimate to ask each of these institutions: What do you think is right? We do not pretend to have the answer, but we want to know who we are asking.
Senator Meighen: You mentioned that it would be nice if we had a national securities commission. Does anything else leap to your mind in terms of legal restraints on your institutional activities within the market-place that you would like to see change? I am thinking of insider-reporting rules, the fact that you do not necessarily know who your fellow shareholders are because of CDS, the dissident proxy circular problem, as some people describe it? Is there anything that leaps to your mind that you would like to see changed to improve your ability to serve your constituents?
Mr. Gunn: We would invite all corporations to voluntarily comply with U.S. disclosure standards; and we would like to see world markets moving together in a more uniform fashion, and that the free flow of information to the highest standards would work in the interest of all Canadian companies and would involve shareholders. The Canadian standards would be much closer to the American standards.
Senator Meighen:Thank you very much for an excellent brief. I am sure your board members receive their brief earlier than the day of their meeting. Perhaps we can improve our practices here.
The Chairman: When you talked about the remuneration level of your board members, you say that you are paying your board members 30 per cent or less compared to what they would make in any other comparable sized institution. I understand it is nice to get cheap labour, but are you really being fair to them?
Mr. Richard: I will take that question back to the board members.
The Chairman: I am asking the question seriously.
Mr. Richard: I know you are. One of the arguments that is raised is that a certain element of public service comes with this job. As well, we are nominated to a board of directors.
The Chairman: It is a combination of board service and charitable service; is that what you are implying?
Mr. Richard: Yes.
The Chairman: Thank you very much for assisting our committee. As usual, your brief was quite thorough.
The committee adjourned.