Remarks: Canada, The Americas and the Global Economy: Investing in an interconnected world - October 14, 2020

The annual Global Macro Conference sponsored and organized by the Official Monetary and Financial Institutions Forum (OMFIF) and Scotiabank’s Global Capital Markets - October 13-14, 2020

My remarks on the Oct. 14 Pension CIO panel follow.* 

As I was planning my response to the moderator’s question about how I saw COVID-19 impacting the pension industry, I thought about the long shadow this pandemic continues to cast over everything and everyone I know. I then remembered a quote from Abraham Lincoln. “The best thing about the future is it comes one day at a time.”  

With that pace in mind, I’d like to talk about COVID’s implications for the pension industry in two areas, regardless of who wins the contentious presidential election now in its homestretch to the November 3 election day. 

The first area that’s top of mind involves implications of the economic contraction that’s taking place under COVID for state and municipal revenues -- and by extension, for public pension funding, given pensions’ dependency on state and local contributions. 

I am sanguine when it comes to the larger funds because they’ve been smart, long-term investors. These larger funds also belong to a vanguard of institutional investors who have moved ESG-factor investing by way of risk mitigation from boutique to mainstream -- and more recently to incorporate real assets into that mix. In the process, they have developed tools to identify, model and measure future exogenous risks to their portfolios and to insist that companies they invest in do the same. Their advocacy does not them from COVID’s punch, but it does mean that they have more tools and arguably are in a better place as a result. 

The most fragile funds, on the other hand, are in jurisdictions with severely underfunded systems going into COVID. In Illinois, for example, nearly $1 in every $5 was earmarked for pensions even before COVID got factored in. The risk of insolvency may be low, but it’s not without possibility. As of late April, the Chicago system was about 23 percent funded.

Still, all plans were seriously off their projections at the end of the first quarter of 2020 as COVID literally closed the economy down and kept it closed. Many have since recovered to end the fiscal year on June 30 at break-even -- or on the upside of break even. According to a June Pew Trusts report, the typical public plan fell short of its target return by 4 to 5% but ended the fiscal year with returns in the range of 2 to 3%.

The other side of the equation concerns state and municipal taxes and fees. According to the Center for Budget and Policy Priorities, state revenues will drop by more than 10% in fiscal years 2020 and 2021 due to COVID. Meanwhile, these governments also must continue responding to the ongoing public health issues as a result of COVID. If states are smart, they are not sitting on their hands – which may not always be optimal for pension coffers. 

California, for example, has redirected state pension debt payments to support school districts and local governments. Colorado has suspended $225 million in supplemental pension contributions. Oklahoma has lowered the statutory contribution rate for its plans. 

The second area that’s top of mind when it comes to COVID’s impact on the pension industry concerns regulation. This is very much a developing story. 
The emerging hot button issue is defining what financial and capital market regulators’ responsibilities are when it comes to ESG factors – the environment, social issues and governance items. Is ESG a systemic risk? Or is it idiosyncratic to some companies and not to others? 
Is it the purview of central bankers or of capital market regulators like the SEC? Or both? It’s a debate, and it’s moving into front and center for institutional investors and others in the sustainability finance value chain.  
It was the Europeans who set the ball rolling this past summer when they legislated requirements that are now pending implementation but requiring that European companies recognize ESG as systemic risks and disclose their exposure - and do so by way of adhering to a specified taxonomy or set of disclosure definitions. This gets tricky because companies all around the world do business in Europe and come under European regulatory requirements when they do.

As if on cue, the debate over whether and if so, how to mandate corporate disclosure has been forced from the sidelines and into the fray in the US, Canada, UK, Japan and in other parts of Asia and the world as well. So now the reasoning goes, it’s better to have a single set of standard and a single framework – maybe two – for companies to disclose against. That way, there will be less confusion and greater credibility, conciseness and comparability in the data that is disclosed.

A solution could look something like the accounting rules companies now follow when reporting their assets and liabilities, cash flows and capital spending. If that company is in the US, it reports its financials based on rules set by FASB and referred to as GAAP. If the company is in Europe or most other places in the world, a company will follow accounting principles as defined by IASB and referred to as IFRS requirements. 

The issues are exceedingly complex, cross border and just now on track for a possible resolution. Perhaps it’s pie in the sky thinking that a resolution could happen inside of roughly 12 months but if that were possible, it would hitch an outcome to the timing of the UN Climate Change Conference or COP26 next November in Glasgow, UK. Stay tuned! 

On the more traditional regulatory front, the SEC, under Chairman Jay Clayton, responded quickly to COVID by easing restrictions on logistics of shareholder meetings. The new practice of virtual convening or a hybrid between virtual and person-to-person meeting could be marked for even broader use into the future. 

Another action in response to COVID, however, was met by concerns that it failed to go far enough to satisfy sustainability proponents. The SEC agreed that COVID has underscored the importance of investors understanding how public issuers are treating workforce and other human capital issues but stopped short of outright requiring them to do so. Instead, they recommended disclosure as part of corporations’ MD&A (Management, Discussion and Analysis) section in the SEC’s quarterly and annual disclosure statements. 

Another action had its genesis pre-COVID and put the capital markets regulator clearly on the side of corporate interests. This concerned new restrictions on proxy advisory services and shareholder proposal filings generally. This is important to institution investors who both rely on proxy advisors and then over the course of the 2020 proxy season, filed 140 climate-related shareholder proposals at US companies.

They won at least two high-profile votes, one against Chevron and the other against Phillips. Both oil companies are targets of a powerful investor coalition that was front and center in the challenges – the Climate Action 100+ which enjoys the support of mighty pensions and asset managers, including CalPERS, CalSTRS and BlackRock. 

The emphasis on climate change and other environmental impact issues are likely to be rolled out as part of the 2021 proxy landscape as well. Climate will be top of mind along with diversity, gender equity and racial and ethnic diversity in C-suites and boardrooms. 

Meanwhile, a decision by the Climate Related Market Risk Subcommittee of the Market Risk Advisory Committee of the CTFC (Commodity Futures Trading Commission) pointed to just how disparate the US regulatory framework is. The subcommittee voted unanimously to recommend that 16 financial regulators and other bodies “incorporate climate-related risk into their mandates and develop a strategy for integrating these risks in their work, including into their existing monitoring and oversight functions.” 

At around the same time, the Trump administration’s Department of Labor was rolling out a proposed rule banning ESG fund listings from 401-K prospectuses. The proposal received nearly 10,000 comments in opposition on its website during the month-long public comment period and is yet to be put in force. 

*Joining me on the panel were Brett House, vice president and deputy chief economist, Scotiabank; Ziad Hindo, CIO, Ontario Teachers’ Pension Plan; Eloy Lindeijer, former CEO, PGGM; Satish Rai, CIO, Omers; and Eduard van Gelderen, CIO, PSP Investments.