Proceedings of the Standing Senate Committee on
Banking, Trade and
Commerce
Issue 9 - Evidence - Morning meeting
CALGARY, Wednesday, February 18, 1998
The Standing Senate Committee on Banking, Trade and Commerce met this day at 9:00 a.m. to continue its study of the governance provisions contained in the Canada Pension Plan Investment Board Act (previously Bill C-2).
Senator Michael Kirby (Chairman) in the Chair.
[English]
The Chairman: Our first witness this morning is Mark Milke from the Alberta regional office of the Canadian Taxpayers Association.
Thank you, Mr. Milke, for coming down this morning.
Mr. Mark Milke, Canadian Taxpayers Federation: Thank you for having me.
For those of you who may not be familiar with the Canadian Taxpayers Federation, let by begin by pointing out who we are and what it is that we do.
The Canadian Taxpayers Federation was founded in 1989 in Saskatchewan, and now has offices in the capitals of five provinces, as well as a federal office in Ottawa. We are a non-profit organization, and independent of all political or institutional affiliations. Neither myself, the other directors, or the board members of the federation are allowed to hold memberships in any political party.
The federation seeks to inform taxpayers of government's impact on their economic well-being, to promote responsible fiscal and democratic reforms, to advocate taxpayers' common interests, and to mobilize taxpayers to exercise their democratic responsibilities. The federation is entirely funded by free-will contributions from over 70,000 supporters across the country, approximately 25,000 of whom reside in Alberta.
To review our history of interest in the Canada Pension Plan, the federation submitted a proposal to the trigovernmental committee reviewing the Canada Pension Plan in 1996, in which we suggested a phased-in move to a mandatory retirement savings plan based on the Chilean model. In November 1997, we released our study on the tax implications resulting from Bill C-2, pointing out the difference between 1996 contribution rates, stretched out over 1997 to 2003, and the rates proposed under Bill C-2. We used 1996 as the base year, as the legislation proposed a retroactive increase for 1997. The difference between constant 1996 contribution rates and the -- now legislated -- changes is $47.8 billion over those six years. In November, we released our revised alternative, once again suggesting a mandatory retirement savings plan.
In December of last year, our federal director, Walter Robinson, appeared before the Committee of the Whole in the Senate immediately after Paul Martin, stating our views on why passage of Bill C-2 should not proceed.
As Bill C-2 has now become law, we respect the decision of Parliament. We will, however, continue to press for systemic reforms to the pension system in Canada. In the interim, we offer our suggestions on the CPP investment board.
The important issues, as we see them, are: expertise in managing the funds entrusted to the advisory board, accountability, transparency, and impartiality. Our recommendations today seek to de-politicize, in every way, the management of pension funds in Canada. Taxpayers must have the confidence that their money will be invested prudently -- without regard for the political issues of the day, or for the whims of any particular bureaucrat or well-connected political party member.
We urge you to view our recommendations in that light. They preserve accountability to Parliament, yet prevent present and future governments from interfering in the decisions of the CPP investment board. Our recommendations preserve the right of the Minister of Finance to recommend persons the minister believes suitable to serve on the investment board, yet also involve other parliamentarians in the process. Given a dispute over the suitability of proposed members of the board, our recommendations give the minister yet another opportunity to suggest candidates who will be suitable to the majority of the members sitting on the oversight committee.
Our recommendations set out a clear target of what the investment board should be seeking -- maximized returns with an acceptable and clearly defined level of risk, which should be minimal.
We believe that institutional safeguards should be set in place to preserve the integrity of the investment board, and its independence from political and bureaucratic interference. At the same time, these safeguards should preserve the board's accountability and access to Parliament and, ultimately, the citizens of Canada.
It is not a reflection on any current members of Parliament to ask that well-defined and clear safeguards be in place in advance. One never knows the future, and our inherited British system of governance assumes the rule of law to be important for this very reason.
Our first recommendation is for a parliamentary oversight committee. We recommend the creation of a parliamentary committee of the whole to oversee the CPP investment board. The committee should contain elected representatives only, in approximate proportion to their number of seats in the House of Commons.
We recommend that the committee vote on each member who is to serve on the CPP investment board, acting on recommendations from the government and from the opposition parties. We recommend that each member who is to serve on the CPP investment board be approved by two-thirds of the all-party committee. The two-thirds majority would be preferable to unanimous approval, in that requiring unanimous approval would, in effect, give each member of the oversight committee a veto.
A two-thirds majority approval would also be preferable to a simple majority of 50 per cent of the committee members plus 1, since a simple majority might engender partisan positioning. The party with the majority of seats in the House of Commons would obviously have a majority of the members on the oversight committee.
The future of the Canada Pension Plan, and of the investments made by it, are too important to be linked to public positions or the partisan arguments of the parties of the day. A two-thirds majority decision would ensure that the individuals appointed to the CPP Investment Board had the confidence of more than just the bare majority of the Members of Parliament. Such confidence will be crucial to the board's activities and duties.
It may happen that the committee rejects a number of proposed candidates, resulting in a board which does not have the required minimum number of members. In such a situation, we propose that the committee be required to petition the government and the opposition parties for additional candidates, until a sufficient number are approved by the Committee of the Whole.
We also recommend that the committee be given the authority to remove a member of the investment board if two-thirds of the oversight committee deem such an action necessary, and vote accordingly. We recommend that all the decisions and votes of the committee of the whole be made public.
Our second recommendation pertains to the Canada Pension Plan investment board. We recommend that the board contain only experienced investment advisors whose qualifications are equal to -- or exceed -- those established in major investment houses, stock market advisory firms and private sector mutual fund companies.
We recommended that the CPP investment board not contain any currently elected representative to the House of Commons, a provincial legislature, a territorial or municipal government, or any other public office holder in Canada. We recommend that the CPP investment board not contain any current member of any branch or level of the civil service. We further recommend that no member of the investment board hold a political party membership while said member is serving on the board.
Our third recommendation concerns investment limitations. In our view, the first -- and only -- goal of the fund managers should be to maximize the returns of taxpayers' invested dollars. Such a goal should take into account the necessity of prudent investing, given that these dollars are not volunteered to the government. Minimum risk should be assumed, with acceptable fluctuations due to market volatility.
We recommend that investments made by the board be narrowly circumscribed to a predefined written set of criteria, which pinpoint what does and does not constitute an acceptable risk. Such criteria ought to be clear, unambiguous and able to be objectively assessed. A comparison to private sector norms and the various risk categories employed in the private sector would be helpful, prudent and crucial.
As the goal of the fund should be to maximize returns within the framework of acceptable risk, we recommend that there be no preset foreign content limits. The goal of maximizing the returns of the fund within acceptable risk limits must not be held hostage to one or several stock markets' natural limitations. It may be assumed that investments will be deposited mainly in Canadian equities, but there should be no restrictions on the ability of the investment board to invest prudently.
To require that the board invest only in, or mainly in, Canadian equities or bonds, would, ipso facto, mean that investments might one day be given consideration that they would not otherwise receive. To require that the investment board be restrained from investing where prudence dictates is to eliminate what should be the first and only objective; that of maximizing terms within acceptable risk limits. In addition, insofar as investments within Canada are concerned, the same criteria ought to apply. Decisions on where to invest within Canada should be based solely on the aforementioned goal within the context of the clearly prescribed criteria.
Investment choices made by the board as to whether to invest wholly in one region or another, this year or the next, partially or not at all, should be based on sound investment decisions, not on regional or partisan preferences or grievances. The pension money to be invested belongs to all Canadians, and the goal of maximizing that return must not fall prey to any other agenda. Members of the investment board should have the right to appeal to the members of the oversight committee regarding issues which concern them.
Our fourth recommendation pertains to access by the Auditor General, and the response of the investment board. We recommend that the Auditor General be given unfettered access to the minutes, deliberations, and decisions made by the Committee of the Whole. He should be given the same access to the minutes, deliberations and investment decisions made by the investment board. While the Auditor General should have unfettered access, he should restrict any advice and commentary to the procedural, technical and forensic activities of the investment board while withholding advice on investment related matters. At a minimum, the Auditor General should report his findings to Parliament on an annual basis. The investment board should be required to respond to each specific recommendation and/or critique given by the Auditor General, within four months of the recommendations being made available to the Committee of the Whole and to Parliament.
Our fifth and final recommendations concerns the Access to Information Act. We recommend that all activities of the oversight committee, and of the CPP board, be made public, as well as subject to the Access to Information Act.
One estimate of the size of the pension fund is $150 billion in fifteen years -- roughly the size of this year's federal budget. Parliament would be remiss in the extreme if it did not make such moneys, and the decisions that will accompany them, open and accountable to the public at large. Such dollars are, of course, property of the Canadian taxpayers and ought to be regarded as such.
In summary, we propose that a committee of the whole be created to oversee the creation and the activities of the investment board, and that the investment board advisors be professionals from the private sector. Further, the sole goal of the investment board should be to maximize returns within an acceptable level of risk, which should be minimal. The Auditor General should have unrestricted access to the board, and both the Committee of the Whole and the investment board should be subject to the Access to Information Act.
Honourable senators, we strongly urge the creation of institutional safeguards to protect the pension money of Canadian taxpayers.
The Chairman: May I say that we all agree with your objectives; I do not think that there is any dispute on that. I have a couple of questions, and I will ask for a couple of clarifications.
With respect to your recommendation on membership, just for your information, the act now explicitly prohibits your second and third points -- anyone currently in the House of Commons and provincial legislature, et cetera. It also explicitly prohibits anyone currently employed by governments, so your second and third points are met.
With respect to your first point -- it deals with the desirability of having only people who know the investment business on the board. We had this discussion yesterday with people from two major pension funds, the Ontario Teachers', which is the country's largest fund, and the Ontario Municipal Employees, which is the fourth or fifth largest. Their view was that you do not just want people who know the investment business. What you do want is a mix of talents; some people who know the investment business, some who understand the legal considerations, and some who understand broader public interest.
You have narrowed it down, saying that the only people who could be there are people who are, in effect, employed in the investment business. That is the net effect. Anyone who is an experienced investment advisor, with qualifications equal to those required in major investment houses, is probably employed by a major investment house or retired from it. That would be my guess.
While we recognize the need for experience, it is the word "only" that I am wondering about. I understand you might want a majority of people to have investment experience. If the dominant group of people on the board did have this experience, however, what other elements of experience would you like to see in the board members?
Mr. Milke: The purpose of the recommendation was to ensure that, when it comes to investing, the people making the decisions on where to invest and how to invest have experience in that area. Of course we need legal opinions; a lawyer who is not necessarily an expert in a certain stock is fine. You would need that, and we assumed that.
The Chairman: Therefore, while investment experience ought to be the main thrust of the board, you would allow for some flexibility around the edges.
Mr. Milke: The important point being that we stay away from political appointees.
The Chairman: That led me to your last bullet point. I can understand that you would not want membership in a political party to be the sole criteria for appointment. On the other hand, there are an awful lot of talented people in this country who belong to some political party or another. As a matter of fact, most involved people in the country do belong to some political party. You would rule them out?
Mr. Milke: In our organization, current directors and current board members must give up political memberships while they serve in those positions.
The Chairman: People can be members of your organization, then, and still belong to a party. If they join the executive, however, they must cease to be active party members for the length of time that they serve on the executive?
Mr. Milke: Right. We would prefer that.
Senator Austin: That is because your federation has a charitable standing.
Mr. Milke: Actually, we do not have a charitable standing.
Senator Austin: You do not? You are non-profit?
Mr. Milke: We are non-profit. We do not have charitable status, because we are an advocacy group.
The Chairman: We do not require that people running the United Way give up their political affiliations.
Senator Tkachuk: There is no requirement whatsoever.
The Chairman: That is not linked to the charitable status. It is that you cannot be a political organization and have a charitable status.
Senator Hervieux-Payette: We have a Charter of Rights, and the freedom to participate in politics is one of the freedoms that we have and enjoy in this country. If the bill were to prohibit membership in a political party -- I think that the Minister of Justice would hesitate to write that.
The Chairman: Just so we are clear, members of the judiciary are not allowed to be members of the political parties. Members of the judiciary, once appointed, give up their political affiliations.
Senator Hervieux-Payette: I think that we should make a distinction between the investment committee, which is made up of specialists and financial analysts, and the investment board. The board is making the policy, the broad picture; the investment committee is making the analysis and investing the money, in accordance with the broad policy. We need to make a distinction between those who are sitting on the board, and those who, on a day-to-day basis, really are financial analysts and specialists.
Senator Kenny: Mr. Milke, what is a parliamentary committee of the whole?
Mr. Milke: My understanding from the federal directory is that it is a committee that is set up specifically to oversee something.
The Chairman: He means a special committee.
Senator Kenny: I think that you mean either a standing committee or a special committee. If you are after a committee of the whole --
The Chairman: When you read it, it is in proportion to the members of Parliament.
Senator Kenny: I understand that, but, if you are referring to a "parliamentary committee of the whole," I do not think there is such an animal.
Mr. Milke: I was misinformed.
Senator Kenny: What is so magical about two-thirds?
Mr. Milke: In our proposal, the oversight committee votes on each member of the investment board and of the investment committee. If there were a majority government in the House of Commons, the majority of the members on the oversight committee would obviously be from the government. In that case, there would be little point to having a vote, if the requirement were to be 50 per cent plus 1. The present and future Ministers of Finance, with all due respect, would then have undue influence. A two-thirds requirement, however, would involve opposition parties, and require a high level of confidence in the candidate. Our goal is to promote a high confidence level, as well to ensure that the process is non-partisan.
Senator Kenny: On the other hand, however, a minority party could block the process. You are setting up a system where the Bloc, for example, or Reform, could bring this whole process to a stop, or could control it.
We believe that 50 per cent plus 1 is how we operate a democracy. I think that there can be certain special circumstances; if you are amending a constitution or something that is very profound, you might want to consider more than 50 per cent plus 1.
What is so special about this operation? If you look at this committee, for example, it will operate on a majority basis, as will all other parliamentary committees -- 50 per cent plus 1. Why should we distinguish this committee from any other parliamentary committee?
Mr. Milke: With all due respect, this committee will potentially manage $150 billion worth of taxpayers' money. In my belief, that sets it apart significantly.
The same arguments can be used in reverse. That is, there is no point in having a committee and having selections offered by opposition parties if the committee can simply be controlled, influenced by the governing party.
With a two-thirds regulation, a minority party could, to some degree some degree, block the actions of the committee. On the other hand, if you take the reverse position, that it should only be 50 per cent plus 1, the government members could simply ram through certain measures.
We find that the two-thirds requirement provides a nice balance, which is also why we did not ask for a unanimous vote. If you were to ask for unanimous approval, you would be giving each member a veto, which we think would be a mistake; you would have precisely that situation that you referred to. A two-thirds balance is a balance.
Senator Kenny: I hear what you say, but there are parliamentary committees that vote on all of the government expenditures, not just these -- and they deal with 50 per cent plus 1. Opposition parties in Ottawa kick up very effective fusses when they do not like how things are going; some parties come with mariachi bands or whatever, and get a whole lot of public attention. The opposition parties can be very effective when they do not like the way that the government is running things.
I would need to hear a more substantial case to convince me to support a two-thirds majority. I would be more than willing to listen to one, now or later. I will move on to my next point.
In bullet 1 of recommendation 2, you recommended qualifications that are equal to, or exceed, those established in major investment houses. I do not know what those standards are, and, even if I did, I do not know how I would measure them.
In order to save time, I will pose my third question, which deals with political party membership. I understand your concern, but asking people to deny their party memberships seems to make them closet members of a party.
You say that your board does not have any political affiliations. They all have political views, however, and I think that it would be much more transparent if they were upfront and said, "I am a Liberal" or "I am a Reformer", as the case may be. We could then judge them accordingly, by how they behave and how they speak.
You seem to be in favour of transparency in many other areas, but you are inconsistent if you are asking people to pretend, for a period of time, that they do not have political views, and are not members of a political party; that just leaves us guessing. I would far sooner have someone say, "I am a card carrying whatever." I would watch how they vote and behave, and judge them accordingly. If you would care to comment on those observations, I would appreciate it.
Mr. Milke: I will deal with the last one first. In our organization, we make no secret of the past political memberships of our directors. In terms of this particular committee, it is a symbolic gesture that we think that each board member should make. To do so demonstrates that the interests of the country come first; the interests of this pension fund come before political leanings or any other concern. With all due respect, we recommend that they do this.
The board members will have political views, of course, and we are not asking them to hide that, nor to pretend that they do not have them.
Senator Kenny: With the possible exception of the officials, every member sitting around this table is a card carrying member of some party. If you were to ask us, however, we would tell you that we put the needs of the country first, and that we do that every time, regardless of the needs of our parties.
Mr. Milke: I am not disputing that.
Senator Kenny: Frankly, if someone is involved in the political process, he or she is usually involved in order to better serve the country, not the opposite.
Mr. Milke: I do not dispute that. Again, it is a question, quite frankly, of appearances. Do you want the media starts to start tallying up how many people on the board come from this political party or that political party?
Senator Kenny: They will do it anyway.
Mr. Milke: I think that it would be much better for board members to determine to remove themselves from partisan politics while they serve on the board. I take your point, but I think that we will disagree on this one.
Senator Kenny: And the qualifications?
Mr. Milke: Just because it is difficult to establish what proper qualifications should be does not mean that you should not aim to set qualification standards. I am certain that every major investment house or stock market firm has minimum criteria. With the amount of money involved, you want people who are qualified and competent, not people who are there simply because of party affiliations.
Senator Kenny: After your exchange with Senator Kirby, is seems fair to say that you are not firmly wedded to having a board made up solely of investment dealers and people from the investment community. Would you say that what you really want is a broad, balanced, and qualified board?
Mr. Milke: I would assume that the investment board would gather advice if it were required. We would prefer, though that the majority of individuals on the investment board, especially those on the investment committee, have some knowledge of the stocks, bonds, and funds with which they are dealing.
Senator Meighen: Notwithstanding your appearance before us today, I assume that, in terms of the oversight committee, you are looking for a House of Commons select committee. You have been very careful to point out that you do not want any non-elected people dealing with this. I do not know that I agree with it, but it is very clear that I can give up any ambition of sitting on this committee, am I not correct?
Mr. Milke: Yes.
Senator Meighen: Is there a particular reason for that?
Mr. Milke: To be frank, the particular reason is that, if issues of concern arise, political heat should be directed towards those who can be held accountable. With all due respect, senators cannot be held accountable, and we would want to see political heat directed towards those who could be. I am not familiar with the workings of the Senate, but I have no doubt that, if you wanted to review certain aspects, you could do so.
Senator Meighen: In your third recommendation, which deals with investment limitations, you clearly are not supportive of any limitation -- let alone of a 20 or 30 per cent one.
The Chairman: You may not be aware of this, but there is a law in Canada which requires all pension funds, not just the CPP pension funds, to invest no more than 20 per cent of their assets outside of the country. At least twice in the last five years, and as recently as three or four months ago, this committee has urged the government to start moving that 20 per cent up -- to allow a greater diversification into foreign assets. I wanted to make sure that you understood what the current rule is, and that the proposal is to have the CPP be subject to the same rule as every other pension fund.
Mr. Milke: I was aware.
The argument against a pre-set limit is that, if you force domestic investment, you will force investment in stocks that would not otherwise be considered. All of a sudden you start investing in banana plants in the Northwest Territories, simply because you have to invest a certain percentage of your money somewhere in Canada. That is a mistake.
Senator Meighen: As opposed to investing in electronic companies in Japan?
Mr. Milke: Yes.
Senator Meighen: You can make a mistake anywhere in the world, though.
Mr. Milke: True enough. The point is that, with two percent of the world's stock market capitalization, you are really restricting the ability of this fund. You cannot have it both ways. You cannot say, "The number one goal of the money invested has to be to maximize the returns within an acceptable framework of risk," and then handicap it immediately by saying, "but a certain percentage must always be invested within Canada." It seems that these are, at least in some years, completely opposite goals.
Senator Meighen: There is a report in the press this morning, detailing questions that this committee asked in Toronto yesterday in connection with the regulations, and with what they say about the first three years of the operation of the fund. The regulation indicates that the fund would have to invest in a basket of stocks that mirror the broad indices of market activity, rather than trying to pick stocks. According to the press report and according to reports I have had from my colleagues here, the experts who came yesterday were not supportive of that idea for a number of reasons; for one, it is not enforceable, because you can get around it with derivatives and other mechanisms.
In my understanding, you would not only prefer not to see limits in terms of where the fund invests, but you also would not want any particular restrictions, not even in the first three years.
Mr. Milke: No restrictions on where you can invest. The more technical side of the question, which deals with what the acceptable level of risk ought to be, we decided to leave up to the experts. That is, those who do this on a regular basis, who invest money on a regular basis. Even though it may be difficult to define what an acceptable risk level is, you should attempt to do so. We prefer, however, that that be done on the recommendations of those with proven experience.
We are simply saying maximize returns with an acceptable risk level; we assume that we will get lots of advice on how to determine acceptable risk levels.
Senator Meighen: This is my last question, and it is a very difficult one -- what is acceptable risk? What level is acceptable? You talked about minimum risk, acceptable risk, and the act talks about undue risk of loss.
Mr. Milke: Again, I am not trying to avoid the answer on this.
Senator Meighen: I do not know the answer.
Mr. Milke: Off the top of my head, I can simply say that we would want to go with recommendations received from those who do this day-to-day. We would want them to say "this is the sort of thing that will guarantee that you not lose the money you invest", to look at our options with us; moderate risk, low risk options. We would lean towards the low risk; we would want to see the money handled very conservatively, so to speak. We would not want to see pension money -- that has not been volunteered -- put at all at risk. There are some obvious things that you do not invest in these days -- mining stock in Indonesia, for example.
The Chairman: On the last sentence in the first bullet point under recommendation 3, you say, "Minimum risk with acceptable fluctuations due to market volatility should be assumed." I take it from that that what you are really saying is, "Look, you should not go with high flyers." On the other hand, it also says that you recognize that investing in the market means that some things will go down, and that you cannot lose on any single investment policy, because then there is no risk; right?
Mr. Milke: Right.
The Chairman: Yesterday someone pointed out to us that, unfortunately, the general public may have difficulty understanding that. If the fund makes 100 investments and 99 investments go up and one goes down, all the attention would be on the one that goes down. I interpret that to say that you fully recognize that you want a lot more ups than downs, but that there will be some downs.
Mr. Milke: Exactly.
Senator St. Germain: Mr. Milke, I congratulate your organization for some of the work that it has done. I am surprised that the general public in Canada have rolled over to this huge tax grab; this is a payroll tax in its true form. It will take off a bottom line of a lot of companies, especially labour intensive organizations.
I know a lot of the people in British Columbia, in the area that I represent, and I happen to represent this region as well. I think that you have a little bit of question about Senate involvement because we are underrepresented in this region. We have not got enough numbers, but that is beside the point. That is a constitutional thing.
Senator Kenny: You have quality.
Senator St. Germain: Quality, yes. To return to your desire for a two-thirds methodology; the government, I believe, is fearful, because it would take away from the partisan GIC appointment method that they will use. I am very concerned about this, regardless of which party is governing.
Yesterday, Claude Lamoureux, the President and CEO of the Ontario Teachers Pension Plan Board, with whom I was quite impressed, said that the first boards will be critical to the overall well-being and performance of this particular fund. This may well be too important for us to leave it as a GIC appointment. As you know, out here in Alberta and British Columbia, where we are from, everybody is screaming about partisan appointments.This will be a purely partisan process, unless this committee recommends changes to the process, and the minister, in his wisdom, acts upon them.
I believe that your two-thirds methodology could work. I have been an elected member of the House of Commons, and most House committees have a confrontational atmosphere. I agree with Senator Kenny, in that your process would likely result in gridlock. At the same time, however, I disagree with using mariachi bands to disagree with what we do not like, and to overturn what is not acceptable to Canadians.
It has been brought to my attention that the Ontario Teachers Pension Plan Board has an intriguing method. The Department of Education in Ontario, the government, appoints half of the board, and the other half is appointed by the Teachers' Federation. They then jointly pick a neutral chair. I think that this is a great idea, because I do not think that governments want to relinquish their power to give out appointments to their qualified friends.
My suggestion, then, would be to make the process more transparent by having the Feds pick half of the board, and the provinces the other half; together, they would pick a neutral chair. I find it funny that the current government denounced the GIC appointments of the previous administration, and is now trying to sit back smugly and make the argument that it would never, ever do anything that was partisan or political. What is your reaction to the proposal that we do half and half and pick a neutral chair?
Mr. Milke: I am not sure what the half and half idea would accomplish. The appointments would still be entirely in the hands of government, whether it be provincial or federal. It would seem, again, to engender partisanship, as well, perhaps as adding regional and provincial bickering. I am always open to ideas, but I cannot speak for the organization. Our position is that two-thirds of a committee is a better idea because, quite frankly, it forces the committee members to make a decision, and there will be no investment board members if two-thirds of the members of the standing committee do not agree to someone. Eventually, they will have to get together and agree on it.
To restate what I said earlier, if you only go at 50 per cent plus 1, as the current proposal requires, then you might as well give the current Minister of Finance -- and future finance ministers -- a sheet, and let them just fill it out.
Senator Tkachuk: That is what they are doing now.
Mr. Milke: In our view, that is simply too much power to give to anyone when you are talking about tens of billions of dollars, and potentially about hundreds of billions. We appreciate the job that the Minister of Finance has done in bringing the yearly deficit down to zero, and his financial skills are obvious, but that is too much power to give to one person. I do not know why any one person would want that kind of responsibility, why anyone would want the weight of hundreds of billions of dollars on his or her shoulders.
Senator Austin: What your presentation seems to miss, in my view, is the role of the provinces.
The Chairman: I should add that Senator Austin is from B.C.
Senator Austin: We are not inventing the Canada Pension Plan de novo; it is not something new. These changes are based on a historic arrangement that goes back, I think, to 1966. In this area, there is a shared political and constitutional jurisdiction; in order to establish the plan, you had to have the agreement of the provinces. You will recall that, during the Pearson government, Quebec opted out, and has its own plan. The other nine provinces participated, and one of the terms of their participation originally was that the funds that were collected for the plan would be lent back to the provinces, in proportion to the collection ratio. This went on for some time, and the rate was not at market rate, but rather, below market rate.
The result of that arrangement, a federal/provincial arrangement, was to create a problem that this particular legislation, C-2, is tackling. The problem was, in fact, underfunding. What we have passed in C-2 is a federal/provincial agreement to create a funding level which, according to the actuaries, will take care of the requirements of the present benefits system. It is a mistake, therefore, to discuss the governance of the board without being aware that the provinces have a very substantial role to play.
Recommendations for a House of Commons committee or a Senate committee would have to be approved by the provinces. It is my view, after practising in the field of federal/provincial relations for quite a few years, that the provinces would never confer that authority on the federal Parliament.
What has been done is to set up a nominating committee where, for example, each of the provinces nominated one person and the federal government nominated one person. I have a list of people on the nominating committee. Alberta, for example, is represented by Mr. Brian McNeil, who is president and CEO of IPL Energy, of Calgary. He was appointed by the provincial government. It is these people who have come up with a list of 40 people. It is not the federal government that has chosen them, but rather the committee as a whole came up with a list of 40 people who are acceptable to the federal government and to the provinces. As you know, the provinces involve a number of different political parties.
The 12 members of the board will be chosen from that list of 40 by the Minister of Finance. His range of choice is subject totally to the approval, by the federal government and the provinces, of a list of directors. The idea of a House of Commons oversight committee will not be approved by the provinces. They will continue to have oversight as to the eligible list from which the federal government can make its choice. If you have comments on that, I would like to hear them.
I have one other question to ask you and that relates to compensation. Is it the view of the Canadian Taxpayers Federation that the compensation paid to the board and the management group should be equivalent to market rates, or do you believe that, because they are managing so-called public funds, they should be paid more at a public service or civil service rate? Those are the two questions.
Senator Tkachuk: Before you answer that question, I will try to give you another view of the history of the CPP. It is true that there was a transfer of authority to the federal government to implement a pension plan, which is actually under provincial jurisdiction. There is no question that the incentive was below market rates, and that they allowed the federal government to play with the large amounts of money that were being delivered by my generation, and to extend benefits.
Senator Austin: I have been paying it longer than you have.
Senator Tkachuk: Senator Austin was asking Mr. Milke to comment on a question that involved what the senator had presented as facts. And frankly, in the future, the Minister of Finance will not be compelled to choose from a list. He will simply make the appointment; he has the power to make it.
The Chairman: I am sorry.
I will put the facts on the table and then the witness can answer the question. The fact is that the first list has been developed by federal/provincial consultation. Secondly, future vacancies will also require federal/provincial consultation. The process, then, is essentially the same when renewals and new names come into play. That is the agreement that the provinces and the federal government have reached. From a political party standpoint, of course, this means that there were Conservatives, NDP and Liberal representatives reaching those conclusions.
The rationale for the involvement of both the federal and the provincial governments in the selection process stems from a sense that the supervision of the CPP, because it is in an area of social policy and -- historically -- was an area of provincial jurisdiction, ought to involve both levels of government.
Senator Kenny: I have a point of order.
The Chairman: Colin, stop it. I do not care about the point of order. Let the witness go ahead and answer the question.
Senator Kenny: You will take the point of order or I will keep talking so take your pick.
The Chairman: You are being a pain but go ahead.
Senator Kenny: That is fine. What I am saying is this: It is not up to other members of the committee or you to interpret another member's question.
The Chairman: I was not interpreting anything.
Senator Kenny: I am sorry. There was a question from Senator Austin, and we had an interpretation of it and then we had a second interpretation of it.
The Chairman: I was not interpreting. I was telling the witness what the facts were.
Senator Kenny: That is fine. You are certainly entitled to do that, but the way the committee should function is that, if a member asks a question, he is entitled to an answer. And then if you want to make a comment or someone else wants to make a comment, that is terrific.
The Chairman: I am happy to let the witness go ahead and answer the question. Obviously you got everybody on a bad morning. Go ahead.
Senator Austin: Can you remember the question?
Mr. Milke: I was about to.
Regardless of how people are selected for the investment board, the final approval should not rest in the hands of the Minister of Finance, or of any other individual. That decision that should rest with a committee that, by a two-third's vote, approves a member of the investment board.
I do not necessarily see a conflict between having provincial input, and the final approval. We are simply arguing that, in the end, it would be a mistake to allow one individual to approve the list of names, and to pick from that list of names. We would rather have a committee of elected parliamentarians be responsible for that.
Senator Austin: You have a degree in Political Science.
Mr. Milke: Yes.
Senator Austin: I understand that, after June, you may have two.
Mr. Milke: Yes.
Senator Austin: In our parliamentary practice there is a distinction between the executive and the legislative functions. It strikes me your recommendation is to move the executive function to a legislative role; to allow a legislative committee to exercise what we have traditionally understood to be executive functions.
In putting your recommendation to us, you are calling for an amendment to the parliamentary.
Mr. Milke: That may be a bit of an extreme statement. We do want to amend the parliamentary system, but I would have to brush up on my review of the executive and legislative branches, and their responsibilities, to discuss that.
Our basic point is that there may well be over $100 billion at stake here, and to allow one individual to have the final say on the list strikes us as a bit risky. I do not know why any one individual would want to have that responsibility.
Senator Austin: Your comments on the question of compensation?
Mr. Milke: We have not discussed that issue. I could tell you my personal view, but there would not be any real point in doing so. As a federation, we have not discussed compensation.
Senator Austin: I was curious, because your federation is well known for its concern regarding government spending. I wondered whether you had a different model for attracting these highly competent people, if you thought that you could attract them at lower than market rates and save money.
Mr. Milke: Not necessarily. You could theoretically attract individuals who do not have the qualifications, and you may, in the end, end up with less money in the fund. That being said, all of our focus for the last year and a half has been on why government is not setting up bodies like this to begin with. The federal government should have at least looked at models from other jurisdictions, and from other countries, before going ahead and taking money, billions of dollars, and investing it on our behalf. Our concern for the last year and a half, then, has been "Why are we going down this road?" We understand the arguments.
As to an earlier point that you made, we are also well aware of the predictions that were made 30 years ago, 20 years ago and ten years ago with regards to what contribution rates should be. They have been wrong.
The CPP contribution rates were never supposed to rise above 5.25 per cent and they stand at 6.4 per cent this year. We are here to contribute in a proactive and positive way to what we think this investment board should look like. We did not consider some of the questions that you have raised because our focus was on why should this happen in the first place. Now that we are here, we think there should be political and institutional safeguards so that $150 billion in taxpayers money are not under the sole jurisdiction of the Finance Minister, competent as he may be.
Senator Kelleher: If you are working towards a higher degree, you are probably entitled to a course credit for having to appear here today.
Mr. Milke: I will mention that to the university.
Senator Kelleher: With respect to recommendation 5, which involves the Access to Information Act, I think that your suggestion that the activities be made public, as well as subject to the act, is commendable. I would, however, suggest to you that perhaps your recommendation is too broad; you may be exposing the investment strategies of the board. If the board were to recommend the accumulation of forest company shares -- if that ever got out, God knows what might happen to the markets, considering the fund's buying power. Conversely, if the board decided to get out of certain areas, it could have quite an impact on the market. I would be a little concerned about that.
I know that, under the Access to Information Act, certain types of information are confidential. I do not think this would cover all of the activities of the board. I suggest to you that you may have gone a bit too far here in terms of the kinds of information that you may the board to disclose.
Mr. Milke: We do not disagree. We assume that there are privacy positions with both the provincial Freedom to Information Act and with the Access to Information Act. They are in the laws. There are things -- like the examples to which you alluded -- that we would not want to see covered by the Access to Information Act.
Senator St. Germain: I am really surprised that a taxpayers association is applying that great adulation to Paul Martin, especially considering that he has off-loaded to the provinces, and kept income and payroll taxes extremely high. Having said that, however, I respect both you, sir, and your organization.
For those of us here who have sat in the House of Commons -- and those of who have know how these committees work -- this would be a trade-off situation. As Senator Austin so aptly pointed out, the provinces do have a major stake in this particular process. This is why I believe that my recommendation, where the board is appointed by both the provinces and the federal government, has credibility. I am not trying to force you to support my idea, but the provinces are not prepared to relinquish their power. You heard him speak about the executive branch of government; unfortunately, this is how our system works.
The Chairman: Do you want to come to your question, please?
Senator St. Germain: Yes.
Senator Austin: It is so unusual for him to be agreeing with him.
Senator St. Germain: I have a certain amount of time. We are getting along well at this end. Oh, there is another witness. Excuse me. To the other witness, I ask forgiveness.
Do you not see that aspect of it? In coming up with your proposal, did you do an in depth study of this particular aspect? I do not think that it would work.
Mr. Milke: We came up with the proposal, and we are always open to suggestions. My concern is that, regardless of how you initially select the candidates, it would not be a contradiction to select the candidates from a list of 50 per cent from provincial lists and a list from the federal lists. In our view, you would not have opposite goals by requiring lists from the provinces, if that is what your suggestion is. If I understand it correctly, 50 per cent of the people to be selected would come from a provincial list.
Senator St. Germain: They would supply 50 per cent of the board and they would meet as a group. The feds would give their 50 per cent, and then they would pick a neutral chair.
Mr. Milke: In the end I think it would be preferable to have a committee that would approve the choices. It would seem more bureaucratic to have a committee for each provincial choice that comes up, a committee for each province. We still prefer the two-thirds option, quite frankly, even if that changes the entire nature of government, as one senator seems to think it might.
As for our confidence in Paul Martin, as I said, we are non-partisan. We recognize the job that has been done. We wish that former finance ministers had been able to balance the budget; we would have preferred that much earlier. This one, however, gets the credit due, in part, to downloading -- we have made no secret of that -- and due, in part to higher taxes, which we have also made no secret of.
The Chairman: I have one follow-up question. Is it true that your organization, along with others, has proposed that a variety of federal appointments -- Supreme Court Judges, heads of federal agencies, et cetera -- should be subject to a parliamentary committee review process, as they would be in the US? I assumed, when I read the selection proposal in your brief, that it was part of a larger proposal, which concerns a number of appointments, and not just the selection of this board. Is that correct?
Mr. Milke: Keep in mind that we have not made any recommendations regarding official appointments.
The Chairman: I know that other groups have.
Mr. Milke: When it comes to accountability, we always argue that more is preferable to less. In this case, we think that the two-thirds rule would force people to get along, so to speak, and would also force a generous amount of accountability on the part of elected officials.
The Chairman: Thank you very much for coming.
Senators, our next witness is Mr. Philip Heimbecker from IDA, the Investment Dealers Association of Canada, Alberta branch.
Mr. Philip Heimbecker, Past Chair, Alberta District Council: Good morning, ladies and gentlemen. My name is Phil Heimbecker. I am past chairman of the Alberta District of the Investment Dealers Association. I am appearing this morning on behalf of the Alberta District Council.
Canadian Pension Plan reform has been discussed, and, regardless of our preferences for a new structure, we are pleased to see that the issue is being addressed. The challenge will be to institute an effective and accountable governance structure for the Canadian Pension Plan investment board, and an appropriate investment policy for the pension plan.
The revisions to the Canada Pension Plan contemplate a 12-person board which will be responsible for creating the management structure for the fund. We suggest that a single centralized investment fund will not be in the interests of all Canadians. While very large funds have cost efficiencies resulting from economies of scale, we believe that a more suitable structure for the CPP would be multiple funds, managed by experienced regional investment managers who are accountable to the pension board. This arrangement would ensure that the role of the fund, as it relates to small business investment, would be more attuned to regional opportunities. In a country as large as Canada, a highly centralized investment structure is unlikely to allow for regional investment opportunities.
We also believe that the 20 per cent foreign property rule, the FPR, unnecessarily inhibits fund performance, restricts the flow of capital, and restrains the development of Canadian international investment capabilities. Arguments and empirical studies have been submitted to your committee which quantify the underperformance of pension funds resulting from the FPR. What should also be understood is that the FPR, as it now stands, is arresting the evolution of Canadian investment capabilities. Canada is a trading nation. We should have a national dedication to becoming the best, and most competitive, trading nation in the world. Our quality of life depends on our ability to compete in world markets. We cannot do this with restraints on Canadian investment capital.
At the present time, many of our large pooled funds allocate their foreign investment component to offshore advisors. The ancillary functions, such as foreign investment research, and the related business of examining a foreign corporation for investment merit, done in a competitive context to Canadian companies, are lost to Canadians. This loss of foreign investment intelligence may well impair merger and acquisition opportunities for Canadians, and may also impede technological advancements in Canadian business, thus impairing our global competitiveness.
We encourage changes to pension legislation which allow the "prudent man rule" to prevail for foreign investment. This concept is in place in the United States, the United Kingdom, and Australia. This approach does not set any limits on foreign investment.
Ladies and gentlemen, the Alberta District Council of the Investment Dealers Association encourages you, and any future board to consider multiple regional investment funds for Canadian pension fund investment. Further, we propose that the pension legislation be amended to allow for a "prudent man" concept for the foreign investment component of pension funds.
The Chairman: On several occasion this committee has urged the government to increase the 20 per cent limit. I think that we suggested a phasing in consistent with the two per cent a year for five years method that was used when it was increased from 10 to 20 per cent a decade or so ago. We support what you are saying; not just with respect to the Canadian Pension Plan, but with respect to all RRSPs and pension plans.
Senator St. Germain: Thank you for coming, sir, and thank you for your presentation. It was brief and to the point. I am concerned with the GIC appointment method of naming the board. That is one thing. One of our senators, Senator Bolduc, was in the Caisse de dépôt -- he also was a former senior bureaucrat in the Quebec government. On a couple of occasions, he has spoken of establishing multiple funds, although he has not actually gone to regional funds. He suggested multiple funds to mitigate the risk involved in investment. Instead of losing it all in one pool, other pools, if they were established, would minimize the risk of huge losses. As we pointed out yesterday, in the 1970's the stock market dropped 43 per cent -- or in the 1940's anyway. The question I have to ask is why did you come up with "regional" as opposed to just saying "multiple funds"? Do you see this as an economic tool for these regions?
Mr. Heimbecker: Yes, we do. The opportunities appear to be there, especially in light of what we would call the burgeoning developing markets in this constituency. I am particularly referring to the successes of the Alberta Stock Exchange, and to some of the business that is being done through that facility. The magnitude of the trickle effect may be rather minuscule in terms of the overall money in the plan, per se, but it augments what we are doing here in Alberta. Regionally we are very strong in that activity and quite proud of it.
Within the context of your question, senator, yes, I think that we certainly do have regional designs on that. We feel that the fund, per se, would benefit from our expertise in that area.
Senator St. Germain: The sole purpose of the fund is to clearly serve the interests of the shareholder, and to get the optimum return. Do you not think that this would take away from that mission statement?
Mr. Heimbecker: I think, Senator, that you only have to look at the returns in our areas to see that we are doing quite well here.
Senator St. Germain: How, then, would this work? Are you suggesting that each region that has an exchange be given a fund; Vancouver gets one, Alberta gets one?
Mr. Heimbecker: I am not speaking on behalf of the B.C. region. I am only talking about my region, about our sentiments.You are not talking to a national body here. You are talking to the regional aspect of a national body.
Senator St. Germain: I am trying to say that we have to make a national decision. I am concerned that, if we start thinking regionally on something that is really of national interest, we will run into dangers. I respect your position being as an Albertan.
Mr. Heimbecker: I see the other side of it, senator.
The Chairman: There is a proposal that the funds should be invested on an indexing basis. You would take one or more of the market indices in Canada, and using those indices, determine the proportion of stocks that you would buy. In our discussions yesterday, a number of people thought that that would be difficult to do -- even on the TSE, which has substantially greater capitalization than either the Alberta exchange or the Vancouver exchange.
As both you and your association are active in trading on the Alberta Exchange, perhaps you could talk to us about the difficulties, if you see any. If a fund like this were to invest, say $3 billion, on the Alberta Exchange using the Alberta index mix of funds, that is, buying stocks in proportion to their mix in the index, would that figure be sufficiently large to cause distortions in the market?
Mr. Heimbecker: If I read the press properly, yesterday's presentations indicated that, even if you took the TSE 300, it would impact the market -- notwithstanding what it would do here. I was talking about what we call a trickle effect; the money coming into the system through this vehicle would undoubtedly enhance the activity in the markets here. I am not addressing whether or not the fund should invest directly in, shall we say, the developed product of the exchange, or, on the other hand, in the venture capital end of the market. The sheer activity, as it were, would have a trickle effect into that market. It is levels of activity that I am talking about.
The Chairman: Is the trickle effect positive, or does it have market distortions attached to it?
Mr. Heimbecker: I think that it is very positive.
The Chairman: That is what I thought that I heard you said. I will have to summarize yesterday's argument about the TSE. The argument was that the top 35 to 50 stocks are substantially well capitalized that if a company --BCE, for example if it happens to be 10 per cent of the TSE 300 -- it has enough float that CPP could enter and put 10 per cent of its investments in it, and that would not be a problem.
A couple of the pension fund managers said that, when you get down to stock number 299 of the 300, however, you have a problem. It has, relatively speaking, a smaller market cap, and if the CPP is also buying that stock in proportion, it would cause a market effect. The demand alone would be enough to move the price up, causing a market distortion.
That witness did not trade out here, which is why I will ask you this question. If that is the case at number 299 of the TSE 300, what if they start buying the indices of the Alberta and Vancouver exchanges?
Mr. Heimbecker: I am not really addressing that. We are talking about two different issues here; money management and indigenous talent in this region.
The Chairman: I am asking a different question. What would happen?
Mr. Heimbecker: I think that it would be a subliminal bonus; the activity on our indigenous exchanges, no matter how minute they are, would benefit just from recognizing that there are people in this jurisdiction operating in the fund. I see it as an overall advantage.
Senator Kenny: I do not have the benefit of the brief, but I am assuming when you talk about multiple funds, that you are not referring to risk funds and income funds?
Mr. Heimbecker: No.
Senator Kenny: Just checking. You talk about regional funds, and about breaking up their management, while at the same time advocating the increase of the 20 per cent limit, in order to enhance global competitiveness. The more global we get, however, the more skills will be needed, in terms of analyzing markets and choosing investments. Are you not concerned that, by having a series of small funds spread across the country, you will really be increasing your expertise overheads? What I am asking you is, how do you combine your desire for global competitiveness with a desire for smaller regional funds? Would a single large fund not have a whole lot of analytical ability, and therefore be better equipped to compete on a global level than several smaller funds?
Mr. Heimbecker: Again, we are into two different issues. When we talk about the global situation, as I see it, we are currently developing Canadian expertise because of the limits. Jobbers are being used outside of our particular professional element; that talent is outside our realm. We need to be more pointed in the use and development of that expertise. My partners are involved in MNA work, and I realize that, to move outside that element is an opportunity that we really have not developed. We would, however, like to see access to that opportunity.
When you come back to the regional funds, we trying to address the fact that there is indigenous talent, and it should be called upon. If it drifts back down to Bay Street and does not come out here, you are doing yourself a disfavour. It is like having an oil analyst operating out of a Toronto office. It is not reality.
Senator Austin: Are you focused on the managers or on the regional capital requirements? Do you want local managers because they are more sensitive, or do you want attention paid to regional capital requirements?
Mr. Heimbecker: I was surprised, Senator, when I heard that there was a formula <#0107> however antiquated -- for the funding to come back into the province. I apologize, as I was not aware of that. Is it that there is a system, or that there was a system?
Senator Austin: There was a system, but the new system will not return capital to the provincial governments.
Mr. Heimbecker: It is a funding mechanism at off market rates, as you said.
We would like to see the capital on a proportionate basis, and we would also like to see the management expertise being used in these jurisdictions.
I am representing the industry in this particular jurisdiction, obviously.
Senator Kenny: If I understand you correctly, you are saying that you have skilled folks out here. Your concern is that they may not be adequately utilized if this fund is managed entirely in one location, and you would like to see regional funds. You would particularly like to see one established here. That is the first point that I am hearing you make.
Mr. Heimbecker: That is right.
Senator Kenny: Your second point, if I understand it, is that there are investment opportunities here in Alberta that this market is aware of, of which other markets are not aware. You feel that, from here, these opportunities could be exploited in a way that they would not be exploited from Toronto or some other location.
Mr. Heimbecker: Absolutely. You have hit both nails on the head.
Senator Kenny: That is basically the message you want to leave the committee with?
Mr. Heimbecker: That is the gist of it.
Senator Tkachuk: You mentioned multiple funds. Were you talking about having the one board, and then having a fund managed maybe out of Toronto, a fund managed out of Calgary and perhaps one in another city?
Mr. Heimbecker: Yes.
Senator Tkachuk: You are not suggesting that we have three boards and three organizations.
Mr. Heimbecker: No, not at all. We recognize that this is a centralized situation in terms of the overall mandate of the pension fund. At the end of the day, what we want to see is some valuable input coming out of our particular region.
Senator Meighen: Since we're in Alberta, I have to ask about the lessons learned from the Alberta Heritage Fund. In your view, are there any lessons that we should retain? Specifically, is there any problem with brokerage small "P" patronage? In other words, is there any danger that one broker, for whatever reason, would get the lion's share of the deals? Did that ever occur? Are there any other points that you could bring to our attention?
Mr. Heimbecker: I do not wish to address the Heritage Fund because I do not think I am knowledgeable enough about it to do so.
As to your second question, are you suggesting that there would be preferential treatment inside this jurisdiction, that the brokerage community might attempt to gain, or to assign, advantages in its dealings with the fund? Is that the question? Are you suggesting that?
Senator Meighen: I was not asking you to comment on the investing practices of the Alberta Heritage Fund, or on whether they did a good job. You are from this jurisdiction; I wonder whether there are any lessons that could be learned, in terms of the way that procedures were followed, for the investment of funds?
Mr. Heimbecker: I would imagine that there are, but I cannot reach into that at this point. I am uninformed in that area.
Senator Meighen: To your knowledge, was there ever any criticism about one broker or two brokers getting most of the business? Is this a problem that we should concern us, with respect to the investment of the Canada Pension Plan moneys?
Mr. Heimbecker: There is always bickering in those areas. My colleagues and myself chose to disregard those situations. We are talking about quite awhile ago I think.
Senator Meighen: How would this work in practice? If someone had a great stock idea, would they bring it to the investment board?
Mr. Heimbecker: I would assume that it would not be any different than procedures in the east.
Senator Meighen: How will the investment board select its investments? Will it base its choices on its own information, or on information brought to it by the brokerage community?
Mr. Heimbecker: As you well know, most people are more familiar with what is going on in their own back yards than they are with the situation of a jurisdiction that is 3,000 miles away. The conduit of information to the investment board, no matter how it surfaced, would be enhanced by involvement in the region.
Senator Meighen: I am afraid that you are missing my question. I am asking you whether, based on your experience in the industry, you believe that your firm, for example, would make representations to the investment board as to what investments it should make. Further, if the investment board were to adopt your suggestions, would it then be normal custom to expect that some or all of those investments be placed through your firm? I am just asking you how it works.
Mr. Heimbecker: In all honesty, I have not thought that one through because I am not here representing my firm. I am representing the overall industry.
At the outset, I would presume that we would expect an involvement in the placement of investments. There would be activity in that area, yes.
Senator Meighen: If that is what would happen, those closest to a particular industry might be rewarded for having brought information to the attention of the investment board. If the norm were then to do the trade through the organization that brought the information to the board, you would have some regional input, presumably, and reward?
Mr. Heimbecker: And reward, certainly. I think that goes without saying, because we are not talking about transportation here. We are talking about flows of investment capital and that is our business.
Senator Austin: The present set of objectives are being put in concrete, Mr. Heimbecker. We have had an agreement between the federal government and all of the provinces. What they have agreed to is the following, and I would quote: "The investment board is required to invest its assets with a view to achieving a maximum rate of return without undue risk of loss, having regard to the factors that may affect the funding of the plan and the ability of the plan to meet its financial obligations."
Mr. Heimbecker: That is very generic. I think that, in the industry, we all operate with those objectives.
Senator Austin: It is expected that the investment board will parallel industry practice <#0107> examples like CN or Ontario Teachers', as well as US funds, come to mind. There is to be a methodology for investing. Senator Kirby referred to the indexing structure as one of those methodologies.
As I understand it, regional input will come from the board of directors. There will be 12 members, and, although they will be required to meet the hurdle level on expertise, not all of them will be investment specialists. Some of them will be people who are knowledgeable about the business conditions of their respective regions. I would assume that, given the economy in Alberta, there would be a significant presence on the board, a person appointed from Alberta. I would also like to point out that the provinces have agreed that this should be the style of regional representation. The Minister of Finance will choose from amongst the group of nominees.
Mr. Heimbecker: I am sorry, Senator. Was that 40 people or 12 people?
Senator Austin: There is a group, apparently, of 40 selected by a nominating committee, and from that 40, the Minister of Finance will choose 12 to be on the board of directors. Regional representation is one of the guidelines. "Regionality" does not mean that every province will have a director, but all five regions will be represented on that board. How, then, does the IDA, Alberta division, speak to that particular representative, or how do you make your representations to the investment board for a profile and share of the overall program?
Mr. Heimbecker: Given that that is the structure we have; one or two individuals on this board who represent us..
Senator Austin: There will be two people from Western Canada, maybe three.
Mr. Heimbecker: In our statement, we are suggesting that there be a structure in this jurisdiction to advise those members -- in no uncertain terms -- of the availability of opportunities in our area.
Senator Austin: Your suggestion, then, is that investment proposals ought to come to the investment board from all sorts of appropriate groups.
Mr. Heimbecker: Certainly.
Senator Austin: And they will run them through their tests.
Mr. Heimbecker: Yes.
Senator Austin: That investment board will have people from this area, and those people will be asked for their opinions. The board itself will not make investment decisions. There will be a special management committee that makes the investment decisions, although the board will look at the proposals.
Mr. Heimbecker: Let us talk about that special management committee.
Senator Austin: They will be chosen, by the board, to run the plan. These are to be highly professional people who are chosen for their experience, and their past performance. It will be the investment board itself that chooses a president and CEO, and a management team to model all of these risks.
Mr. Heimbecker: I am here as a spokesman, a messenger. We would rather see that fragmented.
Senator Austin: Yes. I hear you.
Senator Hervieux-Payette: At the Caisse de dépôt in Quebec, there was a mixed feeling about that regional aspect, as well as about the small cap companies; where the Caisse de dept would invest and so on. Of course, it is not the same philosophy as you have seen with the Ontario Teachers or with OMERS, where the decisions are based strictly on the best return on the investment.
When you try to have an economic policy of regional development combined with a mandated responsibility to achieve the best return, it is difficult to avoid getting politicians involved in the administration of the fund. This is one of the major criticisms about the Caisse; it has to fulfil roles which sometimes conflict with each other.
Mr. Lamoureux, who seems to be one of the best fund managers in this country, recommended that we adopt a very clear mandate. In his view, there should be only one goal, which is to do the best possible for those who will be collecting from the fund.
Senator Meighen: With the least risk.
Senator Hervieux-Payette: With the least risk, yes.
When we try to achieve different goals, you may run into problems; this is coming from somebody who has been in that business for quite sometime. This is the advice of a professional fund manager.
I, too, am a member of IDA, and I understand your concern. In the Quebec region, we have 17 per cent unemployment in Saguenay-Lac-St-Jean region, and 20 per cent unemployment in the Gasp. It is tempting, when you have a fund that holds billions of dollars, to want to invest some of that money in your region, but it is hard for the fund to really address those questions. Every time that a decision that seemed to be tainted with political flavour was proposed, there was a lot of criticism.
That is just one comment, because I think that we have had the experience of a government fund managed by a board.
Mr. Heimbecker: I am not asking that capital be injected into the area because there is some kind of disparity in the unemployment rate, or anything of that nature. We are obviously coming from a different sides of the fence, and we have been very fortunate in Alberta because of our resources. I am not addressing it from that end.
I am talking more about the development of the profession; exploration of the opportunities that are indigenous to the province, and of the information that is available here. I spoke specifically about a trickle effect; professionally, we would be rising to the occasion of dealing with this money, and it would just draw the whole system up to a higher level. I am not talking about venture capital in Whoop-di-doo mines in the Northwest Territories or something like that. That is not what I am here to address. It is the development of our business.
Senator Tkachuk:Before I ask a question, has there been a decision by the government yet as to where the CPP headquarters will be?
The Chairman: Not that I know of.
Senator Tkachuk: So there has been no decision to locate it in Toronto?
The Chairman: If there has been, I have not heard of it.
Senator Austin: It is the decision of the board. When the board is appointed, they will decide where they put the office.
Senator Tkachuk: I just wanted to ask, because I have always believed that there should be fund management offices, and not only in Toronto. I do not necessarily believe that the headquarters of the fund should be in Toronto. Warren Buffet is not located in New York and he does quite well out of Oklahoma. In the States, they have taken the deliberate step of developing their financial resources throughout the country -- not centralizing them. I would urge you to continue your campaign, not only through our committee, but also through other ways. Perhaps you will be able to influence this politically, through your members of Parliament.
Mr. Heimbecker: Okay.
Senator Tkachuk: This is something that is very important to Western Canada, to Calgary, to Vancouver. The location of the CPP headquarters should not be taken for granted. We should not presume that it will be located in Toronto, and will make its investments there; Western Canadians might be insulted by such a presumption.
The Chairman: Mr. Heimbecker, thank you very much. We appreciate your time.
Senators, our last witnesses before our lunch break are Professor Stanley Hamilton, the Associate Dean of the Faculty of Commerce at the University of British Columbia, and Professor Rob Heinkel, who is vice-chairman of the faculty pension plan at the University of British Columbia. I think, Rob, that you also teach at a business school.
Mr. Stanley Hamilton, Associate Dean, Faculty of Commerce, University of British Columbia: Thank you, Mr. Chairman.
First of all, honourable senators, I would like to express appreciation on behalf of both Rob and myself for the opportunity to be here. We think this is an incredibly important piece of legislation and policy move, and we are delighted to have the opportunity to address several of the issues. If I may, I would like to thank the very professional staff that assisted us in coming here.
We looked at the mandate of this committee, Mr. Chairman, in relation to a large pension plan in the private sector, a defined benefit pension plan. We then asked ourselves what is different about the circumstances here. We are essentially building from something that we know. Both Rob and I serve as trustees on a mid-sized pension plan, and so we have had some occasion to look at these issues. The way we would like to proceed is to very quickly outline a kind of typical organizational structure you might find in a private sector, defined pension plan, to introduce the way we would look at some of the key decisions in the context of a little model. Then we will look at the governance issues in particular. I think we can move through these quickly. I will ask my colleague, Rob Heinkel, to characterize our view of a typical private, defined pension plan.
Mr. Rob Heinkel, Vice-Chairman, Faculty Pension Plan, University of British Columbia: Thank you for inviting us. We would like to refer to figure 1. We want to begin by looking at what we consider to be a typical organizational structure for a defined benefit plan. This looks a little bit different from what we saw in the act for the CPPIB, but we thought it was important to focus on the role of the board of trustees in particular in linking the investment committee's activities with what we call the operations committee, which is something that I note is absent in the act. Our view of the operations committee is to monitor the liability of the plan and to meet the needs of its members. Now, perhaps that is being done somewhere outside the CPPIB and we are not aware of it. We think liability is a very important feature of the typical defined benefit plan, and the documents we have seen do not deal with it.
The liability is simply in current dollar terms the present value of all the obligations that the plan has, and all the benefit payments that are foreseen to be made into the future. A key element of managing the assets of the plan is understanding the liability of the plan. So while the investment committee is being given the mandate to manage the assets, we do not understand how the board of trustees will instruct them to manage those assets without a full knowledge of the liability.
Professor Hamilton will talk about the audit committee a little bit later. My focus is on this investment committee versus operations committee organizational interaction, and the approach we took is a very simple one. Figure 2 is a simple characterization of what we call an asset liability management model. To determine how to manage the assets, you must understand the liability. In fact, most defined benefit trustees focus on the difference between assets and liabilities, and that is called the funding surplus.
The Chairman: You are right. As a matter of fact, just to fill you in, yesterday we had Claude Lamoureux, of course, who is the CEO of the Ontario Teachers' Pension Plan. He corrected me in response to a question from Senator Hervieux-Payette, and he said he focuses his entire management attention on the funding surplus. The funding surplus is the number he always tracks. Their systems are very sophisticated.
Mr. Heinkel: We are raising this issue because the board must understand the characteristics of funding surplus in order to provide the instructions to the investment committee. Professor Hamilton and I really do not have a sense of what the funding surplus is for the Canada Pension Plan. We assume it is a shortfall. If a private defined benefit plan had a shortfall, they would, first of all, get an actuarial estimate of the liability, and subtract that from the assets. If that is less than zero, there is a funding shortfall.
Senator Hervieux-Payette: Would they then raise the contribution?
Mr. Heinkel: Well, something has to be done. They could raise the contribution rates and lower the benefits. I would consider both of those options beyond the mandate of, certainly, the investment committee and maybe the investment board, so what is left is the growth rate of the assets. That is a very primary mandate of the investment committee. The investment board, the CPPIB, has to give direction to the investment committee on how to manage the assets, and the primary objective is how fast those assets should grow while still controlling the risk. If you have a funding shortfall, and you decide the mandate is to make up that shortfall in ten years, an actuary can work out for you what the underlying asset growth rate would have to be to achieve eliminating that shortfall in ten years.
Senator St. Germain: May I ask a question at this point? Was it not said yesterday that this fund differs from a private fund in that its assets will never cover its liabilities? That was said yesterday.
Senator Austin: That is a different issue here. It will not have assets, but it will have a flow of receipts at the 9.9 per cent rate that will fund all the predicted liabilities. I think we should let our witnesses carry on. Perhaps you could address that item.
Mr. Heinkel: Our answer would be that even if there will be a shortfall, the question is how big it will be. I am not even sure that is the investment board's decision, but it is someone's decision to decide how big that shortfall will be. You could let the assets be zero. That would solve your problems. You would not need any investment committee. You would not need an investment board.
The Chairman: That is the way the funds have been managed up until now.
Mr. Heinkel: That is right. Let me move on to a slightly more complex figure, figure 3, to give an indication of why we think it is important that you understand what the funding shortfall is and what that implies about the required asset growth rate. If you understand that you have a target to reduce the deficit to a fixed amount in ten years, that implies an asset growth rate that you need for the assets to grow in order to provide the funding shortfall that you wish to achieve.
There are lots of very technical ways to determine how to achieve that expected asset growth rate. I have shown you one simple example. This parabola shows you different portfolios, that is different compositions of asset classes that will provide different levels of volatility and different levels of expected growth rates. Here I have shown an example where you might want to combine international equities, Canadian equities, bonds and money market investments in a portfolio.
How do you do that? That is an important decision of the investment board and the investment committee. If the actuary tells you how fast the assets have to grow to either maintain a given deficit or to make the deficit shrink, that dictates the growth rate you will need from the assets. What we call a mean-variance analysis will therefore dictate what asset mix would provide that long-term growth rate. It might vary from year to year, but in the long term, it would provide the necessary growth rate. We think it is very important for the investment committee to understand this. What are their objectives in terms of expected growth rate? If you use something like this mean-variance technique, you will be achieving that growth rate at the minimum risk, which is exactly what your mandate is.
This little analysis demonstrates that it is very difficult to provide performance incentives for the investment committee or the investment board without understanding the liability structure and where you are trying to take this plan in terms of the size of the assets. With that, I will turn back to Stan.
Mr. Stanley Hamilton: Mr. Chairman, I will look at the governance of the investment board. Before I do, I want to stress that this funding surplus or deficit is vital. We do not see a mandate within the act for the investment board to be making decisions on how large that funding surplus should be. I think if someone decides the pension plan should not be fully funded, then that is taken into consideration as part of the mandate under which the investment board operates. They then have to govern their behaviour against this standard, so I think that is the issue. You need some benchmark for this board. Ultimately, you will measure their conduct and pass judgement on it, and I think both sides need to know what is expected of them.
When we look at the governance, to achieve the points that Rob has made, I guess we have two or three points that we would like to highlight. It is clear that this board has the potential to be politically sensitive, and I think we have already seen examples of that. We commend the government for at least taking one step back and having this advisory committee draw up a group of names. I am sure there are other alternative strategies, but we could think of none that are, on principle, any better than this. I must say that both Rob and I know several of the people that have been appointed to the committee and we feel very confident about them.
When we look beyond that, there are some issues, though, that start to concern us. I think the process for identifying and appointing the initial board of directors has provided some reasonable safeguards, but it is not clear to us what the qualifications of these directors must be. I think there is ambiguity, at least in our reading of the statute, on what qualifications are necessary. There is a suggestion that the Minister shall have to consider regional representation. While that might be an attractive feature, I think we feel very strongly that the first and most important requirement is expertise. You will see a little later on that it is not necessarily expertise in managing money, but rather in managing pension assets and managers. We are concerned that perhaps there is a little more emphasis on regional representation than we would like.
A suggestion has been made off and on that the investment funds could have some regional representation, and we are very concerned about this. We think first and foremost the responsibility is to get the best risk reward in terms of the benefits to the stakeholders in this plan.
The Chairman: You would like independent regionality.
Mr. Stanley Hamilton: It is our assumption that with the implementation of this new policy, the governments at all levels are not abandoning their other taxing authorities, and they will have the wherewithal to put in regional policies using other instruments.
Looking downstream, there are some other points. While we think reasonable care has been taken to get the current pool of potential directors, it is less clear how future directors will be selected. I am not sure if this advisory committee is a standing committee that will be ongoing, and would like clarification. We have some concern about the appointment, the three-year term with rotation. The rotation we think is quite satisfactory. Our own experience is that three years is probably an unreasonably short learning curve for such a complex activity. We would prefer a four or five-year term. We also suggest a maximum of eight years, which seems reasonable.
There does not seem to be any clearly stated criteria for removing directors or, for that matter, for removing the entire slate of directors. I think that this might be included. In terms of the objective of the board, we note a couple of things that I guess if you wanted to be cynical, you would be concerned about. If you were less cynical, it would not be a concern, but the objective here is to run this on behalf of the plan's sponsor and on behalf of the beneficiaries. In this case, the plan's sponsor is presumably the Government of Canada and the provinces, and the beneficiaries are the citizens of Canada, and it is not always clear that there is a unity of objectives here.
There are a couple of other minor points. In section 14(1), we were a little concerned that there is a statement that the directors are to act honestly in the best interests of the board. It is not clear to me that the best interests of the board are what we have in mind here. It should be in the best interests of the stakeholders, and I do not believe that is the board, nor does my colleague Rob.
The qualifications of the directors are a matter of some concern, particularly the reference to financial expertise. There was no reference to expertise in pension plan management specifically. Rob made a point earlier that the other half of the ballot sheet represents the liabilities and the plan. I think you will need some directors who understand pension plan issues as well as financial planning. We believe the conflicts of interests are reasonably covered.
In terms of the chairperson, we have only two concerns, I guess. There is no established criteria that we can identify, and we think that is an important omission. Secondly, there is no term on the office, and I think that would be important.
In terms of remuneration, we quite rightfully believe that these people should be properly compensated for their work. Because this will be viewed as part of a quasi-public domain, I think it is absolutely essential that there be some clear mechanisms established for benchmarking the remuneration, and that is an issue.
Rob will deal specifically with the investment committee.
Mr. Heinkel: We also have concerns about specifying qualifications for members of the investment committee. I think you do not need to be an investment management expert to be on the investment committee. You need to be an expert in the investment management process, and that is the management of the managers that you will be employing and the type of structures that you will use to employ managers to manage the actual fund. We also think it is important that the investment committee make use of third-party experts. There is a wealth of knowledge in Canada that can answer almost any question an investment committee can raise. My view is that you almost have a responsibility to get those expert opinions on important questions. The investment committee's primary task, I think, is to achieve the required asset growth rate with minimum risk, and I just want to raise a couple of questions in two areas. One is in the asset mix decision. I referred to this in figure 3. You certainly should consider all available asset classes, domestic and foreign bonds and stocks, derivatives, real estate and venture capital. We have some questions about restrictions that may already exist on the assets in the plan. We do not understand fully the agreement for managing provincial bonds or retaining non-negotiable provincial securities in the plan. We do not know how much that is. We do not know how that will affect the asset mix decision. Stan and I were just talking about how much we have in provincial bonds in the UBC Faculty Pension Plan, and we would guess it is probably two per cent of our assets. It is a very small portion of our total investment assets. We do not know quite how big that is.
I am sure you have heard about the 20 per cent foreign equity rule, and a higher level might or might not be appropriate. In our particular plan, we wish to be 25 per cent foreign equity in terms of market value.
I do not know if the question of ethical investing has been addressed. What guidelines will you give to the managers about appropriate and inappropriate types of investments at the individual security level? Will you invest in tobacco stocks or gun manufacturers, and who will make those decisions?
In addition to the asset mix decision, there are questions about the investment management structure, and I understand you have been dealing with this in some of your earlier meetings, the question of active versus passive management, to index or not to index. I think our view is that when the plan gets very large, when you have a huge amount of assets, it will be very difficult to do something different from what the market does as a whole.
If you refer to figure 4, we just did some very simple calculations on the impact that this plan would have at different plan sizes. We assumed, for example, that the CPP would now have 35 per cent of its assets in Canadian equities. What we have written down here is if the CPP was $25 billion, the Canadian equity component of that would be $8.75 billion. We asked what fraction of the total value of the Canadian equity market that represents. Of the TSE 35, that is the 35 largest Canadian corporations, that $8.75 billion would represent just under five per cent of the TSE 35. So even at $8.75 billion, if you restricted your Canadian equity investment to the largest Canadian corporations, you would have what some people would say is a significant ownership position in every one of those corporations. If you go down to the TSE 300, so you were willing to spread your allocation over all 300 stocks, then you have a more reasonable position of 2.6 per cent, which is still not inconsequential. As the plan gets bigger, of course, these numbers all get bigger, and if the plan ever got to $100 billion, even if you invested in all 300 stocks of the TSE, you would have a very significant ownership position of 10.4 per cent.
The Chairman: This 10.4 per cent is 10.4 per cent of the total capitalized value of the TSE 300 which, in turn, I guess, if you buy exactly on the index is 10.4 per cent of each of the individual 300 companies.
Mr. Heinkel: Exactly, and that raises important questions about how you will vote proxies? Who will decide what is the right decision on proxies? Will you elect someone to the board of directors and who will that be? These are, I think, important questions. I think this will be the area of concern. If you look at the bond market, it is much larger. The foreign equity market is even larger. The problem will be on the Canadian equities side, if the plan ever gets that big.
In closing, there are other issues. Should you bring non-economic factors into your decision making? Should you be investing regionally? Our suggestion is that it is probably not in the best interests of all the stakeholders to make regional investments. Our final comment is on openness. It is very important to let the Canadian citizens know what the assets of the plan are at public meetings. We think it is also reasonable for you to explain to them what the liabilities are; that is just how far in the hole the plan actually is.
Mr. Stanley Hamilton: We want to comment on the role of the audit committee and potential governance committee. When we looked at the role of the audit committee, which is named in the act, we noticed that there is no reference to the size of the audit committee. More importantly there is no mention of the expertise of the audit committee, and this gets back again to the question of what package of expertise do you want on this board so you can then properly serve the needs of all its committees.
The second issue is that while I believe the auditing provisions in the statute give comprehensive requirements on financial reporting, at least on traditional financial reporting, there is no mention of the other kinds of information that you might want in terms of comparative performance or the benchmarking of performance. We would traditionally think of this as information that we would want to give to our stakeholders so they can pass judgement on our trustees. So I think the references to the audit committee have taken a somewhat narrow and traditional view of what ought to be reported for a pension plan, and I would encourage that to be expanded.
We have a minor concern -- and neither Rob nor I are cynical and so the concern is minor -- about permitting the Auditor General of Canada access to the records. I think there is an uncomfortable element here. I realize that under complementary changes to the Canadian Pension Plan there is a provision that the investment board and its auditors must provide the Auditor General with some information, but it says rather specifically "with information necessary to audit the Canada Pension Plan." It does not say information necessary to audit this board. Now, there is a slight difference and, as I say, if one were cynical, one might be concerned with that difference. I always assume that these statutes are written carefully. I would suggest there is an omission.
We believe there is room, although not named specifically, for a governance committee. But there is a provision for a committee, and we see four roles that will somehow have to be handled in the greater scheme of things. We think a governance committee would be a logical place for them to be handled in the private sector plan. First, the governance committee could establish the qualifications for the directors; secondly, it could ensure that there is a clean and open platform for determining remuneration; thirdly, the governance committee could monitor conflicts of interest, which must surely arise in all of this; finally, as we see the funds getting larger and larger, the governance committee could establish some policies relating to the exercise of proxies, and we think this is a highly sensitive area. We address it in the private sector as an issue that trustees must consider, but in this case, I think it is even more sensitive because many of the companies in which you will be investing are also companies that will almost certainly be doing business with some agency of government in Canada. You will have to carefully consider the suggestion that you could have any influence through proxies on the boards of those companies when they are doing business with the government.
With that in mind, Mr. Chairman, honourable senators, we will stop and try to answer any questions.
The Chairman: There will be lots of questions. First, let me thank you for a superb brief. One of my colleagues on the committee just passed me a note that said, "Would not this committee be delightful if all the briefs were as good and as thorough and as well organized as yours was?" We really appreciate the effort you put into it. I will begin with a question from your fellow British Columbian colleague, Senator St. Germain, which will be reasonably brief, I presume, Senator St. Germain, since most of the rest of us already know the question.
Senator St. Germain: That was an excellent brief, very well presented. I only have one concern about this whole thing. The issues you have brought up are very, very important, but if we do not get the right methodology of selecting the board and the right boards for the future, confidence will not be there. I think the GIC method of selecting the board, where the minister may consult, is very, very dangerous, and I want this to be on the record. I hope that we do not experience the same dilemma that we are experiencing now with the collapse of our pension plan because the liabilities cannot be funded.
Do you feel, gentlemen, possibly that the government should be looking at a different methodology of selecting the board as opposed to going through the traditional GIC, Governor in Council, method that they are proposing under the terms as set out?
Mr. Stanley Hamilton: Rob and I discussed at some length what alternate strategies might come into play, and I guess there has to be a seed planted. Somewhere you must generate a list of names. Somewhere somebody must ultimately make the call. So we felt that the advisory committee must bring forward, we thought it was a slate of 20 names, but I heard the number 40 earlier. I think the way to provide protection is two-fold. First, ask the board to articulate and do so in a public way the criteria that are expected of the members of the boards of directors, and then the public at large can at least say, "Do those 12 people meet these criteria and if not why are they on the board?" We would hope those criteria are such that you would have a team of 12 that could then properly manage not just a pool of money, but a pool of money that is used for pension plan purposes, so there is an appreciation of the pension rule. By articulating the standards, you then give the public a benchmark against which to measure these appointments.
Secondly, there is some ambiguity about replacing or dismissing board members. If that were a little more carefully documented, then we could at least hold someone accountable against the standard and we would feel then that you probably have a system that is as good as it will likely get. With an upper term of eight years, I think the parameters will probably be as carefully designed as they can be.
Senator St. Germain: My concern, having been in government for 15 years, is that if there is not a real arm's-length methodology for controlling the future boards and the salient points that you bring forward as to the removal of the chair and these things, I think we could end up with real problems. This is my deepest concern. Are you gentlemen familiar with the Ontario Teachers' Pension Fund where they select half, half and a neutral chair? I have tried to suggest that, and it is pretty tough in a confrontational parliamentary system for opposition to really get their suggestions taken seriously, but sometimes they do. The Minister has been quite cooperative in meeting with us, and I ask you for your comments on that.
Mr. Stanley Hamilton: The process you describe is a traditional private sector plan, with the employees and employers represented. But you can think of them differently with different titles, that is as the plan's sponsor and a defined benefit, the group that would carry the ultimate liability and the beneficiaries. There you are talking about them coming together and not only designing the plan, but running it and ensuring that it is financially sound. That is very different, in my opinion, and I think I can speak for Rob, from saying the opposition and the government of the day should be participating.
Senator St. Germain: I am suggesting that the federal government nominate half and the provincial governments nominate the other half, for they are both basically stakeholders in this entire process, and then name a neutral chair. I am not saying opposition. I pointed out opposition, but I did not mean it in the context of being part of the plan.
Mr. Stanley Hamilton: Again, I would say that if the purpose of this board is to invest the money in the best interests of the stakeholders, to get the best return on a risk-adjusted basis, I believe that there are qualified people at all levels and of all stripes that could do the job. If the test is to bring in god people to do the job, I guess I would be less concerned where they came from or what their backgrounds were as long as they had the expertise.
Senator Kenny: I too was impressed with the quality of your presentation. It was very helpful. The question I have is a very general one. You have gone through this proposal and said, "Look, if somebody asked us to run this, how would we go about running it?" When you write legislation or deal with it, and see problems that might arise, you say, "Well, I want to put in a clause that will protect us from that problem," and then you see another problem that might arise and you put in a clause that will deal with that problem. By the time you are finished, you are trying to manage the company through the legislation. Experience has shown that it is not always the wisest way to proceed.
I have been reflecting specifically on the qualifications that you have put in here for directors or the qualifications for the investment committee, and I suspect at the end of the day if you had to do it in a short sentence, you would say, "I would like wise people there" and let it go at that. And you would say, "Well, how will that be translated into reality? How will it deal with Senator St. Germain's concern that we will have a bunch of folks that are there because they hold one political card or another?" My instincts are -- and I am asking for your reaction to them -- that you have given us a lot of questions here that would be very useful for the folks that start running this organization to read through and think about. My question is whether they should be incorporated in the legislation or should the legislation remain fairly vague and broad and assume that intelligent people will deal with these questions in due course?
Mr. Stanley Hamilton: I think we probably have agreed with you in part because we both felt there was very careful draftsmanship in the statute. For example, we found reference to financial expertise, but there was no reference to pension management expertise. There was no mention of expertise of running money managers as opposed to financial expertise. If the act had simply said, "We want 12 directors who collectively provide expertise in managing pension fund assets," I think then we would have put our hats on as trustees and said, "Okay, we can interpret that." But it was because of the one reference and the omission of others that we raised these issues.
Senator Kenny: Do you wonder a little bit when you are reflecting on it whether it is because the drafters were so perfect or whether, in fact, they would have been better to have been a little vaguer themselves? In other words, you are saying, "Fine. This is a polished complete piece of legislation. We will take it as it stands, and every word is there for a purpose." And, in fact, we know that most pieces of legislation that come out really are pretty incomplete. So I put the question to you again: Does a piece of legislation like this require more specifics or less specifics? In other words, you are saying, "Fine. We see some specifics in there. Since those specifics are there, add some more because there is an imbalance." Now, you could do that or you could take out some. Which do you prefer?
Mr. Stanley Hamilton: I guess I would opt for more enabling legislation so long as that enabling legislation ensured that there would be public access to the next level of decision making so you could pass judgement on it.
Senator Austin:You would opt for regulation.
Mr. Stanley Hamilton: Yes, I would opt for regulation of policies at the board level, with transparency.
Mr. Stanley Hamilton: Yes. So given that and the extreme difficulty in amending legislation after the fact, I think we would both opt to say, "Let us have it broad based, but let us make sure in that broad base there is a mechanism to ensure quickly thereafter that there is a transparency of what is happening."
Mr. Heinkel: Could I ask a question about the role of this advisory board that has been put together to pick the 20 people from which the 12 will be selected? Will that advisory board continue to exist, and will it perform any function?
The Chairman: You can tell it is not clear because we are all about to give you different answers. The one element that is clear in the legislation is that when a vacancy occurs, there is still a requirement for a consultation between the federal minister and his provincial counterparts. Whether or not there is an independent panel that picks five names or something is unclear from the process in both the regulations; am I correct? The answer is the minister has that option but he does not have to exercise it, but he does have to consult. There is a thing that says the minister may appoint a committee but he shall consult with the appropriate --
Senator Meighen: The Minister does not have to follow the recommendations.
Senator Tkachuk: He does not have to follow the recommendations of the committee.
Senator Kenny: Is he confined to a list?
Senator Meighen:He is not confined to a list, sorry. Are we agreed on that?
Senator Kenny: On the first ground.
Senator Meighen: On the first ground, yes, but thereafter he is required to consult, but is not bound to any list.
The Chairman: The option to go to a list is there but it is a "may" option.
Senator Meighen: But the other side of the equation is that he can consult who he wants and then do something totally different than what was produced by the consultation.
The Chairman: That is absolutely correct. I will tell you, though, having been involved in putting together federal/provincial panels, on both the provincial and federal sides, that at enormous peril do you disregard entirely the nature of those consultations between the two levels of government. People just do not do it unilaterally and survive there. Jack, you may want to comment. That has certainly been my history, and I have been involved in putting a number of those together between Nova Scotia and the federal government, for example.
Senator Austin: Political vacuums just do not occur, and the reality is if you have an established board and there is a vacancy, the chairman of the board will play a very large role in establishing the optional choices.
Senator St. Germain: I agree with what both these senators have said, but this is such a unique, huge fund that I think it surpasses anything we have ever dealt with before and that is why it has to be like Caesar's wife.
[Translation]
Senator Hervieux-Payette: Presently in Quebec, there is no proxy voting for members of the Caisse de dépôt who have investments. They sit on the board as observers, but they do not have the right to vote. Would you be prepared to make this suggestion considering the fact that they could have considerable influence over the fate of the businesses where they have invested? They sit on the board as observers, but cannot vote on businesses where they have investments. What do you think of that proposal?
[English]
Mr. Stanley Hamilton: I guess as a first comment if I may, it is not clear to me that having an observer who represents a significant shareholder's stake has any less impact simply because they do not have a formal vote. I would think that any corporation that ignored the concerns of a major shareholder would be doing so at their own peril. So the issue of not having a vote, I think, is perhaps only a minor consideration. I would think that as a responsible investor, if you had money committed to a company, to Air Canada or any private company, for example, as a major investor, you would want to make sure that you understood where that company was going and either withdraw your funds or try to get some consensus on the direction. So the voting part concerns me less. I am not sure what the right answer is. We are simply saying, I think, that the process should be open, that if you are voting proxies on this board, that it is open and the ground rules for doing the voting are clear.
The Chairman: What your figure 4 shows, particularly your last column, is quite staggering, when we realize that event will come within ten years, depending on the population growth.
Mr. Heinkel: The TSE will also grow in the next ten years.
The Chairman: I mean, whether it is 10.4 or 8.2, it is a big number; right? What would your advice be on the question that Senator Hervieux-Payette posed? Do you think this fund ought to be passive or active, if you were outside consultants giving it policy advice? I should really preface by telling you this committee is interested in this issue in a broader context because we are in the process of doing a study of the role of institutional investors in Canada in general, in which the active/passive issue is a very hot issue. What do you do with proxies? To what extent do you lean on management? What are your views from the perspective or maybe the safety of a business school? What is the right public policy for this board on that question?
Mr. Heinkel: I will take a shot at this. I certainly think that active versus passive is not a black and white issue. You can do both. What you see many very large plans doing is taking a passive investment approach with 80 per cent of their assets and using the other 20 per cent to be actively managed, because I think my view would be that active management only works if you are not trying to push billions of dollars around in the capital markets. We see this with even the largest money managers today. When large Canadian money managers want to make a stock buy, they have to make it for all of their clients who hold Canadian equity portfolios. They are buying millions and billions of dollars of stock and that moves the market around. So it gets increasingly hard for investment managers to add value with the amount of money they have under management. This plan will face exactly that problem. It is the same for a lot of large plans, and this is certainly very common in the U.S. There is a core passive portfolio --
The Chairman: Let me take a very concrete example. CalPERS puts out at the beginning of every year a list of companies it has invested in that it believes are underperforming.
Mr. Heinkel: I think that is a different issue. One issue is active versus passive. The other issue is trying to change corporate management. Active versus passive means to me, "Do you always just hold essentially an indexed portfolio or do you actively --"
The Chairman: That was not the question I was asking. It was the voting proxy that led me into the other active --
Senator Hervieux-Payette: I have another question.
The Chairman: I know. I was trying to enlarge on your question. Respond to mine or, if you want, let Céline continue and then we can come back to the other one.
Mr. Heinkel: I misinterpreted it. In our pension plan we are, as trustees, ultimately responsible for every vote that is made on behalf of the shares that we own, every vote. We are not aware of every vote that occurs with our shares. The decision-making process on who votes our shares depends upon the type of vote there is. There are independent third parties that will identify routine versus non-routine issues. Certainly for the non-routine issues, we see those at the board and we need to make decisions. I think the answer here is that you need to establish policies on how you will deal with this. Whether there is somebody sitting on the board or not, I think, is probably less important than establishing policies about how you will deal with being a shareholder.
[Translation]
Senator Hervieux-Payette: It is too bad that Senator St. Germain has left the room, I would have told him that the Quebec government has a list of several hundred people who act as observers, and who receive directors' fees for setting on these boards. Since my colleague is concerned about patronage, imagine if we have people who sit on 500 or 600 boards, that means 600 patronage appointments at $15,000, $20,000 or $25,000 per year. There is no doubt that if you sit on the board of a bank where you have investments, you receive directors' fees. Even if their mandate does not entitle them to vote, they receive directors' fees as they act as board members. All that to explain that this is an extremely important point that must not be underestimated. It is not only members of the investment board who participate in or are represented on the board of directors. There are a host of people who are appointed and who act on behalf of the board. I know some of these people and, very often, they have no expertise in the areas where they are appointed. They are there simply because they have friends in the right places. That worries me even more, because the reason we want observers is to know how the business affairs are being conducted, and whether our investment is well protected: my concern is that someone who does not understand how a board of directors operates may be appointed because he has a friend in the system.
Earlier I talked about voting rights, because that is probably the most powerful tool combined with a number of rather important steps. I agree with you that having an observer present can have great influence as long as the person is qualified and can exercise the powers entrusted to him. There is great danger and that is why I wanted to hear your comments. It is much more than simply an issue of voting.
There are important procedures for appointing these representatives. I had linked this to the question of active versus passive management. I understood your comments to the effect that active management could perhaps be used for 20 per cent of the portfolio's assets, and that for the rest, passive management was used. Once the fund has reached maturity with 150 million dollars, there are still considerable amounts of money over which we have a direct effect.
I would simply like to hear your comments so that this aspect is crystal clear. Yesterday, Mr. Lamoureux told us that investing solely on the indexes is perhaps an administrative shortcoming. There must be some flexibility in the system, and on that basis, I accept your comments taking into account the matter of representation on these boards. Do you have any comments on this topic?
[English]
Mr. Stanley Hamilton: The first comment I would go back to again is that as soon as somebody owns a large portion of my company, I have to listen to them, whether they have a vote or not, whether they are formally or informally on my board, or whether they simply come over and talk to me. This does not have to be just an equity ownership in my company. If someone holds a large block of my debt, I have to be nervous about that as well, or at least be sensitive to their needs. We have some protection at the corporate level. Even if this board as an investor appointed one member of the board of General Motors Canada, there will still be other members. As you move down the scale, you will have more influence because you will represent more of the purchasing power.
I guess I can only go back and say I do not see that there is a clear principle that can be followed, other than ensuring the system is open so that you can then respond to it. Because on the one hand, this investment board has a responsibility to ensure they are getting the best return on their investment. If they look at a company that they have an ownership position in that is, in their mind, underperforming or misperforming, they have one of three choices. They could stay there and suffer the consequences, which would be highly irresponsible. They could sell their position and move it elsewhere, or they could go to the company and say, "Are there some things that we can talk about you doing to improve performance?" I do not see that there is a clear principle that says one process has to be followed over the other in all circumstances.
[Translation]
Senator Hervieux-Payette: You are suggesting rather specific criteria for appointing members of the board. I assume that when you are invited to become a member of a board you perhaps did not have any previous experience. No one is born sitting on an pension fund board. Do you have criteria for becoming a board member?
When we talk about better defining the debt management model, do you think that directives should be provided through regulations? In other words, should it come from the government, since the fund is not completely financed through contributions?
[English]
Mr. Heinkel: I think the first question had to do with criteria for sending people to a corporate board. It would seem to me that the most basic criteria is whether a member has something identifiable to contribute to that board, some quantity of expertise that can be brought to the management of that board. This would be expertise in understanding industry trends or whatever the professional expertise would be, but something that is identifiable that could be shown to the Canadian citizen whose money is standing behind this plan. I think with all of these things, it is important that when the CPPIB votes a position, that should be made available to every beneficiary of the plan. Your voting record should be public information. So when you make a vote to support a poison pill amendment, that should be available to every member of the Canadian Pension Plan. I think transparency is by far the most important issue, and therefore, I think you need to establish policy so that there will be some consistency in making these decisions across different corporate boards.
Mr. Stanley Hamilton: I would add only one comment, and it is intended not to contradict but to complement. If you have this pool of money to serve the particular purpose and scale of purpose you have in mind, I would first ask what kind of talent you need on this board somewhere to make all of this work. I would then take Rob's point, and ensure that each person contributes to that talent need and that no areas are omitted. That is why we made particular reference to the fact that there was no mention of pension plan expertise because we think that would be a necessary part. We just wanted to make sure that in this portfolio of directors, you would have the skill set to serve the needs of this board as an operating entity.
Mr. Heinkel: You also asked a question, I think, about Mr. Lamoureux talking about indexing or not indexing. I am sorry if I am repeating myself, but to me the key is not whether you strictly index or not, it is whether you are well diversified. Certainly indexing means you will be well diversified. Whether or not you exactly try to mimic a particular benchmark, I think, is not very important. I think minimizing the risk that you need to take is far more important.
Senator Tkachuk: From my point of view and, I think, from our caucus's point of view, we support strongly the principle of what the government is trying to do. We have been urging them to come to terms with the shortfalls that exist in the Canada Pension Plan. We have a lot of problems with the substance, for we believe that this thing will be there for a long time. It will accumulate huge amounts of capital, will be a powerful instrument and will be difficult to change once it starts to run its course.
For example, we are talking now about the directors. We have no clue who they will be. We know which people are reviewing who they will be, and then it will just be announced. The way this legislation is drawn up and considering the 9.9 per cent that will be taken, this will be the only pension plan many Canadians will have. We, as politicians, have a powerful responsibility to ensure that this pension plan will be sound and that, most importantly, people have confidence in it.
I want to bring you up to date on a couple of things. If I am wrong on this, and you know how I hate to be wrong, just correct me on the regulations that were brought up yesterday. You asked a question. We can see the small hand of small "P" politics already. The provinces will most probably be exercising their rollover options, around $35 billion dollars' worth, although it will now be at market value. But there will be another provision, or at least it has been proposed in the regulations. We were briefed on it yesterday. There are two points: 50 per cent of the bonds that the CPP board will invest in must be provincial bonds. I think that is correct.
The Chairman: Yes, for three years. That is a three-year transition period.
Senator Tkachuk: Yes. They must be provincial bonds. From what I can see, if they exercise all of their rollover options, which I believe they will, by 2020 this fund will be $255 billion, give or take 10 billion. That is what we gather from the Department of Finance. That is a lot of money and 2020 is not a long time off. It is hard for us to imagine what a powerful instrument this will be, governed by 12 people. The other instruction is that for the next three years the money that accumulates within the fund must be invested in index funds. So instructions are being given as we speak and we have not even started. The three big policy decisions are already being made on the fund. I would like your comments on that.
Mr. Heinkel: Did I understand that you said there would be $35 billion in provincial bonds?
Senator Tkachuk: This 35 billion is the amount that the provinces owe to the fund, which will be rolled over because their time is coming and we are broke. That is why we are doing all of this; right? There is no money left in there.
Mr. Heinkel: My earlier comment was that our pension plan portfolio, which is probably not uncommon for a lot of pension plans, has two per cent of its assets in provincial bonds. You will have, it sounds to me, 100 per cent provincial bonds as you get started.
Senator Tkachuk: We will probably have them in the next three years.
Mr. Heinkel: And that will have a really major impact on the growth of the fund.
Mr. Stanley Hamilton: It will have an impact on the growth of the fund. It will clearly have an impact on the risk of the fund, because if you went to any professional consultant and said, "What is the optimal asset mix for a fund of $35 billion," I cannot believe they would recommend all bonds, but I think we recognize there will be some transitional issues. At least we are comforted by the notion that these bonds are rolling over to market rates, which is a significant change, and that is a major advantage. I guess we had not looked specifically at the transition problems, and I think we would be happy to go back and consider that and send in a supplement to our report, but we recognize there will be some transitional issues.
Mr. Heinkel: It certainly has to affect expectations about what the fund will do during its initial years.
Mr. Stanley Hamilton: As we look forward -- and perhaps this is part of the transition as well -- a very large fund will have differential impacts on submarkets. We have expressed concerns in figure 4 of where it will be on the TSE. But the same-sized fund in a global market would be just another actor, and so the issues differ. The same-sized fund with an allocation to bonds generally has a differential impact. So while we are trying to give you little pieces, we recognize that as this fund grows and you go to, hopefully, a well-diversified fund, that you then have to look at the impact you have in each sector in which you operate. If you were in venture capital, you could potentially be the largest pool of venture capital in the country if you were not careful. If you were in Canadian real estate, you would have very localized impacts and one suspects highly political impacts, political with a small "P." So you have different problems as you address different asset classes in your growth curve.
The Chairman: Thank you. I wonder if we could take advantage of your offer of passing on additional thoughts on the transitional problem. That would be helpful to us because there is obviously a gearing-up problem. We would appreciate that.
Senator Austin: I want to thank both of you, Mr. Hamilton and Mr. Heinkel, for this excellent paper. I have read it through and I will read it more than once. Given the time, I just have two technical questions to ask you. The issue of liability management that you raised is one that was raised with us as well in Toronto. As you point out, the act does not provide legislative guidelines. No doubt there will be regulatory guidelines in this area. We have a draft of regulations. I would like to ask our chairman or our clerk if it is possible to make a copy of the draft regulations available to these two witnesses? What I would like you to do, if you are willing, is to review the regulations and give us your comments on the draft regulations. You have an expertise that this committee values.
The Chairman: We only have until Monday. Just to tell you what the process is, the draft regulations have been circulated to the provinces and to us for comment. To that extent, I guess they are still modestly restricted, but if you could go through them and give us your comments, that would be really helpful.
Senator Austin: These draft regulations are just that, draft for consultation, and I value your expertise. On the issue of liability, however, the second last bullet point in 2.1 reads, "In the context of the act, it is not clear what percentage of the Canada Pension Plan liabilities are to be funded and by what date." There is no question that this is essential information, but I presume that, first of all, the chief actuary will be responsible for laying out the liability side and setting the targets for the operating committee's guidance. I wonder if you would comment on that. There is a lot of actuarial methodology available, and no doubt the plan will have its own actuarial support team. Can you comment on that?
Mr. Stanley Hamilton: I think there are three issues that you need to consider. The actuary could certainly go in and say, "This is your liability." The investment board can say, "These are your assets and therefore, here is your deficit or surplus." But before you do the actuarial study, there has to be some understanding of what the promises are because that is what they build from. I mean, your liability starts with a set of promises. So presumably, there is the social policy for Canada --<#0107>
Senator Austin: We have the demography. We have the benefit structure set by legislation.
Mr. Stanley Hamilton: So my point is, given the benefit structure, given a forecast of the population, you can get a reasonably accurate estimate for the present value of the liability. I think the point is that there is no clear statement that this will be fully funded and, therefore, on the asset side, if you end up with $100 billion, we do not know if it is the right number or the wrong number. We may know that the liabilities are $150 billion. What we do not know is is there a clear political, if you like, policy statement that a $50 million deficit is the right number?
The Chairman: We were told yesterday, and I do not know where this number came from, but we were told yesterday that the fund, once it was built up, would cover about 20 per cent of the liabilities. I cannot for the life of me remember who gave us that number.
Senator Austin: Malcolm Hamilton, an actuary, gave us evidence yesterday saying he was satisfied that at 9.9 per cent, the Government of Canada had set a rate which would cover the liability side. Now, we do not have a calculation, but these are liabilities as they come due. We will not have assets against all foreseeable liabilities. We will have assets against actuarily forecasted liabilities. That is what the contribution rate is in that area.
Mr. Stanley Hamilton: We tried to make the point that to conclude that a 9.9 per cent contribution will cover something has imbedded in it an implicit understanding of what the expected growth rate is in the assets.
Senator Austin: Oh, yes.
Mr. Stanley Hamilton: If you think about this again, go back to a private plan, because that is what we start from. In a private plan, we would be told as trustees that we need to deliver $600 to all retired people. Having been told we must do that, we are then told we have to be fully funded, and then we are told that the contributions will be 15 per cent per annum. Given all of that, we are then left to go into the market with our investments and achieve a growth rate that makes it happen. I think what we are saying is there are some uncertainties in this set of information. This investment board will go there and say, "I will do good things," but you can do good things earning five per cent very low risk and you can also do good things earning 12 per cent very high risk if that is your necessary mandate. So we are trying to get a sense of how we close the loop.
Look back at figure 1. When we first looked at this statute, this act, we said, "Are we talking about an act that creates what we call the board of trustees here or is this act creating what we called the investment committee," not to confuse the terminology. Because the board of trustees would normally have full understanding of the liability and full responsibility on the asset side. What we sense you have here is what we characterized more as only the asset side. In our brief, we said that you need to close the loop in order for the Canadian population to ultimately have confidence in what you are doing. You tell them, "Oh, look, we have 100 billion and it has gone up 18 per cent." If you do not tell them that our liabilities have gone up 30 per cent, they have not completed the loop. That is what we were looking for.
The Chairman: We cannot provide you with this information because we do not have it, but you have now raised in our minds the question of why we do not have it, which is a different issue. Thank you very much for coming, gentlemen. We appreciate it. The clerk will give you a copy of the draft regulations, and any comments that you have on the transition provisions would be really helpful. Your brief was just terrific.
The committee adjourned.